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In re Smart World Technologies

January 6, 2009



Appeal from a judgment of the United States District Court for the Southern District of New York (Cedarbaum, J.) awarding Appellee $2,142,006.27 in fees and $73,981.18 in expenses. We affirm, holding that the bankruptcy court's Retention Order was a pre-approval within the meaning of 11 U.S.C. § 328(a), and that no subsequent developments warranted modifying the terms of Appellee's retention.

The opinion of the court was delivered by: Wesley, Circuit Judge

Argued: November 20, 2008

Before: SACK and WESLEY, Circuit Judges, and KAHN, District Judge.*fn1

This appeal poses a question of first impression. How does a court determine whether a bankruptcy court has "pre-approved" a debtor's retention of a professional pursuant to 11 U.S.C. § 328(a)? In this case, we find that the bankruptcy court's order was a section 328(a) pre-approval, and that no later developments rendered that approval improvident, and therefore affirm the judgment of the United States District Court for the Southern District of New York (Cedarbaum, J.).


Between 1996 and 2000, Smart World Technologies, LLC, Freewwweb, LLC, and Smart World Communications, Inc. (collectively, "Smart World") provided free dial-up Internet service to subscribing customers. When it failed to generate a profit, Smart World filed for bankruptcy in 2000 and agreed to sell its subscriber list -- its most valuable asset -- to Juno Online Services, Inc. ("Juno") as part of the bankruptcy proceeding. Shortly after the United States Bankruptcy Court for the Southern District of New York (Blackshear, J.) approved the sale of the subscriber list to Juno, Smart World alleged that Juno was undercounting the number of subscribers.

On August 16, 2000, Juno filed an adversary complaint seeking declaratory relief that its conduct was proper and its obligation to Smart World was limited only to paying for qualified subscribers. In response, Smart World's bankruptcy counsel began negotiating to retain Appellee, the law firm of Riker, Danzig, Scherer, Hyland & Perretti, LLP ("Riker Danzig"), to represent Smart World in the Juno litigation in an effort to maximize the sale price from Juno. These negotiations culminated in a contingency fee proposal memorialized in an October 31, 2000 letter from Riker Danzig to Smart World's bankruptcy counsel. Smart World then 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 providing for pre-approval of compensation for debtors' counsel.

In response to several objections to the conditions of the retention, Riker Danzig agreed to modify the terms at a November 14, 2000 hearing before Judge Blackshear, informing the court that the amended terms were "basically worked out in the hallway before we were called." WorldCom, Smart World's largest creditor, told the court that its initial concern was that because it and other creditors were already involved in settlement negotiations with Juno, Riker Danzig might be positioned to reap a "huge windfall" if those negotiations culminated in a monetary settlement. However, it explained that the revised contingency fee proposal was "a nice compromise" because it provided an incentive for all parties to reach a quick resolution.

At the hearing, Judge Blackshear preliminarily approved this revised proposal orally from the bench, stating that the "contingency . . . basically addresses the reasonableness . . . . If he's willing to take that chance, on success being paid and unsuccess not getting anything, that to me addresses the reasonableness of his fee . . . [and] I'm not going to review the time records of the individual merely because of the fact that he agreed to a contingency fee." Nonetheless, Judge Blackshear required Riker Danzig to submit a written fee application incorporating the modified terms. The following day, November 15, the terms were documented in a letter from James Rothschild, a lawyer at Riker Danzig, to Smart World's bankruptcy counsel, (the "Rothschild Letter"), which read as follows:

This is to confirm the results of the Court hearing yesterday wherein my October 31, 2000 letter to you was slightly modified. As per the Agreement placed before the Honorable Cornelius Blackshear, Riker, Danzig, Sherer, Hyland & Perretti, LLP ("Riker Danzig") will handle disputes between the debtor and Juno Online Services ("Juno") on a contingent fee basis. Riker Danzig will take the case in consideration of the following payment terms: 1) Riker Danzig will be paid all expenses off of the top 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%.

The following day, November 16, 2000, Judge Blackshear issued his Retention Order. Although the Order did not specifically cite 11 U.S.C. § 328, it authorized Smart World to retain Riker Danzig in connection with the Juno litigation and stated that all compensation "shall be fixed upon further application of this Court and shall be in accordance with the within application and the letter of James S. Rothschild, Jr., Esq., dated November 15, 2000, and annexed hereto and made a part hereof."*fn2

In early 2001, Juno informed Riker Danzig that it had reached a settlement with Smart World's creditors. However, at a February 2001 hearing, the bankruptcy court determined that a settlement had not actually been reached, but was sufficiently close at hand to grant Juno's request to stay the litigation. That stay remained in place for the next two years.

In May 2003, Juno and the creditors filed a joint motion to settle the adversary proceeding under a settlement plan in which Juno would pay $5.5 million to Smart World's creditors. Smart World opposed the settlement, arguing that it had not been able to value its claims against Juno without discovery, and that the creditors lacked standing to settle the proceeding over its objection. Although the bankruptcy court disagreed and approved the settlement, this Court reversed, holding that Smart World's creditors did not have standing to settle the adversary proceeding ...

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