Daily Development for Friday, June 8, 2007
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

Another Jack Murray special: Welcome back, Jack!!

ATTORNEYS' FEES; BANKRUPTCY: U.S. Supreme Court rules that Bankruptcy Code does not disallow contract-based claims for attorneys' fees based solely on fact that fees at issue were incurred litigating issues of bankruptcy law.

Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 127 S.Ct. 1199 (2007).

An issue that has been litigated (with conflicting results) is whether the Bankruptcy Code disallows a lender's contract-based claims for attorneys' fees based solely on the fact that the fees at issue were incurred litigating issues of bankruptcy law. On March 20, the U.S. Supreme Court, in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 127 S.Ct. 1199 (2007), settled this issue by concluding that it does not. Lenders can collect these fees where otherwise permitted.

Prior to the bankruptcy proceedings in this case, Travelers Casualty & Surety Co. of America ("Travelers"), a creditor of the debtor, had issued a surety bond on the debtor's behalf guaranteeing the debtor's payment of state worker's compensation benefits. Travelers filed a claim in the debtor's subsequent bankruptcy proceeding to protect itself in the event of the debtor's future default of payment of the workers' compensation benefits. The bankruptcy court, the U.S. District Court, and the Ninth Circuit Court of Appeals all denied Travelers' application for work done negotiating the language in the debtor's post-petition reorganization plan and disclosure statement that provided for Travelers' right of indemnification and indemnity in the event of default. But the U.S. Supreme Court held that Travelers was not precluded from filing an unsecured claim for its contractual attorneys' fees, merely by virtue of the fact that the fees sought had been incurred in litigating issues of
federal bankruptcy law.

This decision by the Supreme Court abrogated a prior holding by the Ninth Circuit, In re Fobian, 951 F.2d 1149, which had held that where the ability to recover attorneys' fees was basically one interpreting federal bankruptcy law, attorneys' fees could not be recovered even though the dispute arose out of a contract containing a provision for the recovery of such fees. This rule (called the "Fobian rule") was contrary to the rule applied by the Fourth Circuit Court of Appeals in In re Shangri-La, Inc., 167 F.3d 843, 848-49 (C.A.4 1999), and the Supreme Court therefore granted certiorari in the Travelers Casualty & Surety Co. case to resolve the conflict.

The Supreme Court acknowledged that generally the "American Rule" does not award attorneys' fees to the winner of litigation, but held that the rule does not apply when where the parties have entered into an enforceable contract allocating attorneys' fees. The Supreme Court stated that the ability to recover attorneys' fees was basically one of state law and that "unless some federal interest requires a different result, there is no reason why such interests should be analyzed any differently simply because an interested party is involved in a bankruptcy proceeding." Id. at 1205 (quoting Butner v. United States, 440 U.S. 48, 57 (1999)). The court also found that there was nothing in the Bankruptcy Code that supported the Fobian rule and that the Bankruptcy Code simply directs bankruptcy courts to determine whether applicable state law would permit the recovery of attorneys' fees and to apply that same result to disputes in bankruptcy proceedings. As a result of the Supreme Court'
s ruling, a creditor having a legitimate claim can now safely include attorneys' fees (assuming the contract between the parties allows such fees) as part of its bankruptcy claim whether or not the fees arise out of litigation involving issues of federal bankruptcy law (but the resultant increase in the amount of the claim will not alter the relative priority or ultimate collectability of the claim).

Reporters Comment 1: Interestingly, the Supreme Court refused to consider the debtor's argument that 506(b) of the Bankruptcy Code disallows unsecured claims for contractual attorneys' fees where -- as in this case -- the creditor's entire claim was unsecured. (Section 506(b) authorizes claims for contractual attorneys' fees to the extent the creditor is oversecured, but disallows such claims to the extent the creditor is either not oversecured or completely unsecured.) The court stated that the debtor had not raised or addressed this argument in the courts below and that the debtor "has failed to identify any circumstances that would warrant an exception to that rule in this case." Id. at 1207. The court further stated that in this particular case "[w]e granted certiorari to resolve a conflict among the lower courts regarding the Fobian rule, which is analytically distinct from, and fundamentally at odds with, [the debtor's] reading of 506." Id. The court reasoned that such
 a reading of 506 "would prohibit all unsecured creditors from recovering contractual postpetition attorneys' fees in bankruptcy proceedingsE2=80=93 even if those fees were incurred while litigating issues of state law." Id. at n.4. The court was careful, however, to state that "[w]e conclude only that the Court of Appeals erred in disallowing that claim based on the fact that the fees at issue were incurred litigating issues of bankruptcy law." Id. at 1208.

Reporters Comment 2: Section 506(b) of the Bankruptcy Code permits a secured creditor, to the extent that its claim is oversecured, to collect interest on such claim and any reasonable fees (including attorneys' fees, costs, and charges) that are provided for in the loan documents. See, e.g., In re Foertsch, 167 B.R. 555, 562 (Bankr. D.N.D. 1994) (holding, in context of request for recovery of attorneys' fees, that in order to recover "fees, costs and charges" under 506(b), creditor must establish: (1) that it is oversecured in excess of the amount requested; (2) that the amount requested is reasonable; and (3) that the agreement giving rise to the claim provides for recovery of the fee, cost or charge requested); In re Udhus, 218 B.R. 513, 517 (9th Cir. B.A.P. 1998) (same, with respect to claim by creditor for "administrative costs"); In re Direct Transit, Inc., 226 B.R. 198, 201, 203 (8th Cir. B.A.P. 1998) (ruling that 506(b) permits a claim for additional charges if the c
laim is oversecured, the charge is provided for in the agreement, and it is reasonable; In re Hyer, 171 B.R. 67, 70 (Bankr. W.D. Mo. 2004) (holding that oversecured creditor is entitled to enforce valid contractual obligation for payment of attorneys' fees where an attorneys' fee provision is included in the debt instrument, as long as the fees requested are reasonable.)

Reporters Comment 3: The oversecured creditor generally can collect attorneys' fees even if applicable state law prohibits the collection of such fees by the creditor. See, e.g., In re Hyer, supra, 171 B.R. 69 (stating that "506(b) allows an oversecured creditor to recover attorneys' fees if they are provided in the security agreement, notwithstanding Kansas law." [Note: The Kansas Legislature amended Kan. Stat. Ann. 58-2312 in 1994, to allow the inclusion of attorneys' fee provisions in notes, mortgages or other credit agreements. 1994 Kan. Sess. Laws Ch. 276, 3]); In re American Metals Corp., 31 B.R. 229, 234 (Bankr. D. Kansas 1983) (same); In re Schriock Const., Inc., 104 F.3d 200, 203 (8th Cir. 1997) (holding that attorneys' fees provisions in loan documents are enforceable in bankruptcy even though state law prohibits them).

Reporters Comment 4: Another issue that bankruptcy courts have wrestled with is whether the "reasonableness" of the charges under 506(b) is determined by state or federal lawE2=80=93 or both. See, e.g., In re Dixon, 228 B.R. 166, 177 (Bankr. W.D. Va. 1998) ("[t]he reasonableness of charges under 506(b) is determined by reference to the relevant state contract law"). But see In re 268 Ltd., 789 F.2d 674, 676-77 (9th Cir. 1986) (applying single federal standard of "reasonableness" with respect to issue of whether an attorneys' fees provision is allowable under 506(b)); cf. In re Hudson Shipbuilders, 794 F.2d 1051, 1058 (5th Cir. 1986) (holding that fees otherwise enforceable under state law were still subject to 506(b)'s requirement that fees be "reasonable"); In re Hyer, supra, 171 B.R. at 71 ("11 U.S.C. 506(b) is not dependent upon state law. 11 U.S.C. 506(b) allows the recovery of reasonable attorneys' fees to an oversecured creditor if they are provided for in the underl
ying agreement, which is the case herein").

Reporters Comment 5: Bankruptcy courts also have reached conflicting results with respect to the issue of whether 506(b) applies only to post-petition (as opposed to pre-petition and post-petition) fees and charges. See, e.g., In re Nunez, 317 B.R. 666, 670 (Bankr. D. Pa. 2004) ("We hold that section 506(b) applies only to post-petition interest, fees and costs sought as part of a secured claim. Quite simply, interest, fees and costs arising pre-petition are already a part of a secured creditor's proof of claim in the first instance, rendering section 506(b) inapplicable"). But see In re Hyer, supra, 171 B.R. 70 ("When an oversecured creditor is entitled to enforce a valid contractual obligation for the payment of attorneys' fees, 11 U.S.C. 506(b) applies whether the attorneys' fees were incurred before or after the filing of the bankruptcy petition."). Cf. Laxa v. United States (In re Laxa), 312 B.R. 394, 398 (D. Ariz. 2003) ("While post-petition charges, including penaltie
s, may be included in a secured claim only as authorized by section 506(b), pre-petition charges, including penalties, are properly included as part of the secured claim" (citations omitted)). See also In re Leatherland Corp., 302 B.R. 250, 256-57 (Bankr. D. Ohio 2003) ("Even though they all assert they are interpreting the plain meaning of the statute . . . courts have arrived at differing conclusions as to whether 506(b) applies to prepetition as well as to postpetition fees, costs and charges" (citations omitted)).

Reporters Comment 6: It is incomprehensible that the debtor's attorneys did not argue, at any stage during the proceedings in the lower courts, the applicability and relevance of 506(b) of the Bankruptcy Code in this particular matter. The debtor was therefore barred from raising this important issue before the Supreme Court, even though Travelers' entire claim was unsecured. The Supreme Court seems to have vacillated on how it would have ruled if this issue had been properly raised, and was careful to clearly limit its holding to overturning the Fobian rule.

Reporters Comment 7: Lenders should be careful to request specifically, in state foreclosure proceedings, that attorneys' fees and other charges and fees (such as a prepayment premium) provided for in the note and/or mortgage be specifically included in the foreclosure judgment so that the state court will allow such fees and charges and bankruptcy courts will permit collection of such fees and charges if a bankruptcy proceeding is subsequently filed by or against the mortgagor. See, e.g., In re McClung (Bankr. D.Kan., Dec. 11, 2003), ("If [the lender] wished to assert its right, under the note and mortgage that were the subject of the suit, to a prepayment penalty, it was required to raise the issue in the foreclosure proceeding it commenced in state court, or be forever barred").

The reporter for this item was Jack Murray of the First American Title Insurance Company in Chicago.

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