Can Creditors Recover Attorney’s Fees in Bankruptcy Cases?

by Andrew K. Alper and Hal D. Goldflam May/June 2007

Creditors are often faced with the dilemma as to whether they can recover their legal fees incurred in a bankruptcy once the lessee or debtor files a bankruptcy petition. In the Travelers’ case, the U.S. Supreme Court tackled the question as to whether a creditor may recover attorney’s fees authorized by a prepetition contract and incurred in postpetition litigation.

As a backdrop to Travelers Casualty and Surety Company of America, v. Pacific Gas and Electric Company, 549 U.S. (2007), in California, a prevailing party may be awarded its reasonable attorney’s fees and costs pursuant to a contract, which allows for such award (see Civil Code §1717). Additionally, assuming the appropriate attorney’s fees clause in a contract, a secured creditor is also entitled to its attorney’s fees and costs in connection with the protection and preservation of its collateral (see Civil Code §1021). Therefore, unless there is a provision in a contract providing for the award of attorneys fees and costs in connection with litigation or in connection with the protection or preservation of its collateral, a creditor will not be entitled to attorneys fees and costs unless there is some statute providing for the award of attorneys fees.

Travelers Casualty & Surety Company (Travelers) issued a surety bond to guarantee Pacific Gas and Electric Company’s (PG&E) continued payment of workers’ compensation benefits in the event PG&E defaulted on its obligations as a self-insured to pay benefits. PG&E contractually agreed to indemnify Travelers for any loss Travelers may incur in connection Travelers suffered in connection with the bond, including attorney’s fees, which Travelers may incur in protecting or otherwise litigating its rights under the bond.

PG&E subsequently filed a voluntary Chapter 11 bankruptcy petition. Although PG&E had not defaulted on its obligations to provide workers’ compensation benefits, Travelers filed a claim as an unsecured creditor to protect itself in the event PG&E defaulted on its workers’ compensation benefits sometime in the future. Following an agreement with the parties and after the Bankruptcy Court’s approval, PG&E agreed to insert language into its plan of reorganization to protect Travelers’ rights in case of a default. Travelers alleged PG&E then altered the negotiated language that provided the protection it had sought, resulting in additional litigation between the PG&E and Travelers. Travelers and PG&E ultimately resolved the dispute by a court-approved stipulation providing Travelers may assert its claim for attorney’s fees pursuant to the indemnity contracts.

When Travelers then tried to get attorney’s fees for the money it spent in fighting PG&E in the bankruptcy proceedings, PG&E objected. PG&E argued Travelers could not recover attorney’s fees incurred while litigating issues of bankruptcy law. The Bankruptcy Court agreed and rejected Travelers’ claim on that basis, and the District Court and the Ninth Circuit Court of Appeals affirmed. The three courts relied on In re Fobian, 951 F.2d 1149 (9th Cir. 1991) wherein the Ninth Circuit held that attorney’s fees are not recoverable in bankruptcy for litigating issues “peculiar to federal bankruptcy law.” The fees claimed by Travelers failed because they were incurred litigating issues that “were governed entirely by federal bankruptcy law.”

The Supreme Court unanimously overruled the Ninth Circuit finding the Bankruptcy Code did not expressly trump the contractual obligation to reimburse attorney fees even if incurred in litigating bankruptcy law issues. In making its ruling, the Court first acknowledged the “American Rule” that the prevailing litigant generally is not entitled to attorney’s fees, but that this rule may be overcome by a statute or an enforceable contract between the parties. Moreover, under bankruptcy law, fees pursuant to a contract are allowed unless the Bankruptcy Code specifically says otherwise. The Court thus analyzed “whether the Bankruptcy Code disallows contract-based claims for attorney’s fees based solely on the fact that the fees at issue were incurred litigating issues of bankruptcy laws,” (rather than State law claims).

Under the Bankruptcy Code, the Bankruptcy Court must allow a creditor’s claims unless the one of the nine exceptions specified in 11 U.S.C. §502(b)(2)-(9) exists. The Court found that Travelers’ claim for attorney’s fees had nothing to do with any of the exceptions (i.e., the claim had nothing to do with property tax, child support or alimony, services provided by an attorney of the debtor, damages resulting from the termination of a lease or employment contract, or the late employment of any employment tax). Nor was Travelers’ claim untimely.

The Court therefore analyzed whether the attorney’s fees claimed were properly claimed under 11 U.S.C. §502(b)(1). §502(b)(1) provides a claim is “unenforceable against the debtor and property of the debtor, under any agreement or applicable law for a reason other than because such claim is contingent or unmatured.” The Court stated this provision “is most naturally understood to provide, with limited exceptions, any defense to a claim that is available outside of the bankruptcy context is also available in bankruptcy. This reading, according to the Court, is consistent with the language of the Bankruptcy Code, as well as settled law, and thus when the Bankruptcy Code uses the word “claim,” it is usually referring to a right to payment recognized under state law.

In denying Travelers’ claim for contractual attorney’s fees, the Court noted the Ninth Circuit had not concluded that Travelers’ claim was unenforceable under §502(b)(1) as a matter of applicable nonbankruptcy law. And it did not conclude the attorney’s fee claim was unenforceable under any provision of the Bankruptcy Code. Notably, the Ninth Circuit acknowledged that, in some cases, the prevailing party in a bankruptcy action is entitled to fees. Rather, the Ninth Circuit denied Travelers’ attorney’s fee claim based on the Fobian rule, which the Court rejected because the Fobian rule is a rule solely of the Ninth Circuit’s own creation with no support whatsoever in the Bankruptcy Code. The Supreme Court noted Congress has the authority to amend the Bankruptcy Code to expressly disallow claims for attorney’s fees incurred by creditors litigating bankruptcy issues, but since no provision exists, the Ninth Circuit had no basis for disallowing Travelers’ claim.

Finally, PG&E, which made no effort to defend the Fobian rule, argued the Court should affirm on the grounds that unsecured claims for contractual attorney’s fees, such as Travelers’, are categorically disallowed under 11 U.S.C. §506(b). This section of the Bankruptcy Code only allows a creditor to get attorneys fees and costs if it is an oversecured creditor. Since Travelers was an unsecured creditor, it was argued it is not entitled to attorney’s fees as a matter of law. The Supreme Court did not consider this argument since it was neither raised nor addressed by the Bankruptcy Court nor the Ninth Circuit Court of Appeals but the case was taken by the Court only to resolve the issue created by the Fobian rule.

What Travelers teaches us is an attorney’s fees provision on a lease, security agreement, note, equipment financing agreement, deed of trust, mortgage, guaranty, or other document or agreement should be sufficiently broad so it will award a creditor its attorney’s fees and costs in a bankruptcy proceeding since the U.S. Supreme Court has indicated such provisions may now be enforceable.

Andrew K. Alper is a partner with the law firm of Frandzel Robins Bloom & Csato, LC in Los Angeles. Alper has been representing equipment lessors, funding sources and other financial institutions since 1978. Alper obtained his Bachelor of Arts degree in Political Science, Magna Cum Laude, from the University of California at Santa Barbara and received his Juris Doctor from Loyola Marymount University School of Law making the Dean’s List.

Hal D. Goldflam is an attorney with Frandzel Robins Bloom & Csato, LC Goldflam’s practice emphasizes business and commercial litigation at the trial and appellate levels. Goldflam represents court-appointed receivers in many large-scale fraud cases brought by the Federal Trade Commission and the SEC. Goldman obtained his B.A. from the University of California at Irvine, and graduated summa cum laude from Southwestern University School of Law, J.D.

Frandzel Robins Bloom & Csato’s practice emphasizes the representation of equipment lessors and funding sources in all aspects of equipment leasing including litigation, documentation, bankruptcy and transactional matters. Besides representing equipment lessors and funding sources, it represents banks and other financial institutions in the area of commercial litigation, insolvency, secured transactions, banking law, real estate and business litigation.

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