Consultants Emerge as Big Beneficiaries of Bankruptcy Sales

As bankruptcy sales become more common among debt-saddled banks, creditors and government watchdogs are scrutinizing the fees charged by firms that consult on the transactions.

In such sales, called 363 auctions, the bank is sold to pay the holding company's debts. They can be a disaster for investors and management, which face the prospect of losing ownership stakes, and even their jobs, in a forced sale.

But for law firms and investment banks, each sale offers a chance to collect huge amounts in fees – up to seven figures in some cases. The fees, paid by the estate, have eaten up nearly a fifth of the sale price in recent auctions.

Bank creditors, who generally get what remains after a bank is sold and fees are paid, have been the loudest voices complaining about high bankruptcy costs.

"Bankruptcy often benefits the professionals rather than the creditors," says Vik Ghei, founder of HoldCo Advisors, a hedge fund that owns distressed-bank debt. "Fees charged in some of these cases are more than what would be reasonable for even a fairly large bankruptcy."

In First Mariner Bank's April bankruptcy sale to a group of Baltimore investors, fees and reimbursements totaled $3.3 million, or 18% of the sale price, according to court documents. In the auction of Park Cities Bank, fees and expense billings comprised $2.5 million, or 22%, of the $11.4 million sale price. Charges totaled $7.8 million, or 15% of the price, for the September auction of Metropolitan National Bank.

Some of these billings may be denied by the courts. But the three cases are ongoing, so the final costs will likely be higher. Bankruptcy cases often drag on for years, racking up costs for the estate.

Some industry observers consider bankruptcy fees to be egregiously inflated. Others argue that bankruptcies are inherently costly and time consuming, and that professional fees, while high, reflect the complexity of these cases.

"Bankruptcy is not cheap," says Brennan Ryan, a partner at Nelson Mullins Riley & Scarborough, who has worked on 363 sales. "The costs are extraordinary, but there's no way around it. Look at the amount of data that needs to be gathered, the amount of legwork that needs to be done to market these banks."

Others view the dispute as a fight between consultants and distressed-debt investors over who gets to make money off a helpless company. One banking lawyer, who declined to be named because he is litigating a holding-company bankruptcy case, compared consultants to buzzards and investors to hyenas.

In most cases, "the buzzards win big over the hyenas," he wrote in an email. "Living clients do something about excessive legal and consulting fees. Dead ones don't."

Consultants say their fees are higher for bankruptcy auctions because of the risk that they could go unpaid if a sale falls through. Fees are also scrutinized by creditors and trustees to determine if they are reasonable.

"These sales are not uncomplicated, they are very lengthy, and they involve a risk for the consultants," says C.K. Lee, managing director at Commerce Street Capital. "Monthly retainers are rare, so you're relying on the final fee."

Commerce Street received a $900,000 fee for advising on the Park Cities sale, a fee that was unsuccessfully challenged by the company's creditors. Lee says the fee reflected three years of work on Park Cities' behalf. "At the end of the day, if you added up all the hours we spent, we probably worked for minimum wage on this deal," he says.

The high costs of 363 auctions could become a big problem for community banks as more default on trust-preferred debt and are forced to declare bankruptcy. More than 500 banks are either in trust-preferred default or approaching it, according to Fitch Ratings. In two cases, trust-preferred creditors have forced banks into bankruptcy to recover debt. The more expensive a bankruptcy, the greater the chance that a bank's equity holders will be wiped out.

Increasingly, U.S. bankruptcy trustees have been scrutinizing bankruptcy costs and, in some cases, are seeking to deny the payment of fees they consider excessive. Beefed-up fees in the First Mariner sale were a factor that led trustee Judy Robbins in May to criticize the "questionable practice of using bankruptcy courts to facilitate bank mergers and acquisitions."

While most of the fees charged in the First Mariner, Park Cities and Metropolitan National sales were approved by the courts, some may eventually be denied. Trustees overseeing the First Mariner and Metropolitan National sales have filed objections to several fee applications, claiming the charges go beyond court-approved limits or that they were inadequately explained.

There are several reasons why auctions are so costly. The debtor and the creditors hire their own lawyers and sometimes their own financial advisors. Experts are often brought in to testify or provide guidance, along with local counsel, accountants, consultants, Chapter 11 trustees and other experts. All are paid from the bankrupt company's estate, which usually comes out of the return from the bank's sale.

In such cases, national law firms generally charge hourly rates ranging from around $200 an hour for a paralegal to up to four times that for a partner, though rates are sometimes much higher. In the First Mariner bankruptcy, Kirkland & Ellis partners were billed at up to $1,095 an hour. All told, Kirkland billed the First Mariner estate more than $921,000 for three months of work, excluding expenses, according to court filings. Kirkland & Ellis did not respond to a request for comment.

Law firms' administrative costs also add up. In Park Cities' bankruptcy sale, Ballard Spahr noted that one monthly invoice cost nearly $3,000 to prepare. Ballard has billed more than $500,000 for fees and reimbursements for that case.

Investment-banking fees, like legal fees, can vary widely. In the Metropolitan National sale, there were about $4.5 million in fees awarded to financial advisors: $2.5 million went to Keefe, Bruyette & Woods and nearly $2 million to Carl Marks Advisors.

KBW has requested another $65,417 for expense reimbursement, a charge that has drawn an objection from the U.S. trustee. KBW declined to comment, and Carl Marks did not respond to a request for comment.

The most recent bankruptcy sale shows that you can have a successful auction without high fees. Last month, D.L. Evans Bancorp agreed to pay $10.1 million for Idaho Banking, a $102 million-asset bank whose parent voluntarily filed for Chapter 11 in April due to a $7.3 million debt. The bidding was strong, with the final price ending up about $7.5 million above the initial bid.

The fees appear to be much lower than usual, even though the final bills have not yet been submitted. The debtor's financial advisor, Westwinds Capital, is in line for $40,000 for running a successful sale, plus fees of $150 an hour and reimbursements — a far cry from the costs in the Metropolitan National auction.

Ultimately, the high costs of 363 auctions may make creditors less eager to force bankruptcies and more inclined to seek other solutions. Brett Jefferson, founder of distressed-debt hedge fund Hildene Capital Management, says he's "not high on 363s" and would like to see a longer auction process managed by an impartial third party.

If creditors find 363 auctions too costly, it's their obligation to negotiate with debt-burdened community banks, Lee says. "If they're really concerned about consultants charging all these fees, they need to come to the bankers and say, 'Hey, we need to find a way to resolve this,'" he adds.

In many cases, negotiation is out of the question. Most trust-preferred debt has been securitized and bundled into collateralized-debt obligations, making it nearly impossible to identify — much less negotiate with — debtholders. Many banks are under regulatory orders barring them from paying trust-preferred creditors.

In these cases, expensive bankruptcy auctions may be the only solution. But it is possible that, as 363s become more frequent, the process will become more streamlined, and ultimately cheaper.

"We're not going to change the bankruptcy code, but costs may go down as the process becomes more routine," Ryan says. "If investment banks and lawyers can be more confident that some of their fees will be approved, they may charge less."