Who Examines The Fee Examiner?
BY PHILIPE SCHOENE ROURA and EVA LLORÉNS VÉLEZ
When the Puerto Rico Oversight Management & Economic Stability Act (Promesa) was shepherded through U.S. Congress by House Committee on Natural Resources Chairman Rob Bishop (R-Utah), with bipartisan support and approval of then-Speaker Paul Ryan, members of U.S. Congress hoped they were disposing of Puerto Rico’s debt mess. In passing Promesa, they sought to provide Puerto Rico, bereft of access to bankruptcy for its debt, with a mechanism to restructure the government’s towering $72 billion (now $69 billion) debt load through Title III bankruptcy proceedings or through consensual agreements under Title VI.
It did not take long to show members of Congress that Promesa was not the end-all, be-all solution to a debt crisis rife with thorns and the hyper-mitosis—division upon division—of diverse creditor constituents playing against the backdrop of infighting between a Financial Oversight & Management Board (FOMB) and the administration of Gov. Ricardo Rosselló Nevares.
A first sobering moment took place early in 2017, when the Rosselló administration decided to take a second crack at a Restructuring Support Agreement (RSA) struck between the Puerto Rico Electric Power Authority (Prepa) and its various creditor constituents. The Prepa RSA was significant, an emblem of hope for Puerto Rico’s towering debt—the bankrupt utility was strapped with more than $9 billion in debt and creditor constituencies that included Ad Hoc bondholders, fuel line lenders and monoline bond insurers, who were on the hook for nearly $4 billion in Prepa debt combined.
When language in Promesa was being drafted by Bill Cooper, a former president of the Center for Liquefied Natural Gas (CLNG) and then-staff director for the House Natural Resources Mineral Resources Subcommittee, the belief was that the Prepa deal had been codified into law because it explicitly stated that “any deal struck prior to June 2016 qualified as pre-arranged,” which signified it had an iron-clad veneer that would send it to Promesa’s Title VI for consensual negotiations, thus binding the holdouts (30 percent of creditors).
At the very least, Bishop’s staff hoped the most significant and complex portion of Puerto Rico’s debt was heading for consensual negotiations under Title VI. The last thing Bishop expected was Rossello’s restructuring brigades to take a second crack at the deal and, in so doing, blow the deal to kingdom come, setting the utility on a path to Title III bankruptcy and costly litigation.
Thus, it came to pass that Puerto Rico was on its way to legal and advisory costs that could hit the $1 billion mark over a decade at the rate proceedings were going. One very disturbing snapshot of the “fee-for-all” jamboree etched in the minds of observers in the court of Judge Laura Taylor Swain came when counselor Martin Bienenstock told the judge he had reduced his hourly fee from $1,499 to $1,000. Although Bienenstock’s plea seemed to encapsulate the irony of Promesa’s plight—lawyers and advisers making money hand over fist as a control board echoed a mantra of austerity—it was only a slice of the massive cost overruns in legal and advisory costs.
The words of former Detroit Emergency Manager Kevyn Orr, who in March 2017 during a conference on Puerto Rico debt hosted by the Puerto Rico Chapter of the Associated General Contractors of America, declared that Promesa should have been named the Lawyer Relief Act, became prophetic. The Detroit henchman should have called it the Global Law Firm Relief Act because entire teams descended upon Puerto Rico, racking up billable hours in the millions in the infancy of Promesa.
In fact, more than two years after Promesa passed, “the Court appointed the Fee Examiner on Oct. 6, 2017, to execute the duties set forth in the Fee Examiner Order, including, among other things, monitoring the fees and expenses incurred by professionals in these Title III cases. The Fee Examiner Order approved the appointment of Brady C. Williamson as the Fee Examiner and Godfrey & Kahn as counsel to the Fee Examiner.”
Fee for all
Williamson has already said fees and expenses requested through the Title III process, as of Nov. 27, for the first through the fourth interim compensation periods, now total more than $300 million and are expected to go up. The fourth interim compensation alone has already surpassed the $60 million mark.
Fee Examiner Williamson, however, last week called upon U.S. District Court Judge Laura Taylor Swain to tighten the screws on law firms in an attempt to move expenses down. Previously, the Fee Examiner had imposed certain measures for fees to be brought down. This included the imposition that no more than two lawyers would be attending hearings in Puerto Rico, in an effort to reduce payments for travel expenses.
Last week’s motion by the Fee Examiner focuses on two components of professional fees and expenses—each with dramatic effects on the cost of these Title III proceedings. The first is aimed at curbing the practice by some professionals of charging, as expenses, the fees and cost of experts and consultants retained by the professionals on behalf of clients.
“Through the Fourth Interim Compensation Period, professionals have requested a total of $9 million in reimbursable expenses. While that total primarily includes travel, service of process, transcripts, copying and other direct expenses, more than $1 million in third and fourth interim-period expense submissions are professional fees of expert witnesses and consultants neither appointed nor approved under Promesa,” Williamson said.
At least two firms reported the retention and payment of experts as an out-of-pocket expense without notice, Court approval, or documentation of the experts’ engagement terms, Williamson said. “Those sub-retained professionals, in turn, apparently have employed the services of at least 26 individuals to prepare for expert testimony,” he said.
The second component is the professional hourly rate increases. “Through the third interim period, the total amount attributable to rate increases alone is nearly $3.9 million, with the cumulative cost of rate increases in fourth interim fee applications [many, but not all, filed on or about Nov. 16, 2018] not yet determined. Inevitably, rate increases multiply exponentially, making the true cost to the estates both hidden [for now] and significant,” Williamson said.
The New Year will most certainly trigger another round of contemplated rate increases for many professional firms. The U.S. Trustee Guidelines recognize “step increases” as “historically awarded,” Williamson said.
Proskauer Rose in its latest interim fee application (covering the period from June to September) said its Nov. 25, 2016 engagement letter with the Oversight Board provides that Proskauer’s rates were increased on Jan. 1, 2018, “by the lower of the percentage-rate increase announced as of Nov. 1 at 4 percent.” The hourly rate went from $730 to $759 per hour. The law firm is seeking $624,262 in legal fees and $10,753 in legal expenses in its latest interim application.
One for you, two for me
There are several disturbing indicators in the reports—the first being the disparity in the rigor applied to adjustments for local as opposed to stateside firms. Many of the requests for interim compensation show the huge difference between the rates charged by local and U.S. mainland firms. “The Puerto Rico law firms are indispensable for their knowledge of local law. However, there is a disproportionate amount of time dedicated to scrutinizing the small local firms vis-à-vis the time spent scrutinizing large global firms billing tens of millions,” one source from the creditor camp told Caribbean Business on the condition of anonymity. “It is a clear double standard being employed by the Fee Examiner.”
The law firm of O’Neill & Borges, which works with Proskauer Rose locally in representing the board, is seeking $442,234 from June to September in fees and $6,001 in expenses. Puerto Rico law firm Marini, Pietrantoni Muñiz LLC, which is representing the P.R. Fiscal Agency & Financial Advisory Authority (Fafaa, or Aafaf by its Spanish acronym), is seeking $253,168 in fees and $8,176 in expenses.
At the other end of the spectrum, O’Melveny & Myers LLP, which also represents Aafaf, is seeking $4.9 million in fees and $125,000 in expenses for the period from June to September. The firm charges $790 per hour. As counsel to Prepa, O’Melveny & Myers is charging for the period between Aug. 10 through Sept. 30 about $407,832.68 and $4,650 in expenses.
As of the Third Interim Report, Proskauer Rose LLP, which represents the Financial Oversight & Management Board, had made slightly more than $35 million in fees; O’Melveny & Myers LLP, which represents the Puerto Rico Fiscal Agency and Financial Authority billed some $28 million; Paul Hastings LLP, in representation of the Committee of Unsecured Creditors, had billed nearly $25 Million and Greenberg Traurig LLP had racked up $10.2 Million representing Prepa.
Although the disparity in adjustments and fees charged brings to the fore several questions: In its first Omnibus Hearings over compensation for professional fees, Federal Judge Laura Taylor Swain saw “40 separate and properly noticed applications for professional compensation from a total of 30 financial firms and law firms, including eight based in the Commonwealth.
The question this newspaper asked back then was: “why wait for a fee examiner?” when Judge Taylor Swain had the power to impose a ceiling on legal and advisory fees as is done by judges in other bankruptcy cases.
The other glaring admission of lawyers run amok is contained under a section of the first interim report filed on that order, which enabled the delivery of an initial report, filed in March 2018, in which the Fee Examiner presented a summary of uncontested fee applications for the first interim compensation period (May 3-Sept. 30, 2017). The report informs the fees requested for the “First Interim Fee Period” from May 3 through Sept. 30, 2017 total $75 million; expenses requested totaled $2 million.
Born to be wild
The Fee Examiner put the legal morass into context with this understatement: “Promesa is a new and unique statute. The issues it raises are profound, constitutional and statutory, involving federal and Commonwealth law, and the U.S. and Puerto Rico constitutions. The financial and legal professionals working on these cases have confronted massive challenges of time and distance, analysis and advocacy, with little directly applicable precedent. While there have been municipal bankruptcies under Chapter 9, of course, the Commonwealth’s history and status as debtors are unprecedented.”
Indeed. There is a section in the first filing that explains: “Although Mckinsey affiliates [advisers to the FOMB] have extensive experience in Chapter 11 proceedings—and in preparing applications for professional fees—the McKinsey governmental team for this assignment stated it does not track, by individual professional, the time expended—by the hour, by the day or by the week, nor does it record expenses, all of which are subsumed within its monthly flat fees.”
Thus, the legal eagles from large corporate law firms soared along with fees as high $800 per hour, bringing legal costs to heights, which if unattended, are projected to be well in the vicinity of $1 billion over the next decade. The report goes on to explain that “the court could remove McKinsey from the Fee Examiner’s process, and instead entrust the reasonableness assessment to the Oversight Board itself—establishing and applying unique standards for McKinsey to meet the Court’s own mandate for fee review.” [Thus], the Fee Examiner concludes, “the compensation sought by McKinsey today is significant and it may well increase.”
Tax, tax, tax
These lukewarm introspections, admissions of the flimsy provisions and timid oversight in Promesa come at a time when proposed tax reform could be signed into law, as planned by Gov. Ricardo Rosselló. Puerto Rico will tax the fees collected by legal and financial experts working on the island’s bankruptcy and debt restructuring processes.
Under the proposed tax reform, outside law firms and financial experts will pay a 29 percent tax for work related to the bankruptcy process that is done outside of the island.
If tax reform becomes law, most firms would have to increase the fees they charge because they will not be able to afford to continue working otherwise, Bienenstock said at a court hearing in November. In the most recent interim application for fees submitted by Bienenstock’s firm, Proskauer, lawyers are charging a blended fee of $750 per hour. The firm is not only representing Puerto Rico in the bankruptcy case but is also in charge of handling over 50 adversary proceedings filed by creditors and handling negotiations to restructure debt.
Kenneth Rivera, an accountant who is currently head of the Puerto Rico Chamber of Commerce, told Caribbean Business that “the loud secret is that this was done precisely to impact these law firms.”
Right now, Rivera said that if an individual comes to provide a service to Puerto Rico and does it here, the government imposes a tax of 29 percent on the gross income. If the work is done outside of Puerto Rico, it does not pay taxes because the factor is where the work was performed. “That is why many of these lawyers did the work outside of the island and travel very little here,” he said.
Under the proposed rule, Puerto Rico will tax the source of the income. Therefore, the money received for services by outside law firms and financial advisers will pay the tax because the source of the income is Puerto Rico, he explained.
Law firms in Puerto Rico still will pay more in taxes for the service, which is over 30 percent, he explained. “The problem is that the work is done in the mainland United States, and the person will also pay federal taxes and will not be able to get a credit. This poses a lot of challenges because a person can validly challenge this as a violation of the free commerce clause, equal protection clause and due process of the law,” Rivera noted.
Last week, Rosselló said he was evaluating tax reform but was inclined to sign it into law.
The issue about the fees that Bienenstock raised comes as one of the most expensive phases of the bankruptcy may wind down in January, when a debt-adjustment plan for Puerto Rico’s Sales Tax Financing Corp., known as Cofina, is scheduled to come before Swain for approval. The other major debt Puerto Rico has is that of the Puerto Rico Electric Power Authority, whose debt needs to be restructured if the island wishes to sell it. Puerto Rico also needs to negotiate debt for other entities, including other corporations.
At this writing, a hearing is slated for Dec. 19 before Judge Laura Taylor Swain in New York to discuss the Fee Examiner’s request to impose standards on fees collected by lawyers and financial officers.