The ruling of the Ninth Circuit in the case In re SNTL Corp. (SNTL Corp. v. Centre Insurance Co.), 571 F. 3d 826 (9th Cir. 2009) (per curiam) (the SNTL decision for convenience) affirms and adopts in its entirety the published decision of the Ninth Circuit Bankruptcy Appellate Panel in the case In re SNTL Corp., 380 B.R. 204 (B.A.P. 9th 2007), which decided all of these questions in favor of the creditor. The opinion provides a persuasive precedent for courts in other jurisdictions to consider on an unsecured creditor’s right to recover attorneys’ fees and costs in bankruptcy as well as guidance for creditors and their counsel in drafting and enforcing revival clauses in settlements.

Relevant Facts
In simplified form, the facts of the SNTL case concern a debtor that had guaranteed the obligations of its affiliate to the creditor Centre Insurance Company (Centre). Prior to its bankruptcy filing, the guarantor defaulted on those obligations and entered into a written settlement agreement by which Centre was paid $163.4 million as a settlement payment and Centre immediately released the guarantor for obligations up to $180 million. The settlement agreement also included a revival provision by which, if a court of competent jurisdiction over the subject matter or the parties to the settlement “enters a final order, judgment or other finding that … a payment under the [settlement] … constitutes a voidable or preferential transfer, … an improper or disproportionate payment … or is otherwise in violation of law or subject to a claim or preference,” then the creditor could declare the settlement null and void or exercise “any other remedy provided by law, equity, statute or contract.”

Over a year after the debtor/guarantor filed its bankruptcy petition, the insurance commissioner filed suit in state court against Centre for recovery of the settlement payment made to the creditor under the settlement agreement on the grounds that the payment was a voidable preference under applicable state preference statutes. The creditor subsequently agreed to compromise the preference claim for a partial return of the settlement payment of $110 million.

Centre submitted the compromise on the preference claim to the state court for entry of a court order approving the compromise. The court order approving the settlement included a recital that a.) the Insurance Commissioner sought to recover the settlement payment to Centre and avoid the payment as a preferential transfer, and b.) the settlement payment was made on account of transfers asserted to be preferential and not tort claims.

After the debtor/guarantor filed its Chapter 11 petition, Centre filed a proof of claim that included a reservation of the right to seek additional sums if any portion of the settlement payment it received was deemed avoidable. In addition, the initial proof of claim included a claim for attorneys’ fees based on the attorneys’ fees provision of the prepetition guaranty agreement.

The debtor/guarantor later confirmed a Chapter 11 plan pursuant to which a litigation trust was formed with the power to pursue preference and other avoidance litigation through its trustee. After Centre settled the preference claim with the insurance commissioner, Centre filed an amended proof of claim in the debtor/guarantor’s bankruptcy case, asserting an amended claim that included the amount recovered by the insurance commissioner under the compromise of the preference claim. The trustee objected to the proofs of claim filed by Centre.

Legal Framework as to Allowance of Centre’s Claim and Trustee’s Contentions
The term “claim” is defined in §101(5) of the Bankruptcy Code to include claims that are unliquidated, unmatured and contingent. See also 11 U.S.C. §502(b)(1), where the court can disallow a claim against the debtor if it is unenforceable against the debtor under an agreement or applicable law for a reason other than the fact that the claim is contingent or unmatured. Section 502 of title 11 governs allowance of claims in bankruptcy. Claims are to be determined “as of the date of the filing of the petition” under §502(b), and §502(b)(2) expressly disallows claims for “unmatured interest.” In addition, §502(c)(1) authorizes and directs the court to estimate claims that are contingent or unliquidated, if the determination or liquidation of the claim would unduly delay the case.

The trustee asserted that as of the date of filing of the debtor/guarantor’s petition in bankruptcy, Centre had irrevocably released the debtor from its obligations and therefore had no claim against the debtor. The trustee argued that since claims are to be determined under the plain language of §502 as of the petition date, Centre could not rely on postpetition actions and events to revive the guarantor’s liability to Centre and to provide a basis for assertion of a claim against the bankruptcy estate.

Further, the trustee contended that under the language of the revival provision of the settlement agreement, the triggering event that would revive the guarantor’s obligation to Centre had not occurred since there had been no judgment or order finding the settlement payment in the preference action to have been a preference or voidable transfer and that the compromise of the claim with the insurance commissioner did not meet the criteria established in the settlement agreement for the revival to apply. In addition, the trustee argued that the payment to the insurance commissioner by Centre did not allow Centre to assert a claim against the guarantor for recovery of the amount paid as a remedy under applicable non-bankruptcy suretyship law.

Court’s Rulings on the Allowance of Centre’s Claim for Recovery of Payment
The court held that the settlement agreement and release, even though fully consummated prepetition, did not bar Centre’s assertion of a claim against the debtor/guarantor. The court reasoned that the settlement agreement and release was not an irrevocable release but included an express contingency by which the debtor/guarantor remained liable to the creditor; namely, in the event the settlement payment was subsequently challenged and recovered in whole or in part as a preference or other voidable transfer, the debtor would remain liable to the creditor for the amount recovered. The Bankruptcy Code definition of “claim” expressly contemplates contingent claims being treated as claims in bankruptcy.

Section 502(b)(1) and §502(c)(1) confirm that contingent claims can be asserted and valued for the purposes of participation in the claims process in a bankruptcy case. That the contingency contemplated under the settlement agreement occurred postpetition did not mean that for the purposes of §502(b) the claim “arose” postpetition; rather, the claim arose out of the settlement agreement and the debtor’s prepetition contractual relationship with the creditor.

The court also rejected the argument by the trustee that the “triggering event” required under the revival provision had not occurred. Citing the terms of the revival provision, the court concluded that the state court order’s recitals regarding the fact that the insurance commissioner asserted the $163.4 million payment was a preference and that the $110 million payment made by Centre in compromise of the preference action was to restore the alleged preferential payment met the specific terms of the revival provision.

Under the terms of the revival provision, once the triggering event occurred, the creditor was authorized to exercise “any other remedy provided by law, equity, statute of contract.” In a key ruling for creditors under suretyship law, the court concluded: “While we located no Ninth Circuit or California case precisely on point, we agree that the return of a preferential payment by a creditor generally revives the liability of a guarantor.”

The trustee argued that in order for this general principal of suretyship to apply, the repayment of the preference must be “involuntary” and that the payment by Centre as part of a compromise was “voluntary” and therefore did not bring the payment within this principle. The Ninth Circuit also rejected that argument, citing authorities for the general proposition that the return of a payment alleged to be a preference itself revives the guarantor’s obligation and also that even if the return of the preference payment had to be “involuntary” for this principle to apply, a payment made in compromise of pending litigation is not voluntary and is made under a degree of compulsion imposed by the lawsuit. Therefore, the payment made by Centre met this standard and the debtor/guarantor’s liability was revived to the extent of the payment under applicable non-bankruptcy law and Centre had an allowable claim as of the date of the debtor’s petition.

Legal Framework as to Allowance of Claims for Attorneys’ Fees & Ninth Circuit Ruling That Unsecured Creditors Are Not Barred From Claiming Attorneys’ Fees
The trustee also argued that Centre was not entitled to include millions of dollars in attorneys’ fees incurred by Centre postpetition as part of its claim against the estate. The trustee relied on §506(b) as a bar to Centre claiming attorneys’ fees, arguing that only secured creditor whose collateral is worth more than the allowed secured claim are entitled to recover attorneys’ fees as part of their claim. Section 506(b) provides that if the value of the collateral securing a creditor’s claim exceeds the amount of the claim, then “there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs or charges provided for under the agreement” or state law under which the claim arises.

The question of whether the Bankruptcy Code precludes unsecured creditors from recovering attorneys’ fees incurred postpetition based on a prepetition contract providing for attorneys’ fees was raised but not determined by the United States Supreme Court in its decision in Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. ___,
127 S. Ct. 1199 (2007). The Ninth Circuit noted that since the Travelers decision, courts across the country have divided on the issue of whether an unsecured creditor may include attorneys’ fees in its claim based on its prepetition attorneys’ fees clause, with a “sizable minority” concluding that nothing in the Bankruptcy Code precludes such a claim.

The Ninth Circuit joined that “sizable minority,” rejecting the contention that §506(b) somehow implicitly precludes recovery of attorneys’ fees by unsecured creditors and citing the provisions of §502(b), which disallow claims for “unmatured interest” but does not provide for disallowance of attorneys’ fees or other charges. The court also rejected the contention that public policy considerations warranted denial of a claim for attorneys’ fees by an unsecured creditor based on an equality of distribution principle and other considerations.

Further, consistent with the court’s ruling regarding the rest of Centre’s claim, the court ruled that the prepetition agreement between Centre and the guarantor gave rise to a contingent, unliquidated claim for attorneys’ fees that arose prior to the petition date. The court remanded the case to the bankruptcy court for determination of whether the specific contract with Centre authorizes recovery of attorneys’ fees in this case and whether any other grounds, other than Centre’s status as an unsecured creditor, warranted disallowance of attorneys’ fees as part of its claim.

Conclusion
The SNTL decision provides some important guidance for creditors in the drafting and enforcement of revival provisions in a settlement. The specific criteria to be met in order for the revival to arise must be carefully scrutinized and satisfied by the creditor strictly according to the language of the provision to ensure the revival will be deemed effective and to arise under the terms of the prepetition contract. Further, unsecured creditors now have another significant reported decision to rely on in asserting a claim for allowance of attorneys’ fees in bankruptcy based on their written prepetition agreements.

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Lesley Anne Hawes, a partner in the Los Angeles office of McKenna Long & Aldridge, LLP, specializes in the representation of secured and unsecured creditors in bankruptcy proceedings and in the representation of federal equity receivers appointed in civil enforcement actions by federal agencies such as the Federal Trade Commission and Securities and Exchange Commission. Hawes is a regular contributor to the Monitor and other legal journals, and she has lectured for the National Business Institute and other organizations. She graduated Order of the Coif from University of Southern California law school and earned her undergraduate degree in political science magna cum laude from University of Southern California.