Court Orders Sanctions for Non-payment of Accountants

A recent opinion from the Bankruptcy Court for the District of Delaware, In re Washington Mutual, Inc., et al., Case No. 08-12229 (MFW), 2018 WL 704361 (Bankr. D. Del. February 2, 2018), illustrates the value of unambiguous contractual provisions and the importance of timely compliance with court orders.

This matter evolved out of the failure of Washington Mutual Bank in 2008 and the resulting chapter 11 bankruptcy filings.  In early 2008, prior to the bankruptcy, Washington Mutual sought to challenge the constitutionality of certain California tax policy regarding taxation of interest on federal bonds.  Washington Mutual retained the accounting firm Grant Thornton LLP to develop the theory that California was required to tax federal and state bonds similarly and assist Washington Mutual in getting tax refunds based on the theory. Although Washington Mutual and other similarly situated taxpayers stood to receive very substantial tax refunds from California if a court deemed California’s taxes on federal bond interest unconstitutional, Washington Mutual’s principal motivation was to leverage the Treasury bond interest issue against the California Franchise Tax Board (“FTB”) in order to offset Washington Mutual’s other California tax liabilities.

On September 25, 2008, Washington Mutual closed its doors and was turned over to the FDIC as receiver, whereupon the FDIC immediately sold all of Washington Mutual’s assets to JPMorgan Chase. Washington Mutual’s unceremonious farewell remains the largest bank failure in U.S. history by a very large margin. On the following day, Washington Mutual and its affiliates filed Chapter 11 bankruptcy in the District of Delaware

Washington Mutual and Grant Thornton entered into a post-petition retainer agreement pursuant to which Grant Thornton was to continue developing the Treasury bond interest issue and was to be paid its hourly fees, subject to a twenty percent discount, plus ten percent of any “Economic Value” that Washington Mutual received from the FTB, capped at $5 million. Throughout the bankruptcy proceeding, Grant Thornton assisted with the preparation of tax returns, technical memos, and letters to the FTB, as well as continuing negotiations with the FTB regarding Washington Mutual’s tax liability and objecting to the FTB’s $280.5 million proof of claim.

The Bankruptcy Court confirmed Washington Mutual’s Chapter 11 plan of reorganization in early 2012, and a liquidating trust (the “Liquidating Trust”) was set up to handle the distributions to creditors. In August 2012, the Bankruptcy Court entered the final Omnibus Fee Order which included Grant Thornton’s contingent fee. Grant Thornton later learned by browsing the docket that Washington Mutual had reached a settlement with the FTB. Pursuant to the settlement, the FTB obtained a full and complete release in exchange for an immediate tax refund to Washington Mutual in the amount of $225 million, in addition to other deferred refunds. Upon learning of the settlement, Grant Thornton requested that the Liquidating Trust pay Grant Thornton’s contingent fee. The Liquidating Trust refused to pay on the basis that the FTB had always rejected the Treasury bond interest issue and that none of the settlement funds were in consideration for the Treasury bond interest issue. Thus, the Liquidating Trust believed that Grant Thornton was not entitled to the contingent portion of its fees. Grant Thornton moved for the imposition of sanctions against the Liquidating Trust in April 2015.

In granting Grant Thornton’s motion, the Court found that the contingent fee language in the retainer agreement was broad and unambiguous, that the contingent fee was not improvident under Section 328(a) of the Bankruptcy Code, and that Grant Thornton was entitled to sanctions because the Litigation Trust was in civil contempt of the Omnibus Fee Order. The Liquidating Trust had argued that there was a “mutual mistake” regarding the post-petition retention agreement in that the agreement erroneously expanded Grant Thornton’s contingency fee to all recoveries from FTB rather than just those related to the Treasury bond interest issue.  However, the Court determined that the terms in the retainer agreement were clear and intentionally broad, containing no qualification that funds not directly attributable to the Treasury bond interest issue were excluded. The parties had anticipated all along that the FTB might reject Washington Mutual’s position on the Treasury bond interest issue but still agree on a settlement in order to keep a court from ruling on it.

The Court found that § 328(a) sets a high bar for a finding of improvidence. After approving the terms of a professional’s compensation under § 328, a court will only allow different compensation “if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of” entry. In this case, the Court found that the parties could certainly have foreseen that the Court would enforce the agreement exactly as written. Further, the Court was not persuaded by the Liquidating Trust’s argument that there had been a mutual mistake regarding the contingent fee arrangement. The Court noted that even if “the Debtors were unilaterally mistaken,” such unilateral mistake would not be the basis for a finding of improvidence.

Finally, the Court found that the imposition of sanctions against the Liquidating Trust was appropriate where the Liquidating Trust continued to ignore the final fee order entered by the Court even despite Grant Thornton’s repeated requests for payment and despite the Court’s determination that the plain terms of the retainer agreement entitled Grant Thornton to the contingent fee. The Court found that the Liquidating Trust “demonstrated an inexcusable disregard for the Court’s order” that could not be “remedied by a pleading of good faith.” Thus, in addition to the recovery of its contingent fee, the Court concluded that Grant Thornton was also entitled to recover the costs associated with filing and prosecuting its motion as a sanction against the Liquidating Trust.

Although the Liquidating Trust may have had a legitimate disagreement as to the terms of the retention agreement with Grant Thornton, it appears that the repeated refusal to comply with the Court’s order based on the Liquidating Trust’s unilateral position that there was mutual mistake is what led to the ultimate imposition of the sanction.  The Court noted that the Liquidating Trust “could have either remitted the Contingency Fee or sought relief from the Court.” It did neither, and just refused to comply with the Court’s order which proved to be an expensive obstinacy.