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Karen B. Skomorucha Owens, Esq.
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Practice Pointers – When Faced With A Dispute Over a Court Order, Seek Court Intervention Sooner Rather Than Later or Face Civil Contempt Sanctions

In re Washington Mutual, Inc., No. 08-12229 (MFW), 2018 WL 704361 (Bankr. D. Del. Feb. 2, 2018)

In this Opinion, Judge Walrath of the Delaware Bankruptcy Court imposed sanctions against the Washington Mutual Liquidating Trust (the “Liquidating Trust”) for its failure to comply with the Court’s final fee order (“Final Fee Order”) that awarded, among other things, a contingency fee (the “Contingency Fee”) to Grant Thornton, LLP (“Grant Thornton”) in connection with certain tax related work it provided postpetition to the Liquidating Trust.

Prepetition, Washington Mutual engaged Grant Thornton to develop a theory to challenge the constitutionality of California’s taxation of federal bond interest (the “Treasury Interest Issue”).  The primary motivation was to utilize the Treasury Interest Issue in negotiations with the California Franchise Tax Board (the “FTB”) as leverage to offset Washington Mutual’s other outstanding tax liabilities.  Postpetition, Grant Thornton was again retained by the Washington Mutual debtors (the “Debtors”) to continue developing the Treasury Interest Issue.  The postpetition agreement provided that Grant Thornton be paid its “hourly standard rates discounted by 20% and capped at $150,000 . . . .”  Op. at *2.  Grant Thornton was further to be paid the Contingency Fee, which was calculated as 10% of the Economic Value recovered from the FTB.  The engagement agreement defined “Economic Value” as any “tax, interest, and penalty offsets, whether received by check, deposit, overpayment applied, credit, audit offset, or any other means,” including “any reduction of other assessments that are received pursuant to an agreement with the FTB to not file or to withdraw any refund claims.”  Id.  The Court approved the retention of Grant Thornton under section 328(a) of the Bankruptcy Code.  Id.

During the pendency of the bankruptcy, Grant Thornton assisted the Debtors with, among other things, preparing tax returns, drafting letters to the FTB, further developing the Treasury Interest Issue, and objecting to the FTB’s $280.5 million proof of claim (the “FTB Claim”).  The Liquidating Trust and the FTB eventually settled the FTB Claim and the Debtors’ outstanding tax issues.  The settlement agreement provided for, among other things, a net refund to the Debtors in the amount of approximately $225 million.  After learning of the settlement agreement from a review of the docket, Grant Thornton requested from the Liquidating Trust the payment of its Contingency Fee.  The Liquidating Trust refused to make the payment, arguing that the Treasury Interest Issue was repeatedly rejected by the FTB and, therefore, it did not yield any Economic Value in connection with the settlement.  In other words, the Liquidating Trust argued that the term “Economic Value” was limited to amounts recovered only in connection with the Treasury Interest Issue.  Grant Thornton disagreed.

The Court, in granting Grant Thornton’s motion for sanctions, found that the postpetition engagement agreement was “unambiguous and broad” and that “the parties intended the contingent fee to apply to all economic value received by the Debtors from the FTB.”  Id. at *7.  The Court further held that the Contingency Fee was not improvident under section 328(a) of the Bankruptcy Code.  The Liquidating Trust argued that there was a “mutual mistake” regarding the Contingency Fee that led to the parties’ inability to foresee that the Court would approve such a large Contingency Fee.  Noting that “a court may allow different compensation only ‘if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of’ entry,” the Court rejected the Liquidating Trust’s argument and held that even if “the Debtors were unilaterally mistaken, . . . they could certainly have foreseen the Court enforcing the agreement as written.”  Id.

Lastly, and importantly, Judge Walrath found the imposition of sanctions against the Liquidating Trust appropriate, finding that its refusal to pay Grant Thornton’s Contingency Fee “demonstrated an inexcusable disregard for the Court’s order . . . .”    Id. at *8.  While the Liquidating Trust argued that the parties’ good faith contract dispute justified its behavior, the Court disagreed.  Her Honor held that the Liquidating Trust knew of the Final Fee Order, the engagement agreement, and the unambiguous Contingency Fee language, and made an “independent and unilateral determination” not to pay Grant Thornton despite its consistent payment demands.  Id.  Rather than seeking relief from the Court regarding the dispute, the Liquidating Trust withheld payment and forced Grant Thornton to file a motion to recover its Contingency Fee.  According to the Court, this behavior amounted to a refusal to comply with the Final Fee Order and warranted sanctions for civil contempt under section 105(a) of the Bankruptcy Code in the form of Grant Thornton’s costs associated with filing and prosecuting its motion.