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In re Smart World Technologies

March 19, 2008

IN RE: SMART WORLD TECHNOLOGIES, LLC, FREEWWWEB, LLC, AND SMART WORLD COMMUNICATIONS, INC., DEBTORS.
RIKER, DANZIG, SCHERER, HYLAND & PERRETTI LLP, APPELLANT,
v.
OFFICIAL COMMITTEE OF UNSECURED CREDITORS, APPELLEE/CROSS-APPELLANT.



The opinion of the court was delivered by: Cedarbaum, J.

OPINION

Riker, Danzig, Scherer, Hyland & Perretti LLP ("Riker Danzig") appeals from an order of the United States Bankruptcy Court, James M. Peck, B.J., reducing its fee award for acting as special litigation counsel to Smart World Technologies, LLC, Freewwweb, LLC, and Smart World Communications, Inc. (collectively "Smart World"). The Official Committee of Unsecured Creditors (the "Committee") cross-appeals, arguing principally that Riker Danzig's fee should be further reduced. For the following reasons, the order of the bankruptcy court reducing Riker Danzig's fee award is reversed, and the case is remanded for entry of a fee award in the amount of $2,142,006.27, plus expenses of $73,981.18.

BACKGROUND

From 1996 to 2000, Smart World was a provider of free internet service. Unable to make a profit, Smart World agreed to sell its most valuable asset, its subscriber list, to Juno Online Services, Inc. ("Juno"). Juno required Smart World to file for bankruptcy as part of the transaction, and the bankruptcy court, Cornelius Blackshear, B.J., approved the sale. The deal quickly ran into trouble. Smart World asked the bankruptcy court for a good faith hearing. Smart World alleged that Juno, in an attempt to pay less for the subscriber list, had obscured the true number of subscribers who had switched from Smart World to Juno. Juno denied the allegation and sued Smart World for, among other things, concocting false claims in an "'effort to extract additional consideration from Juno ... and to obtain other modifications'" to the deal. Smart World Techs., LLC v. Juno Online Servs., Inc. (In re Smart World Techs., LLC), 423 F.3d 166, 170 (2d Cir. 2005) (quoting Juno's complaint).

On November 7, 2000, Smart World applied to the bankruptcy court for an order approving the retention of Riker Danzig as special litigation counsel "pursuant to 11 U.S.C. §§ 327 and 328," the sections of the Bankruptcy Code regarding pre-approved compensation for debtors' counsel. (Application of Debtors-in-Possession for an Order Approving Retention of Special Litigation Counsel, November 7, 2000, at ¶ 7.) On November 16, 2000, the bankruptcy court issued an order authorizing Smart World's retention of Riker Danzig. The order provided that compensation would be in accordance with "the letter of James S. Rothschild, Jr., Esq., dated November 15, 2000, and annexed hereto and made a part hereof."

The annexed letter, from Riker Danzig to debtors' counsel (the "Rothschild Letter"), provided for a contingency fee for Riker Danzig's litigation services:

1) Riker Danzig will be paid all expenses off of the top [of] any recovery and, after payment of expenses, will receive 33-1/3% of the first $1,500,000 obtained from Juno; 2) Riker Danzig's share of funds in excess of $1,500,000 but less than $8 Million will be (a) 0% if the litigation lasts less than 6 months, (b) 10% if the litigation lasts from 6 months to 9 months, (c) 20% if the litigation lasts between 9 months and 12 months, (d) 37% if the litigation lasts more than 12 months; and 3) Riker Danzig will receive 37% of all funds received in excess of $8 Million. Finally, Riker Danzig's fee for any monies received after 18 months shall be 33 1/3%. (Rothschild Letter at 1-2.)

According to debtors' counsel, the agreement was structured so that "[a]fter eighteen months, thirty-seven percent becomes thirty-three percent ... for the entire amount over $1.5 million," creating an "incentive for [Riker Danzig] ... to settle this within the first 18 months." (Transcript of the November 14, 2000 hearing ("November 2000 Hearing") at 20-21.)

Litigation proceeded until early 2001, when Juno's lawyers told Riker Danzig that a settlement had been reached between Smart World's creditors and Juno. At a February hearing, the bankruptcy court determined that a settlement had not been reached. However, the court believed that the parties were close to settling, and accordingly granted Juno's request to stay the adversary litigation. Over the next two years, the bankruptcy court denied Smart World's motions to recommence litigation, despite the fact that no settlement had been reached. "The bankruptcy court also paid scant attention to evidence suggesting that WorldCom [a creditor] might have been pursuing a quick and easy settlement with Juno, under which it would receive the bulk of the settlement payment, for reasons antithetical to interests of the estate." Smart World, 423 F.3d at 172. In October of 2002, the bankruptcy court ordered the adversary proceeding into mediation, in which Riker Danzig participated.

In May of 2003, Juno and the creditors of Smart World filed a motion to settle the adversary proceeding, under a settlement plan in which Juno paid $5.5 million to creditors.*fn1 Smart World objected on several grounds, including (1) that Smart World, absent meaningful discovery, had not been able to value the likely success of its claims against Juno; and (2) that the creditors lacked standing to pursue settlement of the adversary proceeding over the debtors' objections. Smart World, 423 F.3d at 172. The bankruptcy court dismissed Smart World's objections and approved the settlement, which was affirmed by the district court. Smart World Techs., LLC v. Juno Online Servs., Inc. (In re Smart World Techs., LLC), No. 03 Civ. 9467, 2004 WL 1118328 (S.D.N.Y. May 19, 2004). Riker Danzig appealed, and, in September of 2005, the Second Circuit vacated the approval of the settlement. The Second Circuit held that Smart World's creditors did not have standing to settle the adversary proceeding with Juno over the objections of the debtor-in-possession. Smart World, 423 F.3d at 184.

On remand, the bankruptcy court set a discovery schedule, and discovery proceeded. When Smart World's exclusive period to file a plan of reorganization ended, the Committee, which now had standing as a plan proponent, filed a Plan of Liquidation. The plan included a $6.5 million settlement between the creditors and Juno. Riker Danzig objected to the proposed settlement of the adversary proceeding, arguing that the subscriber list contained as many as 850,000 names, not 132,000 as Juno maintained, and that the settlement therefore undervalued Smart World's claim against Juno for payment for the subscriber list.

The bankruptcy court, James Peck, B.J., dismissed as "rank speculation" Riker Danzig's belief that it would gain a better settlement by going to trial. (Transcript of December 21, 2006 confirmation hearing at 213.) The court confirmed the plan, finding that the proposed $6.5 million settlement "d[id] not fall below the lowest point in the range of reasonableness.... It may be right at that level, but it is not below it." Id. at 217.

Riker Danzig applied for a fee award of $2,320,959.02, plus expenses. At the second of two hearings on the fee award, the bankruptcy court read into the record its opinion reducing Riker Danzig's fee. The fee was reduced pursuant to 11 U.S.C. § 328(a), which allows a court to change a pre-approved fee only when the terms and conditions of the fee agreement "prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions." The court found that the contingency fee arrangement was improvident for four reasons: (1) "the divergent positions regarding litigation and settlement strategy that developed between the Debtor and the Committee and the resulting extreme antagonism, animosity and demonstrable lack of cooperation" between the parties; (2) "the fact that Riker Danzig as special litigation counsel took instructions directly from the [Daums]," meaning Steven and Pamela Daum, officers and majority shareholders of Smart World, i.e., the debtors-in-possession, "who seemed to be [inner]vated principally by their desire to benefit equity rather than the Creditors to whom the Debtors owed a fiduciary duty"; (3) "the unusually prolonged procedur[al] path of this litigation[,] caused in substantial part by the actions of Riker Danzig at the direction of the [Daums]"; and (4) "the fact that Riker Danzig, again acting at its client's direction, was an obstacle, not an asset, when it came to approval of the settlement." (Transcript of the March 22, 2007 hearing on final fee applications ("March 2007 Hearing") at 14-15.)

DISCUSSION

I. Standard of Review

On appeal, a bankruptcy court's legal conclusions are reviewed de novo, and its findings of fact are set aside only if clearly erroneous. One Times Square Assocs. Ltd. P'ship v. Banque Nationale de Paris (In re One Times Square Assocs. Ltd. P'ship), 165 B.R. 773, 774-75 (S.D.N.Y. 1994). A bankruptcy court's decision to award fees and costs is reviewed for abuse of discretion. Lubow Machine Co., Inc. v. Bayshore Wire Products Corp. (In re Bayshore Wire Products Corp.), 209 F.3d 100, 103 (2d Cir. 2000).

For the review of pre-approved fees, the Bankruptcy Code contains a heightened standard. A bankruptcy judge may only change a pre-approved fee if the terms and conditions of the fee agreement "prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions." 11 U.S.C. ยง 328(a). As the Fifth Circuit has stated, a bankruptcy court "applie[s] the incorrect legal standard by finding that the circumstances were merely unforeseen; instead, the bankruptcy court should ... determine[] whether developments, which made the approved fee ...


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