In Re: United Artist

Opinions of the United

2003 Decisions States Court of Appeals

for the Third Circuit

1-9-2003

In Re: United Artist

Precedential or Non-Precedential: Precedential

Docket 01-1351

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PRECEDENTIAL

Filed January 9, 2003

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 01-1351

IN RE: UNITED ARTISTS THEATRE COMPANY, et al.,

Debtors

v.

*DONALD F. WALTON, Acting United States Trustee

for Region 3

*Donald F. Walton,

Appellant

*(Substituted Pursuant to F.R.A.P. 43(c))

Appeal from the United States District Court

for the District of Delaware

(Del. Bankr. No. 00-03514)

District Judge: Honorable Sue L. Robinson

Argued: December 4, 2001

Before: ALITO, RENDELL, and AMBRO, Circuit Judges

(Opinion Filed: January 9, 2003)

James H.M. Sprayregen

James W. Kapp, III (Argued)

David J. Zott

Kirkland & Ellis

200 East Randolph Drive

Suite 6500

Chicago, IL 60601

Counsel for Appellee

United Artists Theatre Company,

et al.

Richard A. Chesley (Argued)

Houlihan Lokey Howard & Zukin

123 North Wacker Drive

4th Floor

Chicago, IL 60606

Counsel for Appellee

Houlihan Lokey Howard & Zukin

Bruce G. Forrest (Argued)

United States Department of Justice

Civil Division, Appellate Staff

601 D Street, N.W.

Washington, DC 20530

Counsel for Appellant

Acting United States Trustee

OPINION OF THE COURT

AMBRO, Circuit Judge:

The United States Trustee (the "U.S. Trustee") 1 appeals

the District Court of Delaware’s approval of a bankruptcy

debtor’s application to retain a financial advisor.

Specifically, the U.S. Trustee objects to the debtor’s

agreement to indemnify the financial advisor for claims of

negligence (as opposed to gross negligence) that may be

_________________________________________________________________

1. Patricia A. Staiano was the U.S. Trustee at the time of briefing, but

her term expired on October 5, 2001. Her current replacement is Acting

U.S. Trustee Donald F. Walton.

2

leveled against it. We first address whether the U.S. Trustee

has standing to bring this suit, and determine that he does.

Next we examine whether subsequent confirmation of the

reorganization plan renders this case constitutionally or

equitably moot. After concluding that it is not moot in

either sense, we turn to the merits of the U.S. Trustee’s

appeal. We affirm the District Court’s ruling that the

indemnification provision is permissible, though we do so in

a way that eschews the inherent imprecision between

shades of negligence. In so doing, we borrow from corporate

law analogues, and focus on the process by which financial

advisors reach their opinions rather than on the substance

of the opinions themselves.

I. Background

United Artists Theatre Company and affiliates2

(collectively, the "Debtors" or "United Artists") filed for

Chapter 11 bankruptcy protection in the District Court.3 At

the outset the Debtors requested court approval of their

retention of Houlihan, Lokey, Howard & Zukin Capital

("Houlihan Lokey") as financial advisor. The engagement

letter provided that United Artists would indemnify

_________________________________________________________________

2. These affiliates are United Artists Theatre Circuit, Inc., United Artists

Realty Company, United Artists Properties I Corp., United Artists

Properties II Corp., UAB, Inc., UAB II, Inc., Mamaroneck Playhouse

Holding Corporation, Tallthe Inc., UA Theatre Amusements, Inc., UA

International Property Holding, Inc., UA Property Holding II, Inc., United

Artists International Management Company, Beth Page Theatre Co., Inc.,

United Film Distribution Company of South America, U.A.P.R., Inc., R

and S Theatres, Inc., and King Reavis Amusement Company.

3. The District Court of Delaware’s relationship with the United States

Bankruptcy Court for the District of Delaware has a checkered past. The

District Court revoked the automatic reference of bankruptcy cases to

the Bankruptcy Court effective February 3, 1997. In December of 2000,

the District Court reinstated the automatic referral, and then revoked it

once more in April of 2001. An order dated September 6, 2001 again

reinstated the automatic reference. Revoking the automatic reference

means in practical terms that bankruptcy cases are assigned to the

District Court unless, on a case-by-case basis, they are referred to the

Bankruptcy Court. The District Court retained this case, which was filed

while the reference revocation was in effect.

3

Houlihan Lokey’s reasonable attorneys’ fees and expenses,

as well as any losses incurred by Houlihan Lokey with

respect to, inter alia, its providing of services. The letter

also contained an exception for "any Losses that are finally

judicially determined to have resulted from the gross

negligence, bad faith, willful misfeasance, or reckless

disregard of its obligations or duties on the part of

Houlihan Lokey."4

_________________________________________________________________

4. The principal indemnity provisions of the retention agreement are as

follows:

(a) If Houlihan Lokey or any employee, agent, officer, director,

attorney, shareholder or any person who controls Houlihan

Lokey (any or all of the foregoing, hereinafter an"Indemnified

Person") becomes involved in any capacity in any legal or

administrative action, suit, proceeding, investigation or inquiry,

regardless of the legal theory or the allegations made in

connection therewith, directly or indirectly in connection with,

arising out of, based upon, or in any way related to (i) the

Agreement; (ii) the services that are the subject of the

Agreement; (iii) any document or information, whether verbal or

written, referred to herein or supplied to Houlihan Lokey; (iv)

the breach of the representations, warranties or covenants by

the Company given pursuant hereto; (v) Houlihan Lokey’s

involvement in the Transaction or any part thereof; (vi) any

filings made by or on behalf of any party with any governmental

agency in connection with the Transaction; (vii) the Transaction;

or (viii) proceedings by or on behalf of any creditors or equity

holders of the Company, the Company will on demand, advance

or pay promptly, on behalf of each Indemnified Person,

reasonable attorneys’ fees and other expenses and

disbursements (including, but not limited to, the cost of any

investigation and related preparation) as they are incurred by

the Indemnified Person. The Company also indemnifies and

holds harmless each Indemnified Person against any and all

losses, claims, damages, liabilities, costs and expenses

(including, but not limited to, attorneys’ fees, disbursements

and court costs, and costs of investigation and preparation)

("Losses") to which such Indemnified Person may become

subject in connection with any such matter.

(b) If for any reason the foregoing indemnification is determined to

be unavailable to any Indemnified Person or insufficient fully to

indemnify any such person, then the Company will contribute

to the amount paid or payable by such person as a result of

4

The U.S. Trustee objected, claiming, inter alia , that the

retention agreement exempted Houlihan Lokey from liability

_________________________________________________________________

any such Losses in such proportion as is appropriate to reflect

(i) the relationship between Houlihan Lokey’s fee on the one

hand and the aggregate value of the Transaction on the other

hand or (ii) if the allocation provided by clause (i) is not

permitted by applicable law, not only such relative benefit but

also the relative fault of the other participants in the

Transaction, on the one hand, and Houlihan Lokey and the

Indemnified Persons on the other hand, and any other relevant

equitable considerations in connection with the matters as to

which such Losses relate; provided, however, that in no event

shall the amount to be contributed by all Indemnified Persons

in the aggregate exceed the amount of the fees actually received

by Houlihan Lokey hereunder.

(c) Any Indemnified Person shall have the right to employ such

person’s own separate counsel in any such action, at the

Company’s expense, and such counsel shall have the right to

have charge of such matters for such person.

(d) The indemnification obligations hereunder shall not apply to

any Losses that are finally judicially determined to have

resulted from the gross negligence, bad faith, willful

misfeasance, or reckless disregard of its obligations or duties on

the part of Houlihan Lokey or such Indemnified Person. In the

event of such final judicial determination, the Company shall,

subject to Houlihan Lokey’s rights of contribution, be entitled to

recover from the Indemnified Person or Houlihan Lokey the

costs and expenses paid on behalf of such Indemnified Person

pursuant to this indemnification obligation.

In addition, United Artists’ application to retain Houlihan Lokey

supplemented the gross negligence and willful misconduct carveouts for

indemnity in subparagraph (d) above by providing that, in the case of a

judicial determination, it must be final and find that either the gross

negligence or willful misconduct is "solely" the cause of any claim or

expense of Houlihan Lokey. The order approving the application contains

the same language.

The application and order also provide indemnity to Houlihan Lokey

for its "prepetition performance of services." The U.S. Trustee, however,

appeals only whether "indemnification provisions, holding a financial

advisor harmless for the consequences of its negligence in connection

with services it provides to the debtors in a bankruptcy proceeding," are

reasonable under 11 U.S.C. S 328(a)(emphasis added).

5

for its own negligence, thus violating the Bankruptcy Code,

public policy, and basic tenets of professionalism.

Specifically, it argued that the agreement was unreasonable

under two provisions of the Bankruptcy Code, 11 U.S.C.

SS 327(a) and 328(a), because allowing a debtor’s estate to

indemnify a financial advisor for its own negligence

undermines the principal purpose of bankruptcy --

conserving the debtor’s assets in order to pay its creditors.

The District Court, rejecting the U.S. Trustee’s objections,

approved the Debtors’ retention of Houlihan Lokey in a

memorandum order dated December 1, 2000 (though not

entered on the docket until December 8, 2000). The

Debtors’ cases then proceeded as "prenegotiated"

bankruptcies.5 The confirmation hearing for the Debtors’

second amended joint plan of reorganization ("the Plan")

was held on January 22, 2001. The District Court

confirmed the Plan that day (though the order was not

docketed until January 25, 2001). On February 5, 2001,

the U.S. Trustee filed this appeal.

At the time of Plan confirmation the U.S. Trustee did not

object to several provisions releasing Houlihan Lokey from

liability. Article X(B) provided:

_________________________________________________________________

5. "Prenegotiated" bankruptcies have plans of reorganization and

disclosure statements filed shortly after the cases themselves file,

usually before the committee of unsecured creditors is formed. In re

Pioneer Fin. Corp., 246 B.R. 626, 630 (Bankr. D. Nev. 2000); see also

Report of the Del. State Bar Ass’n to the Nat’l Bankr. Rev. Comm’n in

Support of Maintaining Existing Venue Choices 18 n.39 (October 3,

1996). This contrasts with typical Chapter 11 cases, where a plan and

disclosure statement are filed many months (sometimes years) after the

cases are filed, and "prepackaged bankruptcies" (or "prepacks"), where

the plan and disclosure statement are filed, and sufficient favorable votes

on the plan are solicited and obtained, before the Chapter 11 case

begins, leading to a prompt plan confirmation. See generally Marcia L.

Goldstein et al., Prepackaged Chapter 11 Case Considerations and

Techniques, in 1 Weil, Gotshal & Manges, LLP, Reorganizing Failing

Businesses ch. 12 (Marvin E. Jacob & Sharon Youdelman eds. 1998);

Alesia Ranney-Marinelli, Prepackaged Plans of Reorganization, in A

Practical Guide to Out-Of-Court Restructurings and Prepackaged Plans of

Reorganization S 4.01[A], at 4-9 (Nicholas P. Saggese & Alesia Ranney-

Marinelli eds., 2d ed. 2000).

6

[O]n and after the Effective Date, each of the Debtors,

the Reorganized Debtors, their subsidiaries, their

affiliates, and the Releasees, and the agents, officers,

directors, partners, members, professionals, and

agents of the foregoing (and the officers, directors,

partners, members, professionals, and agents of each

thereof), for good and valuable consideration . . . shall

automatically be deemed to have released each other

unconditionally and forever from any and all Claims,

obligations, rights, suits, damages, Causes of Action,

remedies and liabilities whatsoever, whether liquidated

or unliquidated, fixed or contingent, matured or

unmatured, known or unknown, foreseen or

unforeseen, existing or hereafter arising, in law, equity

or otherwise, that any of the foregoing entities would

have been legally entitled to assert (in their own right,

whether individually or collectively, or on behalf of any

Holder of any Claim or Equity Interest or other Person

or Entity), based in whole or in part upon any act or

omission, transaction, agreement, event or other

occurrence taking place on or before the Effective Date,

relating in any way to the Debtors, the Reorganized

Debtors, the Chapter 11 Cases, the Plan, the

Disclosure Statement, or any related agreements,

instruments or other documents . . . .

Article X(C) read as follows:

On and after the Effective Date, each Holder of a Claim

who has accepted the Plan, in exchange for, among

other things, a distribution under the Plan, shall be

deemed to have released unconditionally each of the

Debtors, the Reorganized Debtors . . . and the agents,

officers, directors, partners, members, professionals,

and agents of the foregoing (and the officers, directors,

partners, members, professionals, and agents of each

thereof), from any and all Claims, obligations, rights,

suits, damages, Causes of Action, remedies and

liabilities whatsoever, whether liquidated or

unliquidated, fixed or contingent, matured or

unmatured, known or unknown, foreseen or

unforeseen, existing or hereafter arising, in law, equity

or otherwise . . . .

7

Finally, Article X(E) provided:

The Debtors, . . . their members and Professionals

(acting in such capacity) shall neither have nor incur

any liability to any Person or Entity for any act taken

or omitted to be taken in connection with or related to

the formulation, preparation, dissemination,

implementation, administration, Confirmation or

Consummation of the Plan, the Disclosure Statement

or any contract, instrument, release or other agreement

or document created or entered into in connection with

the Plan . . . or any other act taken or omitted to be

taken in connection with the Chapter 11 Cases;

provided, however, that the foregoing provisions of

[this] Article X.E . . . shall have no effect on the liability

of any Person or Entity that results from any such act

or omission that is determined in a Final Order to have

constituted gross negligence or willful misconduct.

We have jurisdiction pursuant to 28 U.S.C. S 1291

because the District Court’s approval of a professional’s

retention is a final order. We review the District Court’s

approval under SS 327(a) and 328(a) of the Bankruptcy

Code for abuse of discretion, but review its legal

determinations de novo. In re PWS Holding Corp., 228 F.3d

224, 235 (3d Cir. 2000).

II. Standing and Mootness

A. Standing

While Houlihan Lokey couches its argument solely in

terms of mootness, reading closely we find a separate

component of its argument: standing. It contends that a

suit against it "could only be brought by someone

proximately harmed by Houlihan’s negligence in performing

these services, i.e., an actual or potential financial

stakeholder of the UA Debtors." Appellee’s Br. at 6. By

virtue of the releases it obtained, it reasons, no such

stakeholder can sue. Because the U.S. Trustee’s appeal

relies upon these potential claims, Houlihan Lokey

therefore argues that the U.S. Trustee lacks standing.

Houlihan Lokey also questions the U.S. Trustee’s standing

more obliquely, observing that "[i]ndeed, it is of more than

8

passing interest that the party threatening to now disrupt

this confirmed and effective plan is one with no such

economic stake." Appellee’s Br. at 12.

Contrary to Houlihan Lokey’s claim, the U.S. Trustee

"may raise and may appear and be heard on any issue in

any case or proceeding." 11 U.S.C. S 307. A lack of

pecuniary interest in the outcome of a bankruptcy

proceeding does not deny the U.S. Trustee standing. See In

re Columbia Gas Sys. Inc., 33 F.3d 294, 295-96 (3d Cir.

1994). U.S. Trustees are officers of the Department of

Justice who protect the public interest by aiding

bankruptcy judges in monitoring certain aspects of

bankruptcy proceedings. Id.; accord In re Revco Drug Stores,

Inc., 898 F.2d 498, 499-500 (6th Cir. 1990). Thus, we find

that the U.S. Trustee has standing to challenge the

indemnification provision,6 and turn to the issue of

mootness.

B. Mootness

Houlihan Lokey argues that the case is both

constitutionally and equitably moot. The first issue is a

question of constitutional significance because, if a case is

moot, we lack the power to hear it. Equitable mootness is

a more limited inquiry into whether, though we have the

power to hear a case, the equities weigh against upsetting

a bankruptcy plan that has already been confirmed. We

address each issue in turn.

1. Constitutional Mootness

The United States Supreme Court sets a high threshold

for judging a case moot. An appeal is moot in the

constitutional sense only if events have taken place that

make it "impossible for the court to grant any effectual

relief whatever." Church of Scientology of Cal. v. United

States, 506 U.S. 9, 12 (1992) (citation omitted). An appeal

is not moot "merely because a court cannot restore the

parties to the status quo ante [the state in which it was

_________________________________________________________________

6. We note that in In re Metricom, Inc., 275 B.R. 364, 368 (Bankr. N.D.

Cal. 2002), Houlihan Lokey implicitly acknowledged the U.S. Trustee’s

standing to object by responding to its objections with proposed

modifications.

9

before]. Rather, when a court can fashion some form of

meaningful relief, even if it only partially redresses the

grievances of the prevailing party, the appeal is not moot."

In re Continental Airlines, 91 F.3d 553, 558 (3d Cir. 1996)

(en banc) ("Continental I") (citations and quotation marks

omitted).

Houlihan Lokey asserts that this case is moot because

Articles X(B), X(C), and X(E) of the confirmed Plan contain

releases that preclude potential negligence claims against

it. The U.S. Trustee counters that meaningful relief may

still be obtained because the retention order may be

vacated, at least as to the indemnification provision. With

respect to Houlihan Lokey’s Article X(C) argument, 7 that

Article by its own terms subjects Houlihan Lokey to

potential suits. Because Article X(C) releases the Debtors

and their professionals from suits by "each Holder of a

Claim who has accepted the Plan" (emphasis added), it does

not bind all holders of claims. Rather, it covers only those

who accept the Plan. Houlihan Lokey is correct that the

"UA Plan was accepted by each impaired class that was

entitled to vote," Appellee’s Br. at 8 n.2, but its point that

each class is bound (regardless whether a member

objected) misses the mark, even for those objecting who

receive distributions under the Plan. If a class member

accepts distributions because it is bound by the cram down

provisions of S 1129(b)(1) of the Bankruptcy Code (i.e., a

procedure for nonconsensual confirmation of a plan of

reorganization), but it has not itself accepted the Plan,

Article X(C)’s release does not apply to it. Thirty-four

unsecured creditors voted to reject the Plan, and thus are

unaffected by the release. Because by its own terms the

release allows future claims, and in any event we can

provide relief by modifying the retention order, Article X(C)

does not render this case constitutionally moot.

_________________________________________________________________

7. We do not focus on Article X(B), which contains a mutual release of all

claims among the Debtors, their affiliates, and the Releasees (defined to

include "the D&O Releasees, the Prepetition Lender Releasees, the

Placement Agent Releasees, Stonington, the Subordinated Note

Releasees, and the Equity Releasees") because it does not affect all

creditor constituencies.

10

Next, Houlihan Lokey argues that Article X(E) of the Plan

moots the U.S. Trustee’s challenge because it excepts

from liability (with a carveout for gross negligence and

willful misconduct) "[t]he Debtors . . . and their . . .

Professionals (acting in such capacity) . . . for any act taken

or omitted to be taken in connection with or related to the

formulation, preparation, dissemination, implementation,

administration, Confirmation or Consummation of the Plan

. . . or . . . the Chapter 11 Cases." It applies to Houlihan

Lokey, albeit only when acting in a "professional" capacity.8

Even on its own terms, Article X(E) contains carveouts

(i.e., no forbearance from or tolerance of liability caused by

willful misconduct or gross negligence). The question in the

appeal comes full circle: can as a matter of public policy a

professional be exempt from its own negligence. The answer

depends on how we treat nonconsensual releases of

nondebtors.

Debtors and their professionals cannot exempt

themselves from liability to non-consenting parties merely

by saying the word. The "hallmarks of permissible non-

consensual releases" are "fairness, necessity to the

reorganization, and specific factual findings to support

these conclusions." In re Continental Airlines, 203 F.3d 203,

214 (3d Cir. 2000) ("Continental II"). Added to these

requirements is that the releases "were given in exchange

for fair consideration." Id. at 215. As in Continental II, here

no finding in the confirmation order specifically addressed

the releases at issue.9 Id. Releases unbacked by adequate

findings of fairness, necessity to reorganization and

reasonable consideration cannot moot a challenge to the

retention agreement’s indemnity. What may not be valid

(releases lacking the findings Continental II requires) ipso

_________________________________________________________________

8. Thus Houlihan Lokey is not a "professional" when it is acting in its

own interest, e.g., buying and selling claims.

9. The order confirming the Plan does provide, interestingly under

"Conclusions of Law," that the "releases . . . set forth in the Plan . . .

shall be, and hereby are, approved as fair, equitable, reasonable and in

the best interests of the Debtors . . . and their . . . Creditors . . . ."

11

facto cannot moot an indemnity agreement whose order

approving it was not final until after confirmation. 10

While the merits of this appeal would have been

singularly focused had the U.S. Trustee objected to the

pertinent release provisions at confirmation, the bottom line

is that the U.S. Trustee did object (and strenuously) to the

scope of the indemnity demanded by Houlihan Lokey.

Potential claimants still exist. Reforming the indemnity

provision would accord them meaningful relief. Therefore

this case is not constitutionally moot.

2. Equitable Mootness

We next examine equitable mootness. In this analysis,

emphasis is decidedly on the first term of the phrase --

whether the requested relief is equitable. "The use of the

word ‘mootness’ as a shortcut for a court’s decision that the

_________________________________________________________________

10. It could be argued that in In re PWS Holding Corp., 228 F.3d 224,

246 (3d Cir. 2000), we found an analogous release to be permissible

under S 524(e). However, PWS’s holding makes clear that it was not

addressing a release that "affect[s] the liability of third [i.e., non-debtor]

parties," id. at 247, and thus "is outside the scope of S 524(e)." Id. In

discussing Continental II, the PWS panel noted that "[w]e did not treat

S 524(e) as a per se rule barring any provision in a reorganization plan

limiting the liability of third parties." Id. Rather, "it was clear under any

rule that the court might adopt that the [third party] releases at issue

were impermissible because ‘the hallmarks of permissible non-

consensual releases--fairness, necessity to the reorganization, and

specific factual findings to support these conclusions--are all absent

here.’ " Id. (quoting Continental II, 203 F.3d at 214).

More to the point, PWS did address the standard of liability for creditor

committee members under S 1103(c) of the Bankruptcy Code, holding

that this provision "limits liability of a committee to willful misconduct

or ultra vires acts." PWS, 228 F.3d at 246. While it is unclear whether

the Court meant to include professionals to committees as well (the very

next sentence refers to "the entities that provided services to the

Committee in the event that they were sued for their participation in the

reorganization," id. at 246-47) and whether the rubric "ultra vires acts"

is intended to cover any form of negligence, in no event does PWS cover

more than immunity from liability under S 1103(c). The level of

indemnity of professionals a debtor employs underS 327 is what is at

issue in this case. Therefore, we cannot hold that the release moots an

issue we have not yet examined.

12

fait accompli of a plan confirmation should preclude further

judicial proceedings has led to unfortunate confusion."

Continental I, 91 F.3d at 559. "[T]here is a big difference

between inability to alter the outcome (real mootness) and

unwillingness to alter the outcome (‘equitable mootness’).

Using one word for two different concepts breeds

confusion." Id. (quoting In re UNR Indus., Inc., 20 F.3d 766,

769 (7th Cir. 1994))(emphases in original). Here we have

the power to alter the outcome because the case is not

constitutionally moot, but we must balance the equities of

both positions and determine whether it is prudent to upset

the Plan at this date. We consider five factors

in determining whether it would be equitable or

prudential to reach the merits of a bankruptcy appeal

. . . [:] (1) whether the reorganization plan has been

substantially consummated, (2) whether a stay has

been obtained, (3) whether the relief requested would

affect the rights of parties not before the court, (4)

whether the relief requested would affect the success of

the plan, and (5) the public policy of affording finality

to bankruptcy judgments.

Continental I, 91 F.3d at 560. In Continental I, we

recognized that reversing a plan’s confirmation might

"knock the props out from under" "intricate and involved

transactions," the consummation of which is relied on by

the marketplace. Id. at 561 (quoting In re Roberts Farms,

Inc., 652 F.2d 793, 797 (9th Cir. 1981)).

In In re PWS Holding Corp., we rejected an equitable

mootness claim in a case involving, as already noted supra

n.10, a challenge to aspects of releases of liability of

creditor committees and possibly their professionals. 228

F.3d 224, 236-37 (3d Cir. 2000). There we observed that

"[t]he plan has been substantially consummated, but . . .

[it] could go forward even if the releases were struck." Id. at

236-37. We therefore declined to dismiss on equitable

mootness grounds.

The relief the U.S. Trustee seeks here does not entail

"knocking [out] the props" under the Plan. He only requests

that the provision indemnifying Houlihan Lokey for

negligent conduct be stricken from its retention agreement.

13

If we were to modify the indemnity provision, the Plan

otherwise would survive intact.

The remaining factors do not persuasively challenge this

result. The fact that the U.S. Trustee did not obtain a stay

weighs against it, but because the remedy it seeks does not

undermine the Plan’s foundation, this omission is not fatal.

Moreover, allowing a challenge on public policy grounds to

an indemnity provision is itself sound public policy. In this

context, there is no equity in mooting the U.S. Trustee’s

challenge to the indemnity provision sought by Houlihan

Lokey.

III. Permissibility of Debtors’ Indemnifying

Financial Advisors for Their Own Negligence

Having concluded that the U.S. Trustee has standing to

bring this appeal and that the issue is not moot, we turn to

whether the indemnification provision was permissible. This

is an issue of first impression for this Court. 11 Section

328(a) of the Bankruptcy Code requires that the terms and

conditions of employment of any professionals engaged

under S 327 be "reasonable." 11 U.S.C.S 328(a). The

question we therefore ask is whether it is reasonable for the

Debtors to indemnify Houlihan Lokey despite its own

negligence (but not gross negligence).

Both parties make plausible points on the issue. The U.S.

Trustee argues that allowing professionals to obtain

indemnity for their own negligence encourages a standard

both lax and "inconsistent with the financial advisor’s

fiduciary obligations to the creditors." Appellant’s Br. at 24.

Houlihan Lokey worries that the courts might "Monday-

morning quarterback," or second-guess, decisions that in

hindsight were clearly mistaken, but at the time seemed

attractive options. Financial advisors would then be

_________________________________________________________________

11. A bankruptcy appellate panel of the Eighth Circuit, Unsecured

Creditors Committee. v. Pelofsky (In re Thermadyne Holdings Corp.), 283

B.R. 749 (B.A.P. 8th Cir. 2002), considered whether Houlihan Lokey, the

financial advisor to a creditors’ committee, could obtain indemnity for,

inter alia, simple negligence. The B.A.P. held that it was not an abuse of

discretion for the bankruptcy court to disapprove such expanded

indemnity under the circumstances of that case.

14

constrained and overly conservative in their advice, thus

disadvantaging the estate.

Though heretofore we have not addressed in depth the

reasonableness of indemnifying financial advisors, we have

recognized that S 330, which deals with what constitutes

"reasonable" compensation for professionals, takes a

"market-driven" approach. In re Busy Beaver Bldg. Ctrs.,

Inc. 19 F.3d 833, 852 (3d Cir. 1994). While this case dealt

with the reasonableness of paralegals’ compensation, rather

than their indemnification, it underscores that some

reference to the market is not out of place when considering

whether terms of retention are "reasonable" in the

bankruptcy context.

Indemnification of financial advisors against their own

negligent conduct is becoming a common market

occurrence. In re Joan and David Halpern Inc. , 248 B.R. 43,

47 (Bankr. S.D.N.Y. 2000), aff ’d, No. 00-10961 SMB, 2000

WL 1800690 (S.D.N.Y. Apr. 4, 2000)). These provisions are

of relatively recent origin, spurred by the In re Merry-Go-

Round Enterprises, Inc. settlement of a suit against

accountants advising the estate. 244 B.R. 327 (Bankr. D.

Md. 2000). Where previously there was no great concern

with bankruptcy professionals being sued for negligence,

after Merry-Go-Round professionals worried that suits would

occur frequently, and they sought to lessen their potential

liability by contracting for indemnification. See Joseph A.

Guzinski, The United States Trustees: Ongoing Challenges,

in 23rd Annual Current Developments in Bankruptcy and

Reorganization 251, 274 (PLI Commercial Law and Practice

Course, Handbook Series No. 820, 2001) ("In re Merry-Go-

Round served as a kind of wake up call for bankruptcy

specialists . . . . Fearing exposure to similar claims,

specialists . . . have sought indemnification by the company

filing the bankruptcy."); Kurt F. Gwynne, Indemnification

and Exculpation of Professional Persons in Bankruptcy

Cases, 10 ABI L. Rev. 711, 727-29 (2002); Shanon D.

Murray, U.S. Trustee Watchdog Starting to Bite, Some Say,

N.Y.L.J., May 3, 2001, at 5 (stating that "the current

movement of restructuring advisers who want to be

indemnified for their bankruptcy work stems from a $4

billion fraud, negligence and malpractice case that a

15

regional trustee brought against Ernst & Young for its role

in the bankruptcy proceedings of Merry-Go-Round").

However, that indemnification provisions like Houlihan

Lokey’s are now common in the marketplace does not

automatically make them "reasonable" underS 328.12 Our

approach is "market driven," not "market-determined,"

especially in the realm of bankruptcy, where courts play a

special supervisory role. With the understanding and

limitations set out below, we believe Houlihan Lokey’s

indemnification agreement to be reasonable and therefore

permissible under S 328. In coming to this conclusion, we

revisit traditional negligence/gross negligence analysis,

borrowing from Delaware corporate law, and emphasizing

that the indemnity provision leaves the door open to

examining the level of care financial advisors exercise in the

process of obtaining the results, rather than the results

themselves. We look to Delaware corporate law as a guide

primarily because it offers time-tested insights on how

courts should best evaluate an issue similar to the one

before us.13 Additionally, Delaware’s law often cues the

market.

Directors and officers in Delaware may obtain indemnity

for their own negligence.14 Section 145(a) of Delaware

_________________________________________________________________

12. See, e.g., Unsecured Creditors Comm. v. Pelofsky (In re Thermadyne

Holdings Corp.), 283 B.R. 749 (B.A.P. 8th Cir. 2002); In re Metricom, Inc.,

275 B.R. 364 (Bankr. N.D. Cal. 2002) (rejecting indemnification of

Houlihan Lokey, advisor to the bondholders’ committee, as unreasonable

where the debtor and official committee of unsecured trade creditors

retained two other financial advisors without such indemnification

agreements, and there was no showing that such an agreement was

necessary). Cf. In re Comdisco, Inc., 2002 WL 31109431 (N.D. Ill. Sept.

23, 2002) (reasonableness of indemnity for professional advisors depends

on the facts of each case); In re DEC International, Inc., 282 B.R. 423

(W.D. Wis. 2002) (indemnity of bankruptcy professionals not per se

unreasonable but must be scrutinized with care).

13. While the retention agreement between United Artists and Houlihan

Lokey purports to be governed by New York law, our opinion relates to

what is reasonable under S 328(a) of the Bankruptcy Code. As this

without doubt is a matter of federal law, we need not examine New York

law, and only refer to Delaware corporate law as a useful analogue.

14. Though directors and officers are fiduciaries of the corporations they

serve, we do not hold financial advisors like Houlihan Lokey to be

16

General Corporation Law provides that corporations may

indemnify directors and officers "if the person acted in good

faith and in a manner the person reasonably believed to be

in or not opposed to the best interests of the corporation."

8 Del. Code S 145(a). Section 145(b) requires that, if the

director or officer is adjudged liable to the corporation, he

or she will be indemnified "only to the extent that the . . .

court . . . shall determine upon application that, despite the

adjudication of liability but in view of all the circumstances

of the case, such person is fairly and reasonably entitled to

indemnity for such expenses which the . . . court shall

deem proper." Id. S 145(b).

Changes in Delaware’s corporate law make plain that

S 145(b) requires the "adjudication of liability" to be one of

gross, rather than ordinary, negligence.

Prior to the 1986 amendment to the statute, the

language relating to the disqualifying adjudication read

‘adjudged to be liable for negligence or misconduct in

the performance of his duty to the corporation.’ Since

Delaware case law has clearly established ‘gross

negligence’ as the standard for liability of directors in

violating their duty of care, the reference to ‘negligence’

_________________________________________________________________

fiduciaries. Still, in the bankruptcy context they may owe a higher level

of care than in ordinary practice. Compare In re Gillett Holdings, 137

B.R. 452, 458 (Bankr. D. Colo. 1991) ("Investment bankers and financial

advisors hired by the Debtor are also fiduciaries."), and In re Allegheny

Int’l, Inc., 100 B.R. 244, 246 (Bankr. W.D. Pa. 1989) ("We now hold that

the investment bankers/financial advisors hired by the debtor and the

Creditors’ Committee are also fiduciaries."), with In re Joan and David

Halpern Inc., 248 B.R. at 46 (earlier cases rejecting indemnification

"overlook the common law principles permitting indemnity of fiduciaries,

and the idea that a fiduciary cannot be indemnified for negligence, or

that such indemnification is contrary to public policy, is just plain

wrong"), In re Mortgage & Realty Trust, 123 B.R. 626, 631 (Bankr. C.D.

Cal. 1991) (rejecting indemnification because it is inconsistent with

"professionalism," but not holding financial advisors to be fiduciaries),

and In re Drexel Burnham Lambert Group, 133 B.R. 13, 27 (Bankr.

S.D.N.Y. 1991) (same). The upshot for this case is that, to the extent that

fiduciaries may obtain indemnity for their negligence, financial advisors

in bankruptcy (who may or may not be fiduciaries) may do the same.

17

in section 145(b) was inappropriate [and was therefore

removed].

E. Norman Veasey et al., Delaware Supports Directors with

a Three-Legged Stool of Limited Liability, Indemnification,

and Insurance, 42 Bus. Law. 399, 405 (1987); see also

Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 364 n.31

(Del. 1993); Smith v. Van Gorkom, 488 A.2d 858, 873 (Del.

1985) (applying a gross negligence standard). In other

words, the most that Delaware law requires of directors,

though they are fiduciaries, is that they not be grossly

negligent. 1 David A. Drexler et al., Delaware Corporation

Law and Practice S 15.06[1], at 15-35 (2001) (citing Brehm

v. Eisner, 746 A.2d 244, 262 (Del. 2000), and Aronson v.

Lewis, 473 A.2d 805, 812 (Del. 1984)). Put another way,

Delaware courts tolerate ordinary negligence from corporate

fiduciaries. It is important, however, to understand how

these terms are understood in this particular context.

Courts are increasingly recognizing the awkwardness

inherent in using the terms "negligence" and"gross

negligence" in the area of corporate governance. The art of

governing (it is emphatically not a science) is replete with

judgment calls and "bet the company" decisions that in

retrospect may seem visionary or deranged, depending on

the outcome. Corporate directors do not choose between

reasonable (non-negligent) and unreasonable (negligent)

alternatives, but rather face a range of options, each with

its attendant mix of risk and reward. Too coarse a filter, the

traditional negligence construct does not allow these

nuances to emerge.

While it is often stated that corporate directors and

officers will be liable for negligence in carrying out their

corporate duties, all seem agreed that such a

statement is misleading. Whereas an automobile driver

who makes a mistake in judgment as to speed or

distance injuring a pedestrian will likely be called upon

to respond in damages, a corporate officer who makes

a mistake in judgment as to economic conditions,

consumer tastes or production line efficiency will

rarely, if ever, be found liable for damages suffered by

the corporation.

18

Joy v. North, 692 F.2d 880, 885 (2d Cir. 1982) (Winter, J.)

(citations omitted).

In simple terms, "[t]he vocabulary of negligence[,] while

often employed . . . [,] is not well-suited to judicial review

of board attentiveness." In re Caremark Int’l Inc. Derivative

Litig., 698 A.2d 959, 967 n.16 (Del. Ch. 1996) (Allen, C.)

(citation omitted). The same principle applies to financial

advisors. In situations where choices are not clear, neither

are gradations of negligence as a means of analysis.

In the last two decades this confusion about what

negligence means led to uncertainty about liability exposure

for both corporate directors and financial advisors. A

"crisis" in corporate governance arose when Delaware

courts began to hold directors personally liable for their

negligence, and directors were unable to find insurance

against the risks associated with their jobs. See 1 Drexler,

supra, S 15.06[1], at 15-36. As already noted, in the

bankruptcy context the In re Merry-Go-Round settlement of

a suit against an accounting firm advising the estate was a

similarly seismic event for financial advisors. Houlihan

Lokey and other financial advisors fear increases in liability

exposure for the risks associated with doing their jobs.15

Delaware courts have resolved the negligence conundrum

in the corporate sphere by evaluating the process by which

boards reach decisions, rather than the final result of those

decisions. A board’s failure to inform itself of"all material

information reasonably available" results in a finding of

gross negligence. Aronson, 473 A.2d at 812. 16 In fact,

Delaware’s jurisprudence is a direct response to the type of

concerns about second-guessing that Houlihan Lokey

voices:

_________________________________________________________________

15. In this respect Houlihan Lokey’s position is similar to that of creditor

committee members. See 7 Lawrence P. King, Collier on Bankruptcy

P1103.05[4], at 1103-32-33 (15th ed. rev. 1996) ("If members of the

committee can be sued by persons unhappy with the committee’s

performance during the case or unhappy with the outcome of the case,

it will be extremely difficult to find members to serve on an official

committee.").

16. In Merry-Go-Round, claims regarding such a failure by the accounting

firm were at issue.

19

[C]ompliance with a director’s duty of care can never

appropriately be judicially determined by reference to

the content of the board decision that leads to a

corporate loss, apart from consideration of the good

faith or rationality of the process employed. That is,

whether a judge or jury [,] considering the matter after

the fact, believes a decision substantively wrong, or

degrees of wrong extending through "stupid" to

"egregious" or "irrational", provides no ground for

director liability, so long as the court determines that

the process employed was either rational or employed

in a good faith effort to advance corporate interests. To

employ a different rule--one that permitted an

"objective" evaluation of the decision--would expose

directors to substantive second guessing by ill-

equipped judges or juries, which would, in the long-

run, be injurious to investor interests.

Caremark, 698 A.2d at 967 (emphases in original).

When Houlihan Lokey agreed to advise the Debtors, it

took on the role of a professional (indeed, one highly

respected for its adept counsel in the high-stakes arena of

major restructurings). Its job was to advise the Debtors

well, and it owed them a duty of care in fulfilling this

obligation. To disappoint the reasonable expectations of the

Debtors, their creditors, and indeed the Court, is

unacceptable. At the same time, Houlihan Lokey

convincingly describes the stifling effects of unduly close

scrutiny by the courts. A rule of reason must prevail.

Delaware has navigated the Scylla of condoning directors’

misconduct and the Charybdis of stifling their business

decisions with a rule that stresses not the end result, but

the path taken to reach it. Under this approach, courts do

not interfere with advice by financial advisors when they (1)

have no personal interest,17 (2) have a reasonable

awareness of available information after prudent

_________________________________________________________________

17. The Bankruptcy Code itself requires that professionals working for

the estate be disinterested persons, a term defined in 11 U.S.C.

S 101(14). See also 11 U.S.C. S 327(a) ("[T]he trustee . . . may employ . . .

persons[ ] that do not hold or represent an interest adverse to the estate,

and that are disinterested persons . . . ."); id. S 328(c) (the court may

deny compensation if during employment the professional "is not a

disinterested person, or represents or holds an interest adverse to the

interest of the estate"). While we leave for another day whether, for

example, a financial advisor trading in claims with respect to a debtor it

serves is disinterested, we note that such a circumstance is not rare.

20

consideration of alternative options, and (3) provide that

advice in good faith. See 1 Drexler, supra, S 15.03, at 15-6.

In the corporate sphere this is known as the "business

judgment rule." A creature of common law, McMullen v.

Beran, 765 A.2d 910, 916 (Del. 2000), it acknowledges a

judicial syllogism derived from five fundamental tenets:

(1) the management of a corporation’s affairs is placed

by law in the hands of its board of directors;

(2) performance of the directors’ management function

consists of: (a) decision-making -- i.e., the making

of economic choices and the weighing of the

potential of risk against the potential of reward,

and (b) supervision of officers and employees --

i.e., attentiveness to corporate affairs;

(3) corporate directors are not guarantors of the

financial success of their management efforts;

(4) though not guarantors, directors as fiduciaries

should be held legally accountable to the

corporation and its stockholders when their

performance falls short of meeting appropriate

standards; and

(5) such culpability occurs when directors breach

their fiduciary duty -- that is, when they profit

improperly from their positions (i.e., breach the

"duty of loyalty") or fail to supervise corporate

affairs with the appropriate level of skill (i.e.,

breach the "duty of care").

1 Drexler, supra, S 15.03, at 15-6.

Here, where a debtor’s financial affairs -- the pith of a

reorganization -- are shaped by its financial advisors, they

lay out the economic choices and assess their risks, and

(though not sureties of success) can be held accountable for

not advising with the level of care or loyalty expected,

transposing the business judgment rule from its corporate

ambit to bankruptcy appears well suited. For by this

transposition we have a means to distinguish gross from

simple negligence, and thus a benchmark for approving as

21

reasonable an arrangement for indemnity that includes

common negligence.18

Our understanding of the developing standards used in

this area fortifies our view that the District Court did not

abuse its discretion by finding the contested terms in the

agreement at issue here to be reasonable. At this initial

stage of the indemnity process (considering and approving

a retention arrangement containing an agreement to

indemnify for ordinary negligence), no evidence before the

District Court tended to disqualify Houlihan Lokey under

the tenets we set out for determining reasonableness of the

indemnity proposed.19

We reach this result with two caveats. The first is that

Houlihan Lokey attempted to supplement its retention

agreement with a provision in the retention application and

approving order that in effect mandates indemnification to

Houlihan Lokey for even its gross negligence if that

negligence is not judicially determined to be "solely" the

_________________________________________________________________

18. Houlihan Lokey argues that our approach nonetheless subjects it to

claims that it has not followed a correct process in advising debtors.

While financial advisors are not Garibaldi for all reorganizations, they are

trained to enhance their prospects. Undertaking this duty for so high a

recompense ($150,000 per month plus a "transaction fee" of 70 basis

points of United Artists’ debt) is hardly reasonable if that training is not

applied.

19. Before the Court was the affidavit of Michael A. Kramer (Managing

Director of Houlihan Lokey), submitted in support of the Debtors’

application to retain Houlihan Lokey, and stating that it was

"disinterested" (and thus had no personal interest in the United Artists

cases), a claim that the U.S. Trustee did not dispute. There was no

allegation that Houlihan Lokey imprudently considered financial options

available to the Debtors, nor was there any allegation of Houlihan

Lokey’s bad faith.

In any event, section 328(a) itself provides a safe harbor for the Court

to reconsider its approval of any employment terms for professionals.

Notwithstanding such terms and conditions, the court may allow

compensation different from the compensation provided under such

terms and conditions after the conclusion of such employment, if

such terms and conditions 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.

22

cause of its damages. In other words, the Debtors would be

bound to indemnify Houlihan Lokey when its gross

negligence contributed only in part to its damages. This

attempted end run goes out of bounds for acceptable public

policy. See Gwynne, supra, at 730-01 & nn.106-07.

Secondly, as note 8 supra and the accompanying text

indicate, Houlihan Lokey in the Plan sought indemnity only

for actions in its professional capacity. The retention

agreement arguably goes further, for it requires

indemnification of Houlihan Lokey for contractual disputes

with the Debtors. To the extent that Houlihan Lokey seeks

indemnity for a contractual dispute in which the Debtors

allege the breach of Houlihan Lokey’s contractual

obligations,20 this is hardly an indemnity-eligible activity.

See Cochran v. Stifel Fin. Corp., No. Civ. A. 17350, 2000 WL

1847676, at *7 (Del. Ch. Dec. 13, 2000), aff ’d in relevant

part, rev’d in part on other grounds, 809 A.2d 555 (Del.

2002); cf. Gwynne, supra, at 731. 21

* * * * *

Financial advisors are an essential part of

reorganizations. Our decision today recognizes the need for

safeguards from the second-guessing of creditors and,

ultimately, the courts. At the same time, it assigns courts

their accustomed task of evaluating the process by which

advice is given. If financial advisors take the appropriate

steps to arrive at a result, the substance of that result

_________________________________________________________________

20. We doubt that this kind of enhanced indemnity was contemplated by

Houlihan Lokey. Subparagraph (a)(iv) of Exhibit A to the retention

agreement speaks only of the breach by the Debtors of their contractual

covenants, representations, and warranties. While subparagraph (a)(i)

relates to any dispute involving the agreement (which theoretically may

involve breaches by Houlihan Lokey of its obligations), it appears that

such a conceivable argument is overridden by subparagraph (d), which

exempts from indemnity "gross negligence, ... willful misfeasance, or

reckless disregard [by Houlihan Lokey] of its obligations or duties" under

the agreement.

21. As noted supra n.4, the U.S. Trustee has not appealed whether the

order permitting indemnification of Houlihan Lokey for its prepetition

performance of services to the Debtors is reasonable under S 328(a). We

therefore do not address this question.

23

should not be questioned. So understood, agreements to

indemnify financial advisors for their negligence are

reasonable under S 328(a) of the Bankruptcy Code.22

IV. Conclusion

The U.S. Trustee has standing to bring this case. His

claim is not constitutionally moot because Plan

confirmation has not released all potential claims against

Houlihan Lokey. It is not equitably moot because the relief

requested will not upset the confirmed Plan. Because it is

permissible for financial advisors to obtain indemnity for

negligent acts if understood in the context noted above, the

contested provision is acceptable. We therefore affirm.

_________________________________________________________________

22. Our concurring colleague has taken a more familiar path to the

same result. That path is plausible and merits consideration. We go

another way because the traditional approach sheds no light on when

negligence becomes gross, and thus not indemnifiable. With great

conviction, however, we disavow the attempt to blot our judicial

escutcheon with the claim that we engage in "policy making" that "goes

far beyond the parameters of our judicial function." We address directly

the issue on appeal, see supra n.4, and in deciding that issue explain

when it is "reasonable" under S 328(a) of the Bankruptcy Code to

approve an agreement to indemnify a financial advisor for its own

negligence by laying down markers to discern what simple negligence is

and is not. As our colleague points out, "the law is unsettled and our

bankruptcy and district courts need guidance."

24

ALITO, Circuit Judge, Concurring:

I fully join the thoughtful and scholarly opinion of the

court but add a few words in response to Judge Rendell’s

concurring opinion. With respect, I believe that Judge

Rendell’s opinion quarrels with an opinion other than the

one that the court has issued. The opinion of the court, as

I understand it, holds only that the "reasonableness"

standard of 11 U.S.C. S 328(a) does not categorically

prohibit indemnification of financial advisers, as the United

States Trustee argues. If such a blanket prohibition is

desirable, it should be enacted by Congress.

Contrary to the suggestion in Judge Rendell’s

concurrence, the court does not hold that Houlihan Lokey’s

indemnification agreement must be interpreted in

accordance with the principles of Delaware corporate law

that the opinion of the court discusses. Nor does the court

issue an authoritative interpretation of that agreement.

Rather, the court discusses principles of Delaware

corporate law because they provide a sophisticated

framework for evaluating the conduct of financial advisers

and because this understanding of the circumstances in

which in it sensible to hold financial advisers responsible

for unsuccessful business decisions helps to explain why

indemnification agreements such as the one in this case

are not categorically "unreasonable."

25

RENDELL, Circuit Judge, Concurring:

I agree with the result reached by the District Court and

agree that we should affirm its order. However, I

respectfully reject the majority’s ruling on the merits, as I

read Judge Ambro’s opinion, because it represents a

significant departure, if not a quantum leap, from the issue

before us.

Writing for the panel, brother Ambro does not address

what the District Court did or the arguments raised by the

parties on this unresolved yet important issue; the opinion

actually ignores the issue presented on appeal. The Trustee

seeks a per se ban on provisions granting indemnity to

financial advisors for negligence. Houlihan Lokey takes the

position that such provisions should be permissible and

that the court should examine them on a case-by-case

basis. The parties briefed the various aspects of that issue,

including the propriety of professionals’ obtaining such

indemnity and whether it was appropriate or necessary in

the given setting. While, as the District Court noted, there

is no binding caselaw, there are numerous cases that

express differing views on the issue.1

_________________________________________________________________

1. In rejecting a per se ban on indemnity provisions, the District Court

focused on the "reasonableness" language in section 328(a) and

conducted an independent analysis of this agreement. A number of other

courts favor this approach and have used it to uphold some indemnity

provisions and reject others. For example, the District Court for the

Northern District of Illinois and the Bankruptcy Court for the Southern

District of New York have both upheld similar indemnity provisions,

rejecting the Trustee’s argument that such provisions should be per se

unreasonable. In re Comdisco, Inc., Nos. 02 C 1174 & 02 C 1397

(consolidated), 2002 U.S. Dist. LEXIS 17994, at *16 (N.D. Ill. Sept. 25,

2002); In re Joan & David Halpern, Inc., 248 B.R. 43, 47 (Bankr. S.D.N.Y

2000). Houlihan Lokey cites to numerous non precedential decisions of

the Bankruptcy Courts for the District of Delaware doing the same. A’ee

Br. at 22. Bankruptcy Courts in California and Colorado have also

subjected indemnity provision to a full reasonableness inquiry. See, e.g.,

In re Metricom, Inc., 275 B.R. 364, 371 (Bankr. N.D. Cal. 2002) (stating

that "the issue is whether particular terms are reasonable under given

circumstances, and such a determination can only be made on a case by

case basis") (ultimately rejecting provision at issue); In re Gillett Holdings,

Inc., 137 B.R. 452, 458-49 (Bankr. D. Colo. 1991) ("This Court will not

26

Instead of addressing these arguments, Judge Ambro’s

opinion ventures into the arena of corporate law and

fashions an open-ended good faith business judgment rule,

based upon Delaware corporate law principles, as the test

for the "reasonableness" of advisors’ indemnity. It does so

because it finds the concepts of negligence and gross

negligence to be too results-oriented.

I do not doubt that scholars and professors -- and indeed

some practitioners -- may have an aversion to distinctions

made between negligence and gross negligence and have

therefore suggested that corporate directors should not be

liable if they follow the appropriate process and exercise

their business judgment. However, that is not the issue

_________________________________________________________________

go so far as to hold that indemnity provisions per se are either

unacceptable or unnecessary in these circumstances. Indemnity

provisions must be analyzed on a case-by-case basis.") (citation omitted)

(ultimately rejecting provision at issue); In re Mortgage & Realty Trust,

123 B.R. 626, 630 (Bankr. C.D. Cal. 1991) (rejecting provision at issue

because debtor had presented no evidence of its reasonableness).

In support of her theory that indemnity provisions should be banned

outright, the Trustee relies on an opinion from one of our own

bankruptcy courts, In re Allegheny International, Inc., 100 B.R. 244, 247

(Bankr. W.D. Pa. 1989). In Allegheny, Judge Cosetti decided that

financial advisors were fiduciaries of the debtors who hired them. Id. at

246. He went on to appropriate Judge Cardozo’s famous remarks in

Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928), for the proposition

that fiduciaries owe the highest standard of care, and to conclude that

"holding a fiduciary harmless for its own negligence is shockingly

inconsistent with the strict standard of conduct for fiduciaries."

Allegheny, 100 B.R. at 247. Courts faced with this issue have referenced

the "fiduciary" language, but have generally looked at an advisor’s

fiduciary status as one factor in a reasonableness analysis, not as

support for a per se ban on indemnity. See, e.g., Gillett, 137 B.R. at 458;

Mortgage & Realty Trust, 123 B.R. at 630.

Here, the parties have not argued that professionals like Houlihan are

fiduciaries as such, and I suggest that resort to nomenclature for

resolution of the issues before us would be wrong. The issue here is

"reasonableness" under section 328(a). An agreement about what status

might be attributed to professionals based on analogous corporate trust

principles should give way to a consideration of what is reasonable

under all of the circumstances in the bankruptcy context.

27

before us, nor is it a concept that either of the parties has

even remotely embraced.

Responding to a line of inquiry at oral argument, the

Trustee and Houlihan Lokey filed supplemental briefs

specifically addressing the propriety of our creating a new

"reasonableness" standard separate and apart from the

negligence principles embodied in their agreement. They

specifically requested that we not do so. 2 As both parties

have noted, we should decide the issue presented to us, not

craft new rules or address matters beyond the scope of the

appeal. I should note that I would favor Judge Alito’s

reading of Judge Ambro’s opinion, but fear it will not be so

read.

I cannot help but wonder why we should resort to

reasoning that "eschews the inherent imprecision between

shades of negligence" when the parties bargained under

traditional negligence principles and rules. And why should

we concern ourselves with Delaware law applicable to

directors, when the retention agreement here was

_________________________________________________________________

2. In their Supplemental Briefs, the Trustee and Houlihan Lokey both

pointed out the dangers inherent in our creating a new standard in this

case. First and foremost, both parties noted that our appellate

jurisdiction should be limited to deciding the issue presented, that is,

whether the District Court abused its discretion in approving the

retention agreement. See App. Supp. Br. at 3 ("The crafting of new

negligence standards . . . seems inconsistent with the scope of this

appeal.")

The parties also implored us not to venture into the realm of the

legislature, as we are not equipped to weigh the many complicated

interests that go into bankruptcy administration, nor can we predict the

implications of a new untested standard or the ways it might upset the

current balance of incentives. App. Supp. Br. at 6-7; A’ee Supp. Br. at

6. The Trustee worries that the majority’s test will essentially excuse all

professional misconduct by financial advisors, while for its part,

Houlihan Lokey fears the rigid test will undermine its own safeguards,

exposing it to "process" litigation by creditors unhappy with their

recovery, even where there was no basis on which to attack the

substantive advice actually given. App. Supp. Br. at 9; A’ee Supp. Br. at

5. In short, neither party revealed any inclination to support what the

majority has done. Rather, both vehemently argued against this

approach.

28

specifically governed by New York law and was meant to

govern a relationship not with directors, but between a

company and its professional financial advisors? 3 Financial

advisors are not directors, and I do not find their status to

be analogous.

I must confess that although I would acknowledge that

my colleagues sincerely believe that their view represents a

contribution to our thinking about the issue at hand, I find

it very difficult to conceive of the application, and

implications, of this new test. Presumably, the first and

third prongs -- "disinterested" and "good faith" -- are easily

met, but what does the second prong mean? When does a

financial advisor not have "a reasonable awareness of

available information after prudent consideration of

alternative options"?

In a footnote, Judge Ambro seemingly applies the post-

hoc test he espouses (n.19), concluding that the evidence

before the District Court revealed no personal interest on

the part of Houlihan Lokey in the United Artists cases, and

that, because there were no allegations of imprudent

consideration by Houlihan Lokey of the available financial

options or of bad faith, Houlihan Lokey is entitled to

indemnity. Even were I to agree that the creation of a new

test is warranted, surely this is not the way to apply it. This

conclusory treatment leaves us uncertain as to how the test

should be applied in other instances. I cannot tell whether

it will provide a blank check for substandard performance

(as the Trustee urges), or will foment process-oriented

litigation (as Houlihan Lokey submits). Further, I cannot

imagine what guidance we are giving to the District Court

by changing the rules midstream, much less what

implications this poses for indemnity agreements already in

force.

The rationale for adopting this test -- namely, an

aversion to a "results-oriented" approach to liability, and

therefore, indemnity -- goes far beyond the parameters of

_________________________________________________________________

3. Although United Artists is a Delaware corporation, its retention

agreement with Houlihan Lokey contains an explicit choice of law

provision specifying New York law as the governing state law. App. at

132-33.

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our judicial function, into the sphere of policy making. To

my mind, the adoption of a business judgment rule as

providing a standard for indemnification of professional

advisors is fraught with policy considerations, none of

which has been explored in this case. These are the types

of concerns that should be considered in the first instance

by a legislative, rather than a judicial, body. Further, the

test can only be applied after the fact, thus essentially

emasculating the bankruptcy courts’ testing of terms of

retention at the time of retention, as is clearly envisioned by

section 328(a). I fear that our grafting such a test onto

section 328(a) goes beyond our ken, especially here where

we are reviewing a determination by the District Court that

followed traditional lines of reasoning.

The issue actually before us, as framed by the parties

and decided by the District Court, deserves our attention.

Is there something essentially problematic with the concept

of professionals bargaining for indemnity against their own

negligence? Should it ever be permitted? If so, under what

circumstances? We should address the issue as presented,

because the law is unsettled and our bankruptcy and

district courts need guidance.

The District Court considered the merits of this issue

very seriously and thoroughly, entertaining briefing and

oral argument that spans nearly 500 pages of the

voluminous appendix submitted on appeal. Instead of

creating a new test, I would affirm by disavowing the notion

of a per se ban, engaging in a discussion of the factors that

the courts have examined in considering "reasonableness"

on a case by case basis under section 328, and approving

the ultimate result reached by the District Court based on

the extensive record presented.4

_________________________________________________________________

4. Among the specified factors, and facts, weighing in favor of the

reasonableness of this agreement in the situation presented here are:

1) the retention of Houlihan Lokey was in the best interest of the estate,

as it played a crucial role in the restructuring; 2) United Artists’

creditors approved the agreement and have never objected to the

indemnity provision; 3) the agreement did not prov ide blanket immunity,

but rather contained detailed procedures for determining at a later date

whether a particular application for indemnity should be granted;

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The review and assessment of the law and the record--

rather than the creation of a slippery slope for testing

consulting professionals’ liability in the bankruptcy arena

-- should be the basis of our rule. The concluding

paragraphs of the opinion seem to venture into an analysis

of "reasonableness," noting two aspects of the indemnity

agreement that are, respectively, an "end run" around

"acceptable public policy" (the indemnity for gross

negligence when that negligence is not solely the cause of

damages), and not an "indemnity-eligible activity" (the

indemnity for contractual disputes with Debtors). These

aspects were never argued or briefed, but I suggest that it

is this type of scrutiny of the provisions of the retention

agreement that is called for under the "reasonableness"

standard of section 328(a). I agree that, assessed under the

"reasonableness" standard, these two terms do not pass

muster. But, unfortunately, we are left confused as to

whether the overall inquiry is, as urged in the thrust of the

opinion, a post hoc examination, or whether some scrutiny

-- on some reasonableness basis -- is to be undertaken at

the outset. It is hard to imagine that reasoning done at the

outset, if it does occur, could be anything other than a

complete and binding determination of "reasonableness,"

making some after the fact business judgment rule

_________________________________________________________________

4) Houlihan Lokey had been retained pre-petition u nder an agreement

containing an indemnity clause. Most of its work was performed prior to

the initiation of bankruptcy proceedings, so, relatively speaking, its post-

bankruptcy indemnity was not particularly significant; 5) United Artists

and Houlihan Lokey are sophisticated business entities with equal

bargaining power who engaged in an arms length negotiation; 6) such

terms are viewed as normal business terms in the marketplace, see In re

Busy Beaver Bldg. Centers, 19 F.3d 833, 849 (3d Cir. 1994) (condoning

a "market-driven" approach to reasonableness); and finally, 7) under the

terms of section 328, the District Court retained discretion to modify the

agreement "if such terms and conditions prove to have been

improvident." 11 U.S.C. S 328(a). Indeed, we have encouraged similar

exercises of discretion in the realm of post-bankruptcy fees for attorney

services to debtors under 11 U.S.C. S 330. In re Top Grade Sausage, Inc.,

227 F.3d 123, 132-33 (3d Cir. 2000). I would therefore approve the

indemnity agreement, subject to the two caveats noted by the majority,

as discussed in the penultimate paragraph of this concurrence.

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unnecessary and uncalled for. Once again, we are left

questioning how to apply this test.

Therefore, although I concur in the resulting affirmance,

I would arrive at that result via an entirely different route.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

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