SCO's Chapter 11 Trustee Edward Cahn seeks to retain Boies Schiller for the SCO litigation, but at what he seems to think is a reduced rate. He says it's the new retention agreement, one the firm and SCO agreed to in August, prior to his watch, but now he is asking the court to approve it.
We learned that Boies Schiller had offered to drop approximately $515,000 of pre-petition "fees" at the July 27th hearing about whether to convert to Chapter 7, during Darl McBride's testimony. According to McBride, it meant a greater *upside* for Boies Schiller if they won. According to Cahn, it's the opposite. Which is true?
We'll break it down, but first, here are the new filings:
Exhibit A is the October 31, 2004 retention agreement between SCO and Boies Schiller. Exhibit B is a new Supplemental Declaration of Stuart Singer. Exhibit C is the proposed new agreement. And Exhibit D is Cahn's proposed order rubber stamping the new fee structure.
10/30/2009 - 941 - Motion to Authorize / Motion of the Chapter 11 Trustee for Entry of an Order Authorizing Modification of Retention Order for Boies, Schiller and Flexner LLP Nunc Pro Tunc to August 6, 2009 Filed by Edward N. Cahn, Chapter 11 Trustee for The SCO Group, Inc., et al.. Hearing scheduled for 11/20/2009 at 02:00 PM at US Bankruptcy Court, 824 Market St., 6th Fl., Courtroom #3, Wilmington, Delaware. Objections due by 11/13/2009. (Attachments: # 1 Notice # 2 Exhibit A # 3 Exhibit B # 4 Exhibit C # 5 Exhibit D) (Fatell, Bonnie) (Entered: 10/30/2009)
Note that BSF itself altered the October 31, 2004 agreement when it asked to be retained as special litigation counsel. The Stuart Singer Declaration [PDF] in support stated that any contingency fees paid should be paid only to BSF, not divided between the Original Three Firms, since it was the only one of the three original firms still providing services, and that it would be paid the full 33% minus any hourly fees already paid "at any time to the Three Original Firms". The three original firms were BSF, Kevin McBride and Berger Singerman. Singer said Kevin McBride still held a 7.5% interest.
Now, there will be no such reduction for hourly fees already paid. Considering the enormous amounts already paid to those firms, that is a huge benefit to Boies, not the estate, by my reckoning and by Darl's.
I can't show you the entire transcript of that July hearing until November 5th, but here's the part I'm referring to, on page 208, McBride on the stand:
Q Do you have an agreement with Boies Schiller with regard to their pre-petitioned fees of $515,000?
Q What is that?
A The agreement there is that that pre-petition debt goes away, and in return for that, we gave them some more upside and a possible recovery in the litigation.
That is how he described it, as "some more upside", and a possible recovery in the litigation. I would understand that to mean BSF had a possible recovery chance under the new arrangement and probably not so much under the old. SCO's lawyer, Arthur Spector, described it later in the hearing as an offer in which BSF would give up the $515,000 in return for a contingency benefit:
The BSF deal is contingent and it's not a done deal. It's an off[er] basically by Boies Schiller Flexner. It hasn't been executed. There's no signed agreements or anything like that. It's just a statement saying if we get past this and we go forward, they will do -- they'll restructure going forward their contingency fee in return for giving up their pre-petition claim and some other consideration which --
I don't know what he means by "some other consideration", but he described the new deal as BSF giving up the pre-petition billing in return for a restructured contingency fee, implying a better one.
Mr. Cahn describes it differently. In his filing, he says the agreement provides a *benefit* to the SCO estates, not to Boies Schiller. I think he's looking at the reduction in the percentages in the contigency scale, not the real-life results of no longer subtracting for amounts already paid.
If you look on page 4 of the motion, you'll see how Cahn compares the new and the old terms in a chart:
|Litigation Recoveries up to $350 million in aggregate yields BSF a share of a contingency payment of 33% of the amount of such recoveries, less payments received for hourly fees to the Original Three Firms (as defined therein), plus|| Litigation Recoveries exceeding the aggregate sum of $100 million yields BSF a contingency payment of 15% of the amount of such recoveries, plus|
| Litigation Recoveries exceeding the aggregate sum of $350 million and up to $700 million yields BSF a share of a contingency payment of 25% of the amount of such recoveries, less payments made to firms other than the Original Three Firms, plus|| Litigation Recoveries exceeding the aggregate sum of $100 million and up to $500 million yields BSF a contingency payment of 25% of the amount of such recoveries, plus
|Litigation Recoveries exceeding the aggregate sum of $700 million yields BSF a share of a contingency payment of 20% of the amount of such recoveries.||Litigation Recoveries exceeding the aggregate sum of $500 million yields BSF no contingency payment on the amount in excess of $500 million.|
That chart doesn't seem complete, if you compare it with the terms as set forth in the new retention letter, because the chart makes it seem like there is no contingency fee in any recovery less than $100 million. But the letter agreement says that BSF will get a contingency fee on any Litigation Recoveries up to $100 million as well. Here's how it's phrased in the letter to Darl that he signed off on:
1. BSF shall be entitled to a contingency fee on any Litigation Recovery as defined in the Agreement, without any deduction for legal fees previously paid under the Agreement.
The letter says it is confirming "the modification of the existing engagement ...currently set forth in the letter agreement of October 31, 2004 ("Agreement"), and as approved by the Bankruptcy Court in approving our retention as special counsel on behalf of the Debtor". But it wasn't approved without modifications, which I don't see mentioned anywhere. So, let's look at those modifications, just for the record.
2. For each Litigation Recovery, until the amount of the aggregate Litigation Recoveries exceeds the sum of $100 million, the contingency payment shall be 15% of the amount of the Litigation Recovery.
3. For each Litigation Recovery, after the amount of the aggregate Litigation Recoveries exceeds the sum of $100 million up to $500 million, the contingency payment shall be 25% of the amount of the Litigation Recovery.
4. There shall be no contingency interest on Litigation Recoveries after the aggregate Litigation Recoveries reach the sum of $500 million.
When Boies Schiller first applied to be special litigation counsel, right after SCO filed for bankruptcy, it included this wording in the application, an alteration of the pre-petition agreement:
7. BSF has consented to continue to provide such services to the Debtors on the terms set forth in the Engagement Agreement (with one modification noted below) with respect to the matters covered thereunder, and on the same basis it had represented Debtor pre-petition with respect to the SuSE Arbitration and Gray Litigation. For example, under the contingency fee provisions of the Engagement Agreement, Debtors would pay the Law Firms 33% of any recovery up to $350 million "less all hourly fees paid at any time to the Three Original Firms". BSF has consented to be engaged to continue providing professional services in these matters on the terms set forth in the Engagement Agreement, except as the sole remaining of the three Law Firms continuing to provide servers, it requests that it be entitled to the full contingency fee payable to the Law Firms (except for such amount, approximately 7.5%, to which Kevin McBride currently holds interest). However, Dorsey & Whitney waived any contingency fees at the November 16, 2007 bankruptcy hearing.
8. Prior to the Petition Date, BSF paid fees to Hatch, James, and Dodge (Utah local counsel) and Dorsey & Whitney (with respect to intellectual property assistance only), and will continue to be responsible for such fees, for work authorized to be conducted in connection with the SCO Litigation. Upon disclosure and any necessary court approval, BSF may seek to share part of its contingency interest with the other firms that it is required to compensate under the terms of the Engagement Agreement.
The US Trustee's Office in November of 2007 objected to the Boies retention terms. And it listed this as one of its suggested modifications:
9. The fees payable to BSF (including fees payable to a Litigation Recovery or a Transaction Recovery) need to be subject to review by this Court under the standard set forth in 11 U.S.C. § 330. More specifically, the compensation terms of the October 31, 2004 engagement letter should not be "pre-approved" under the standard identified in 11 U.S.C.§ 328(a).
The eventual order [PDF] by the bankruptcy court judge explicitly says that "the Application is granted as modified herein". One modification was as follows:
ORDERED that pursuant to section 327(e) of the Bankruptcy Code, the Debtors are authorized to employ and retain BSF as special counsel, effective nunc pro tunc to the Petition Date, on the terms set forth in the Application and the Declaration; provided, however that any compensation payable to BSF would be subject to review under 11 U.S.C. Section 328 with respect to (i) any Litigation Recoveries and/or (ii) any Transaction Recoveries where International Business Machines ("IBM") or Novell, Inc.("Novell") is a direct party to the Transaction; provided further, that compensation payable to BSF for (i) Transaction Recoveries where entities other than IBM and/or Novell are direct parties to the Transaction and (ii) the hourly rate services referenced in paragraph 14 of the Application shall be subject to review under 11 U.S.C. Section 330; and it is further I'm having trouble matching that last paragraph with the new Supplemental Declaration of Stuart Singer. Weren't they supposed to file an application for their bills to be paid *before* SCO paid them? Isn't that the process, so others can object? But he says SCO paid them in July $48,647.37, mainly for expenses from the Novell trial, but without submitting a fee application to the bankruptcy court. Oops. Singer says they'll get right on that.
ORDERED that, subject to the foregoing, BSF shall file applications and be compensated in accordance with sections 330 and 331 of the Bankruptcy Code, the Bankruptcy Rules, the Local Rules, and any such other procedures as may be fixed by order of this Court; and it is further
ORDERED that, with the exception of BSF, this Order does not authorize either the Debtors or BSF to employ and/or compensate professionals referenced in the Application and/or the Engagement Agreement; notwithstanding BSF's obligations under the Engagement Agreement to pay certain fees and expenses, the Debtors are obligated to separately retain such professionals before they are compensated.
And didn't the order say BSF was not to pay professionals referenced in the Application and/or the Engagement Agreement, that SCO was to separately retain them and pay them themselves? But Singer says BSF paid Dorsey & Whitney and Hatch and Dodge after SCO filed for bankruptcy. It paid Dorsey $301,437.84, $296,206 for pre-petition services) and it paid Hatch $243,080.75 ($197,220 for pre-petition services). I don't understand that at all, given the order. The thing about bankruptcy, though, is that so much seems to happen in the dark. It's not like regular civil litigation in that respect. So maybe all the i's were dotted, and I just don't know it.
Notice too the distinction between Litigation Recoveries and Transaction Recoveries? You may wish to make a note about that, since the change is only to Litigation Recoveries, as best as I can determine. So if the company were sold, for example, the Transaction contingency fees are unchanged. Reading the terms of the October 31, 2004 agreement, particularly paragraph d) on page 3, I'd say that if AutoZone is paying SCO anything as part of the proposed settlement, BSF would get its cut, so that's one way to figure out if they did. The phrasing says the contingency payments cover any settlement of claims, by SCO or by its shareholders, calculating both monetary or non-monetary benefits.
Since the new deal states, as described by Cahn on page 3, that BSF gets its contingency fees "without any deduction for legal fees previously paid" I think McBride had it right, frankly.
They've been paid millions already, and if they were to win, they'd get more.
How that works out in real life is like this: let's say they'd been paid, oh, $40 million or so. Under the old agreement, if they won $40 million in court, they'd get none of that award, because of the deduction for hourly fees already paid. Under the new agreement, in contrast, they'd get a total of $53,320,000, the $40 million they were already paid *plus* a percentage of the winnings in court too, according to the sliding scale for contingency fees, or by my math another $13,320,000. How is that a benefit to the estate?
By the old arrangement, BSF had to win the lottery, so to speak, to get past the amounts already paid, before they'd see a dime. Now, if they win even one dime, they get part of it, so the new arrangement guarantees them something, no matter how small the recovery, if any. BSF is not a goody two-shoes about getting paid. I think it's made the offer because it thinks it will benefit. They apparently used to think they'd hit the lottery. Now they are structuring to get at least something.
And so to my reckoning, I think they will, in that although the contingency percentages are lower, 33% of nothing is nothing whereas 15% of anything is still something.
Then there are the expenses that SCO is responsible for.
As of December 1, 2005, the Company had paid BSF $26,000,000, according to
for the fiscal year ended October 31, 2005.
But that's just fees. That's all paid up through the appeals in the IBM litigation. But SCO also has to pay expenses. They allocated, according to that filing, $5,000,000 for that. As of October 31, 2005, $2,875,000 remained in the escrow account.
We know from that same 10K that in that year, from October 2004 until the 10K filing, SCO paid out $212,500 in expenses to Boies Schiller and $300,000 to Kevin McBride as well. That's one year's worth. In the 10K for the fiscal year ended October 31, 2006, SCO added another $5,000,000 to that expenses escrow account. And in that 10K, it says:
Since October 31, 2004, we have spent a total of $9,954,000 for expert, consulting and other costs and fees as agreed to in the Engagement Agreement with our legal counsel in the SCO Litigation.
You can see how significant such expenses can be. And continuing to press the litigation against IBM and Novell and Red Hat will mean more expenses.
Cost of revenue from the SCOsource business was $19,743,000 for the year ended October 31, 2004, $12,847,000 for the year ended October 31, 2005 and $12,307,000 for the year ended October 31, 2006. Cost of revenue was primarily attributable to legal fees and other costs and expenses incurred in connection with the SCO Litigation. During the year ended October 31, 2006, we made the final payment to the law firms of Boies, Schiller & Flexner LLP, Berger Singerman, and Kevin McBride (the “Law Firms”) for legal fees, but are continuing to pay for the costs of experts, consultants and other costs of the SCO Litigation. In addition to the expenses incurred above, we must also pay one or more contingency fees upon any amount we or our stockholders may receive as a result of a settlement, judgment, or a sale of our company.
And as for waiving the pre-petition $515,000, in return for more of an upside, as McBride put it, that's easy to explain: they'll probably never see that money from SCO anyway. SCO is broke. And they are talking about selling "non-core assets", meaning I think everything but the litigation, so unless there is a litigation victory, BSF is looking at being left holding the bag. So all that happened, as I see it, is that Boies Schiller sees a hope, if they can pull off a miracle, of getting paid at least something. This isn't, I don't believe, a firm that does you favors. Someone has to pay for the fun in Jamaica and the $100,000 associate year-end bonuses.
In short, although their fees were capped long ago, in reality, they're not, because the expenses continue, for one thing, and not if they prevail, because the contingency is not based on any reduction of fees already paid.
By the way, did you notice that the terms clearly indicate what Boies Schiller thinks is the top amount SCO can even hope for on its best day? Lawyers don't work for nothing. So when a lawyer says he won't ask for anything if he wins more than $500 million for you, he means he is sure he can't get that much for you. So I take this as a sign of what BSF thinks the case is worth, on its best day even with stars in their eyes.
On the day SCO filed for Chapter 11 protection, it listed a debt [PDF] to BSF of $287,256.39, which Singer indicated was owed for expenses. Fees were paid in full for the original SCO litigations, but then along came the arbitration in Switzerland and the Wayne Gray matter. On those, SCO has to pay hourlies and expenses. So where is the evidence that SCO owed $515,000 in pre-petition "fees"? I may have dropped a stitch somewhere, but how did $287,256.39 become $515,000? I'm guessing it has to be the Swiss arbitration and/or the Gray litigation, but if so, why wasn't it listed in full the day SCO filed for bankruptcy protection? Maybe they didn't have the bills in hand yet, but was the first day filing ever corrected?
When IBM's lawyer, Richard Levin, was summing up at the July 27th bankruptcy hearing on whether or not there should be a conversion or a trustee appointed, he included this:
Your Honor, this case, as has been noted, is about the obsessive pursuit of litigation and perhaps the obsessive pursuit of the mobility applications, although that's a little less clear. But we have here a Chapter 11 debtor who is supposed to be a fiduciary for the estate and for the creditors. And what do we have? In fact, the court decided to appoint a neutral Chapter 11 trustee, and he did so. But has the obsession with litigation stopped?
McBride's testimony in his deposition that he will not consider selling the litigation as part of any sale, but worse we have incorrect financial statements to this court, which were not corrected until called to their attention. We have incorrect testimony not only on the board meeting, which the record will show was incorrect on the June 15th testimony, but also the reasons for the termination of the sale negotiations both with York and with SNCP, the first iteration of that.
Mr. McBride testified very clearly at the June 15 hearing that both of those deals fell apart because of the uncertainty related to the litigation. We heard a very different story today. I don't know which one to believe, but a fiduciary shouldn't be telling this court different stories.
We have a CEO of a business that has 62 employees, and he's not sure who his officers are or what officer positions they hold. We have questionable payments. There was debate about them. They attempted to justify them. But at the most -- at the least -- excuse me, Your Honor -- they were questionable.
We have a mischaracterization of board meetings. We have a public reporting company that has a false website identifying its officers, according to Mr. McBride's testimony. And we have Mr. McBride's testimony that they reached -- I'm not sure it was Mr. McBride, but we have other testimony that they reached an agreement to revise the fee agreement with Boies, Schiller & Flexner in this case without this court's approval. And that is subject to this court's approval under Section 327.
Your Honor, this does not amount to a Chapter 11 debtor that should remain in possession. These things all speak of breach of fiduciary duty, failure to follow the orders of this court, failure to comply with Chapter 11 procedures. We can debate whether that's grossly mismanagement.
So was McBride the only problem?