Thirty-Forth Annual Southeastern Bankruptcy Law Institute Atlanta, Georgia April 3-5, 2008

Transcription

1 Thirty-Forth Annual Southeastern Bankruptcy Law Institute Atlanta, Georgia April 3-5, 2008 COLLECTION OF ATTORNEYS FEES BY CREDITORS- EFFECT OF TRAVELERS CASUALTY & SURETY CO. OF AMERICA v. PACIFIC GAS & ELECTRIC CO. (2007) 1 Paul Steven Singerman Grace E. Robson Berger Singerman, P.A. I. Introduction The issue of attorneys fees is near and dear to all constituents in bankruptcy cases. Supreme Court precedent on the subject is rare, 2 so when the Court addresses this topic, practitioners are well served to pay heed. In March 2007, the United States Supreme Court issued its opinion in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 127 S. Ct (2007). The Travelers opinion is clear in its articulation of what the law regarding the rights of an unsecured creditor to recover post-bankruptcy attorneys fees is not and what issues were not properly before it. But the Court stops short - but not too short - of articulating what the law is regarding the extent to which unsecured creditors claims for attorneys fees are allowable in bankruptcy. This article presents the genesis of the Fobian rule, a discussion of Travelers and its abrogation of pre-travelers law, Travelers possible impact on debtors, creditors and case administration, the questions left open by the Supreme Court in that decision, and decisions since Travelers. In addition, this article offers a discussion of why Travelers does not necessarily alter the likelihood that unsecured and undersecured creditors requests for post-petition attorneys fees will continue to be disallowed. 1 Travelers Cas. & Sur. Co. Of Am. v. Pac. Gas & Elec. Co., 127 S. Ct (2007). 2 Lamie v. United States Trustee, 540 U.S. 526 (2004) is the only other Supreme Court case the authors could find involving the issue of whether attorneys fees should be allowed against a bankruptcy estate. In Lamie, a chapter 11 case was converted from a chapter 11 to chapter 7. The chapter 11 debtor s counsel filed an application for compensation for services provided after the case was converted to chapter 7. The Supreme Court held that section 330(a)(1) of the Bankruptcy Code does not authorize compensation to an attorney for a debtor unless employed by the trustee under section

2 II. The Fobian Rule and Its Genesis The Fobian rule was espoused by the Ninth Circuit in Fobian v. W. Farm Credit Bank (In re Fobian). 3 In Fobian, the Ninth Circuit affirmed the district court s reversal of the confirmation of the Fobians chapter 12 plan. 4 The creditor who appealed sought an award of attorneys fees and costs based upon a pre-bankruptcy promissory note and deed of trust made by the debtor in favor of the creditor which provided for the payment of fees and costs incurred in collecting amounts due or for the enforcement of its rights. 5 Significant for purposes of this discussion, the Fobian rule originated from the Ninth Circuit s holding that where the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law, attorney s 6 fees will not be awarded absent bad faith or harassment by the losing party. 7 The Ninth Circuit cited to four of its own cases in support of the Fobian rule: (a) Collingwood Grain, Inc. v. Coast Trading Company, Inc. (In re Coast Trading Company, Inc.); 8 (b) Grove v. Fulwiler (In re Fulwiler); 9 (c) Merced Production Credit Association v. Sparkman (Matter of Sparkman); 10 and (d) Johnson v. Righetti (In re Johnson). 11 A. Coast Trading In Coast Trading, the debtor was a grain broker which ordered eight carloads of grain from a grain company to be shipped directly to clients of the debtor. 12 The grain company shipped the grain, but the debtor s checks were dishonored and then it filed a bankruptcy petition. 13 The debtor s clients deposited the money owed for the grain with the bankruptcy court, which awarded the debtor the amounts due on six out of the eight 3 Fobian v. Western Farm Credit Bank (In re Fobian), 951 F.2d 1149 (9 th Cir. 1991). 4 Id. at Id. 6 The singular and plural form of the phrase attorney s fees / attorneys fees has been used in the reported decisions cited herein. The co-authors believe that placing the apostrophe after the s is grammatically proper since attorneys is a plural-possessive form of a noun that ends in s. 7 Id F.2d 686 (9 th Cir. 1984) F.2d 908 (9 th Cir. 1980) F.2d 1097 (9th Cir. 1983) F.2d 738 (9 th Cir. 1985). 12 Id. at Id. 2

3 carloads of grain. 14 The issues on appeal included: (a) whether the grain company was entitled to (i) the value of the six carloads under section of the Uniform Commercial Code (the UCC ) or (ii) administrative expense under section 546(c) of the Bankruptcy Code for the value of the six carloads, and (b) whether either the debtor or grain company was entitled to attorneys fees pursuant to Oregon statutes that provide for attorneys fees to the prevailing party in actions on dishonored checks as well as on contracts that provide for attorneys fee awards. 15 The Ninth Circuit, without citing to any authority, held that [t]here is no general right to attorneys fees for actions in bankruptcy. 16 In the next sentence, the Ninth Circuit held that [a] party may, however, be entitled to attorneys fees in the bankruptcy proceeding in accord with the applicable state law. 17 Ultimately, the Ninth Circuit held that the action was outside the scope of the first statute regarding dishonored checks since the obligation to pay was never in dispute. 18 Further, the Ninth Circuit held that the second statute was not applicable because the action did not seek enforcement of the contracts, but sought to rescind or cancel them. 19 The Ninth Circuit held that [a]bsent bad faith or harassment, attorneys fees are not available for the litigation of federal bankruptcy issues under a contract which provides for attorneys fees for the enforcement of a contract. 20 B. Fulwiler In Fulwiler, a creditor filed a complaint seeking to have the debtor s discharge set aside. 21 One of the creditor s objections to the debtor s discharge was the procurement of a loan through an allegedly false financial statement. 22 The promissory note signed by the debtor contained an provision for attorneys fees and costs incurred in connection with collection on the note. 23 The bankruptcy court entered judgment in the debtor s favor, and the debtor later sought to amend the judgment to include an award of attorneys fees and costs as the prevailing party pursuant to an Oregon statute that provided for reciprocal attorneys fees regardless of the language in a contract. 24 The 14 Id. 15 Id. at Id. at Id. 18 Id. 19 Id. 20 Id. (citing Fulwiler, 624 F.2d 908 (9 th Cir. 1980)) F.2d at Id. at Id. 24 Id. 3

4 debtor argued that the creditor s nondischargeability action was, in reality, an action to enforce the note. 25 The bankruptcy court denied the fees, but awarded costs. 26 The Ninth Circuit found that the nondischargeability action was a federal cause of action designed to implement the policies of the former Bankruptcy Act, 27 and that the award of attorney s fees in a bankruptcy proceeding should rest on a firmer foundation than the semantical characterization of a particular proceeding. 28 The Ninth Circuit, following the weight of authority, held that a debtor can be awarded attorneys fees for the successful defense of a nondischargeability action only where the creditor brought the proceeding in bad faith or to harass the bankrupt and that [t]here appears to be no other basis on which such an award could be founded. 29 C. Sparkman In Matter of Sparkman, the debtor financed his honey bee business from Merced Production Credit Association ( MCPA ), an instrumentality of the U.S. government. 30 MCPA filed a proof of claim, and the debtor asserted a counterclaim. 31 The claim and counterclaim went to trial; the claim was allowed in a reduced amount, and judgment was entered in favor of the debtor on his counterclaim, although the bankruptcy court denied the debtor s request for an award of attorneys fees based upon the American Rule. 32 The Ninth Circuit rejected the bankruptcy court s application of the American Rule, finding that California law governed the counterclaim and that [w]hen a bankruptcy court adjudicates a contract claim in connection with a petition in bankruptcy, the court applies state law to the contract dispute unless the bankruptcy code provides otherwise Moreover, the court should apply state law not merely in determining whether a breach of contract occurred, but also in deciding whether to award attorneys fees on the claim. 33 The Ninth Circuit further held that pursuant to the relevant California statute, the debtor, as prevailing party, was entitled to an award of reasonable attorneys fees since the 25 Id. 26 Id. 27 Id. at Id. 29 Id. 30 Merced Production Credit Association v. Sparkman (Matter of Sparkman), 703 F.2d 1097, (9 th Cir. 1983). 31 Id. at Id. See Section III. B. herein for a discussion of the American Rule. 33 Id. (citations omitted). 4

5 contracts, here the security agreements and promissory notes, provided for an award to MCPA upon default or suit. 34 D. Johnson In In re Johnson, the debtors financed the purchase of a parcel of land, executed a promissory note and secured the loan by a first deed of trust against the property. 35 The debtors ceased making payments on the note, then filed a petition under chapter The debtors failed to make payments for the first six months after the case was filed, and the secured creditor filed a motion for relief from the automatic stay seeking to foreclose on its deed of trust. 37 The bankruptcy court denied the creditor s motion and awarded the debtors their attorneys fees in opposing the motion pursuant to the same California statute at issue in Sparkman that allows a prevailing party to recover reasonable attorneys fees where a contract provides for an award. 38 The Ninth Circuit upheld the district court s reversal of the bankruptcy court s award of attorneys fees in favor of the debtors finding that the motion for relief from the automatic stay was an action predicated solely on a federal statute, not an action on a contract to which the California statute applied. 39 As discussed in Section III. B., the Supreme Court s decision in Travelers abrogated the Fobian rule. III. The Travelers Case A. Facts and Proceedings Below The facts of Travelers are simple. In April of 2001, Pacific Gas & Electric Co. ( PG&E ) filed a chapter 11 bankruptcy petition. 40 Travelers Casualty & Insurance Co. ( Travelers ) had previously issued a $100 million surety bond on PG&E's behalf to the California Department of Industrial Relations, guaranteeing PG&E's payment of state workers compensation benefits to injured employees. 41 In connection with the bond, PG&E executed a series of indemnity agreements in favor of Travelers. 42 The indemnity 34 Id. at F.2d at Id. at Id. 38 Id. at Id. at S. Ct. at Id. 42 Id. 5

6 agreements provided that PG&E would be responsible for any loss Travelers might incur in connection with the bonds, including any attorneys' fees incurred in pursuing, protecting, or litigating Travelers' rights in connection with those bonds. 43 Although PG&E did not default under the bonds, Travelers filed a contingent proof of claim in the bankruptcy case to cover the possibility that PG&E might default on its workers' compensation benefits at some point in the future, which would require Travelers to make payments under its bond. 44 Travelers objected to PG&E s disclosure statement on the basis that it did not adequately describe how PG&E s plan would treat PG&E s workers compensation obligations or Travelers rights as surety. 45 The parties then negotiated and agreed upon language to include in an amended disclosure statement and plan to address Travelers' indemnification and subrogation rights in the event of a default by PG&E. 46 from: Travelers claimed that PG&E then unilaterally altered the negotiated language Nothing in th[e] Disclosure Statement[s] or Plan[s] shall affect the subrogation rights of any surety of prepetition or post-petition Workers Compensation Claims to Nothing herein shall affect the rights of the Debtor to object, pursuant to the Bankruptcy Code, to the existence of any such subrogation rights [of Travelers]. 47 Travelers asserted that the revised language substantially diminished the protection it had been seeking. 48 PG&E also objected to Travelers claim and sought to disallow it in its entirety based upon its contingent nature, and asserted that Travelers subrogation rights were not valid. 49 Thereafter, Travelers opposed the objection to its 43 Id. 44 Id.; see also, Brief for Petitioner at 9, Travelers Cas. & Sur. Co. Of Am. v. Pac. Gas & Elec. Co., 127 S. Ct (2007) (No ). 45 Brief for Petitioner at 13, 127 S. Ct (2007) (No ) S. Ct. at See also Brief for Petitioner at Brief for Petitioner at 14-16, 127 S. Ct (2007) (No ) S. Ct. at Brief for Petitioner at 16, 127 S. Ct (2007) (No ). 6

7 claim and objected to PG&E s plan. 50 Travelers and PG&E ultimately resolved the dispute by entering into a stipulation (approved by the bankruptcy court) that provided that Travelers may assert its claim for attorneys fees under the [i]ndemnity [a]greements as a general unsecured claim against PG&E, subject to PG&E's right to object. 51 Travelers subsequently filed an amended proof of claim seeking to recover the attorneys' fees it incurred in connection with the objection to PG&E's disclosure statement as well as PG&E s objection to its claim. 52 PG&E filed an objection to the amended claim, arguing that Travelers could not recover attorneys' fees incurred litigating issues of bankruptcy law. 53 The bankruptcy court agreed with PG&E and rejected Travelers' claim on that basis. 54 Travelers appealed that ruling to the district court. The district court affirmed, relying on the Fobian rule. Travelers appealed the district court s affirmance to the Ninth Circuit. The Ninth Circuit affirmed the district court, also relying on the Fobian rule. 55 While the Ninth Circuit panel acknowledged that, in at least some circumstances, a prevailing party in a bankruptcy proceeding may be entitled to an award of attorney [sic] fees in accordance with applicable state law..., 56 it rejected Travelers' claim because the fees claimed by Travelers were incurred litigating issues that were governed entirely by federal bankruptcy law. 57 The Supreme Court granted certiorari to resolve the conflict between the Ninth Circuit s Fobian decision and the Fourth Circuit s decision in In re Shangra-La, Inc Id S. Ct. at ; See also, Brief for Petitioner at S. Ct. at 1203; See also, Brief for Petitioner at S. Ct. at Id S. Ct. at 1203 (citing 167 Fed.Appx. 593 (9 th Cir. 2006)) S. Ct. at 1203 (quoting 167 Fed.Appx. at 594) (quoting In re Baroff, 105 F.3d 439, 441 (9 th Cir. 1997)). 57 Id. (quoting 167 Fed.Appx. at 594) F.3d 843 (4 th Cir. 1999). In Shangra-La, the bankruptcy court disallowed a landlord s request for allowance of contractual attorneys fees incurred post-petition. 167 F.3d at 847. The Fourth Circuit held that the fact that issues peculiar to bankruptcy law were litigated would not preclude an award of attorneys fees since the applicable state statute allowed landlords to recover attorneys fees if permitted in a lease. Id. at 850. Based upon such ruling, the matter was remanded the bankruptcy court with instructions to focus on whether the attorneys fees were related to collection of amounts due under the lease or enforcement thereof and whether state law would allow for such actions. Id. 7

8 B. The Travelers Opinion In its opinion, the Court began by acknowledging the American Rule, pursuant to which a prevailing litigant is ordinarily not entitled to collect a reasonable attorneys fee from the loser, 59 and by noting that it can be overcome by statute 60 or by enforceable contract 61 that allocates attorneys fees. The Court then focused on the language of the Code and the fundamentals of filing claims and the allowance of claims. Under section 502, creditors are entitled to file proofs of claim, and upon doing so, the claim is allowed over objection pursuant to section 502(a) of the Bankruptcy Code, unless such claim falls within the nine exceptions enumerated in section 502(b). 62 The Court went on to discuss the only potential applicable exception that might apply to Travelers claim for attorney s fees section 502(b)(1). Section 502(b)(1) disallows any claim that 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 reaffirmed that the validity of a claim is determined by the underlying substantive law creating the debtor s obligation, subject to any qualifying or contrary provisions of the Bankruptcy Code. 63 The Court noted that the Ninth Circuit rejected Travelers contract-based claim solely based upon the Fobian rule, not because it concluded that the attorneys fees sought by Travelers were unenforceable under nonbankruptcy law. 64 The Court unqualifiedly rejected the Fobian rule because: The Fobian rule finds no support in the Bankruptcy Code, either in 502 or elsewhere. In Fobian, the court did not identify any provision of the Bankruptcy Code as providing support for the new rule. [ ] Instead, the court cited three of its own prior decisions, In re Johnson, 756 F.2d 738 (1985); In re Coast Trading Co., 744 F.2d 686 (1984); and In re Fulwiler, 624 F.2d 908 (C.A ) (per curiam). Significantly, in none of those cases did the court identify any basis for disallowing a contractual claim for attorney's fees incurred litigating issues of federal bankruptcy law. Nor did the court have occasion to do so; in each of those cases, the claim for attorney's fees failed as a matter of state law S. Ct. at 1203 (quoting Alyeska Pipeline Serv. Co. v. Wilderness Soc y, 421 U.S. 240, 247 (1975)). 60 Id. (citing Fleischmann Distilling Corp. v. Maier Brewing Co., 386 U.S. 714, 717 (1967)). 61 Id. 62 Id. at Id. at (citing Raleigh v. Illinois Dept. of Revenue, 530 U.S. 15, 20 (2000)) S. Ct. at 1205 (citing 167 Fed.Appx. at 594). 8

9 The absence of textual support is fatal for the Fobian rule. Consistent with our prior statements regarding creditors' entitlements in bankruptcy we generally presume that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed. 65 As quoted above, the Supreme Court indicated that the claim for attorneys fees failed as a matter of state law in Johnson, Coast Trading and Fulwiler. However, while that statement is accurate, the rationale for denying attorneys fees in Fulwiler and Johnson was the Ninth Circuit s finding that the state statutes under which the parties were moving were not applicable since the matters being litigated were issues unique to bankruptcy law, i.e., dischargeability and relief from the automatic stay. 66 C. What the Supreme Court Did NOT Rule The Supreme Court was careful to note that: [W]e express no opinion with regard to whether, following the demise of the Fobian rule, other principles of bankruptcy law might provide an independent basis for disallowing Travelers' claim for attorney's fees. We 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. 67 This is significant because the Supreme Court left open the possibility that other sections of the Bankruptcy Code provide bases to disallow post-petition claims asserted by unsecured creditors for contractual attorneys fees. IV. BAPCPA Amendment to Section 506(b) Section 506(b) currently reads: To the extent that an allowed secured claim is secured by property the value of which... is greater than the amount of such claim, 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 statute under which such claim arose S. Ct. at 1205 (citations omitted). 66 See Fuliwiler, 624 F.2d at 910; Johnson, 756 F.2d at S. Ct. at U.S.C. 506(b) (2007) (emphasis added). 9

10 Part of the 2005 amendments to the Bankruptcy Code enacted by the Bankruptcy Abuse Prevention and Consumer Protection Act ( BAPCPA ) included an amendment to section 506(b) to include a State statute as a basis for an oversecured creditor to recover reasonable fees, costs or charges. 69 While there is no legislative history discussing this amendment, prior to BAPCPA, an oversecured creditor s claim for fees was subject to disallowance if based upon state statute. 70 The legislative history of pre-bapcpa section 506(b) reflects that this section codifies current law by entitling a creditor with an oversecured claim to any reasonable fees [(including attorney s fees)], costs, or other charges provided under the agreement under which the claim arose. These fees, costs and charges are secured claims to the extent that the value of the collateral exceeds the amount of the underlying claim. 71 The BAPCPA amendment did nothing to change pre-bapcpa law concerning treatment of undersecured or unsecured creditors claims for attorneys fees. Further, Travelers did not eliminate the requirement in section 506(b) that any fees awarded to an oversecured creditor be reasonable. Further, where an oversecured creditor s fees are not reasonable, but would be allowed under nonbankruptcy law, the oversecured creditor s claim is bifurcated into secured and unsecured claims, with non-reasonable fees portion of the fees being allowed as an unsecured claim. 72 V. Decisions after Travelers Since the Travelers decision, courts have addressed the entitlement of unsecured creditors to post petition attorneys fees. Some court s have allowed such fees, and some have disallowed them. 69 Section 506(b) was amended in Section 712 of BAPCPA, captioned Payment of Taxes in the Conduct of Business, in subsection (d), captioned Payment of Taxes and Fees as Secured Claims. 70 Jennifer M. Taylor & Christopher J. Mertens, Travelers and the Implications on the Allowability of Unsecured Creditors Claims for Post-Petition Attorneys Fees Against the Bankruptcy Estate, 81 AM. BANKR. L.J. 123, 152 (Spring 2007) (citing Bondholder Comm. v. Williamson County (In re Brentwood Outpatient, Ltd.), 43 F.3d 256, 260, 262 (6 th Cir. 1994); City of Farmers Branch v. Pointer (In re Pointer), 952 F.2d 82, 83 84, 89 (5 th Cir. 1992); Lincoln Sav. Bank v. Suffolk County Treasurer (In re Parr Meadows Racing Ass n), 880 F.2d 1540, 1549 (2d Cir. 1989)). 71 H.R. Rep. No. 595, 95 th Cong., 1 st Sess (1977); S. Rep. No. 989, 95 th Cong., 2d Sess. 68 (1978). 72 See UPS Capital Business Credit v. Gencarelli (In re Gencarelli), 501 F.2d 1, pp. 5 6 (1 st Cir. 2007); Welzel v. Advocate Realty Invs., LLC (In re Welzel), 275 F.3d 1308, 1318 (11 th Cir. 2001); Official Comm. of Unsecured Creditors v. Dow Corning Corp. (In re Dow Corning Corp.), 456 F.3d 668, 683 (6 th Cir. 2006). See also Joseph F. Sanson Investment Co. v. 268 Limited (Matter of 268 Limited), 789 F.2d 674, 678 (9 th Cir. 1986) ( [o]ur rejection of Sanson s construction of 506(b) does not preclude it from seeking the contractual fees as an unsecured claim When [ 506(b) is] read in conjunction with 506(a) it may be understood to define the portion of the fees which shall be afforded secured status. We adopt [that] reading. ). 10

11 A. Qmect In May 2007, the bankruptcy court in Qmect, Inc. v. Burlingame Capital Partners II, L.P. et al. (In re Qmect, Inc.) ruled that a prevailing party in post-petition litigation could include post-petition attorneys fees as part of its unsecured claim against the Debtors. 73 First, the bankruptcy court found that the post-petition attorneys fees constituted a contingent claim under the Bankruptcy Code. 74 The bankruptcy court further held that Qmect s argument that by providing that a secured claim shall be allowed reasonable fees to the extent the claim is secured by property, the Bankruptcy Code is implicitly saying that fees are not available to an unsecured creditor was a strained reading of sections 502(b) and 506(b) because: (i) the title of section 506 is Determination of Secured Status and if Congress wanted to disallow claims for post-petition attorneys fees, it would have done so in section 502(b); and (ii) section 506(b) does not distinguish between pre-petition and post-petition attorneys fees. 75 The bankruptcy court went on to indicate that preservation of nonbankruptcy legal rights (except to the extent necessary to facilitate the purpose of the bankruptcy proceeding) was just as important of a bankruptcy policy as equality of distribution. 76 The bankruptcy court finally concluded that the prevailing party-creditor was entitled to all of its reasonable post-petition attorneys fees as part of its unsecured claim against the debtors. 77 The decision did not indicate whether the allowance of reasonable post-petition attorneys fees was based upon a statute or contract. B. Electric Machinery & WCS Enterprises On the other hand, post-travelers, the bankruptcy courts deciding In re Electric Machinery Enterprises 78 and In re WCS Enterprises, Inc. 79 have held that an unsecured creditor could not recover post-petition attorneys fees and costs as part of its unsecured claim despite the contractual right to do so outside of bankruptcy. In Electric Machinery, a creditor filed an unsecured proof of claim that included pre-petition and post-petition attorneys fees, including attorneys fees incurred in connection with the bankruptcy litigation regarding the debtor s objection to its claim. 80 The Electric Machinery court disallowed that portion of the claim asserting post-petition attorneys fees. The B.R. 882, 886 (Bankr. N.D. Cal. May 17, 2007). 74 Id. at Id. at Id. at Id B.R. 549, 554 (Bankr. M.D. Fla. July 6, 2007) Bankr. LEXIS 3914 (Bankr. E.D. Va. November 20, 2007) B.R. at

12 bankruptcy court adopted the four-part rationale espoused by a majority of courts prior to Travelers, finding that such rationale was supported by existing Supreme Court precedent. 81 The four bases are: (i) plain language of section 506(b): if Congress intended for unsecured creditors to receive post-petition attorneys fees, it would have done so explicitly in section 506(b); 82 (ii) the disallowance of post-petition interest to undersecured creditors as espoused in United Sav. Ass n v. Timbers 83 applies equally to post-petition attorneys fees; 84 (iii) a claim is determined as of the Petition Date under the plain language of section 502(b); 85 and (iv) the policy of equality of distribution among similarly situated creditors. 86 Likewise, in WCS, an unsecured creditor filed a proof of claim that included postpetition attorneys fees. 87 The bankruptcy court disallowed the post-petition attorneys fees from the creditor s claim. The court ruled that section 506(b) only allows reasonable post-petition interest and attorneys fees to oversecured creditors and by implication does not allow post-petition interest or attorneys fees to unsecured creditors. 88 The WCS court also adopted the policy articulated in Randolph v. Scruggs, 89 that a contract-based claim for post-petition legal fees can only be allowed for services that benefit the estate, which is currently reflected in sections 503(b)(3) and (4) of the Bankruptcy Code. 90 i. Discussion of Rationale for Courts that Do Not Allow Post- Petition Attorneys Fees as Part of Unsecured Creditors Claims 1. Plain Language of Section 506(b) The first argument advanced by the pre-travelers majority of courts which have disallowed claims of unsecured and undersecured for attorneys fees is that by permitting the recovery of attorneys fees in the 81 Id. at 552 (citations omitted). 82 Id. 371 B.R. at U.S. 365 (1988) B.R. at 551 (citing In re Loewen Group, Int l Inc., 274 B.R. 427, 444 (Bankr. D. Del. 2003); and In re Saunders, 130 B.R. 208, 210 (Bankr. W.D. Va. 1991)). 85 Id. 86 Id. (citing Boese v. King, 108 U.S. 379, (1883)) Bankr. LEXIS at * Id. at *5 6 (citing Sakowitz Inc. v. Chase Bank Int'l (In re Sakowitz, Inc.), 110 B.R. 268, 272 (Bankr. S.D. Tex. 1989)) U.S. 533, 539 (1903). 90 WCS, 2007 Bankr. LEXIS at *

13 case of an oversecured creditor in section 506(b), Congress necessarily denied the recovery of attorneys fees in the case of an undersecured or unsecured creditor. 91 Congress provided for attorney fees only for the secured portion of such a claim. Congress must be presumed to have understood what it was doing. It could easily have provided for attorney fees for the unsecured portion of the claim as well as the secured portion. 92 The pre-travelers majority argues that since only oversecured creditors are allowed to recover their attorneys fees under section 506(b), statutory construction and logic compel the conclusion that unsecured creditors may not recover post-petition attorneys fees. 2. Timbers The second argument advanced by the majority of pre-travelers courts for the denial of post-petition attorneys fees to unsecured creditors is based upon their extension of the rationale espoused by the Supreme Court in United Sav. Ass'n of Tex. v. Timbers of Inwood Forest Assocs. Ltd. 93 In Timbers, the Supreme Court was dealing with the allowability of a claim for post-petition interest. The Court held that [s]ince this [section 506(b)] permits post-petition interest to be paid only out of the security cushion, the undersecured creditor, who has no such cushion, falls within the general rule disallowing postpetition interest. 94 The pre-travelers majority concludes, therefore, that since section 506(b) prohibits an unsecured creditor from recovering post-petition interest, and since section 506(b) treats attorneys fees and interest identically, the Timbers opinion, by implication, likewise prohibits recovery of postpetition attorneys fees by an unsecured creditor Claim is determined as of Petition Date The third argument espoused by the majority of pre-travelers courts for the denial of post-petition attorneys fees to unsecured creditors is based upon the calculation of a claim as of the petition date. Specifically, 91 In re Pride Cos., L.P., 285 B.R. 366, 372 (Bankr. N.D. Tex. 2002). 92 Id. (quoting Sakowitz, 110 B.R. at 272). Accord In re Loewen Group Int'l Inc., 274 B.R. 427, 444 n. 36 (Bankr. D. Del. 2002) ( If post-petition fees and costs were generally recoverable by all creditors, then Congress would not have expressly provided for their recovery by oversecured creditors in 506(b) ); In re Smith, 206 B.R. 113, 115 (Bankr. D. Md. 1997); In re Southeast Banking Corp., 188 B.R. 452, (Bankr. S.D. Fla. 1995); In re Woodmere Investors Ltd. P'ship, 178 B.R. 346, 356 (Bankr. S.D.N.Y. 1995)) U.S. 365 (1988) U.S. at Pride Cos., L.P., 285 B.R. at 373 (citing Adams v. Zimmerman, 73 F.3d 1164, 1177 (1 st Cir. 1996); Loewen Group, 274 B.R. at 444 n. 36; In re Woodmere Investors Ltd. P'ship, 178 B.R. at 356; In re Saunders, 130 B.R. at 210). Accord Elec. Mach., 371 B.R. at

14 since post-petition attorneys fees are by their nature incurred after the petition date, they cannot become part of a pre-bankruptcy general unsecured claim Equality of distribution The pre-travelers majority also advances the policy argument that allowing unsecured creditors to recover post-petition fees would be inequitable to other unsecured creditors and may, in some cases, consume the estate. 97 As stated by the bankruptcy court in Pride Cos., [i]t is not equitable to deplete everyone's pot, only because of an asserted right granted by a contact. After all, bankruptcy routinely alters creditors[ ] rights, and this is simply a situation where the policy of ratable distribution and equitable treatment of the varying interests in bankruptcy should override any asserted rights by unsecured creditors to recover attorney's fees. 98 In Sakowitz the bankruptcy court stated that a primary purpose of the Bankruptcy [Code] is to bring about an equitable distribution of the bankrupt's estate among creditors holding just demands... this principle should bar enforcement of any contractual provision which would permit one creditor-and not others-to charge the estate with legal expenses associated with processing a claim before the Bankruptcy Court. 99 Moreover, it is [generally] the larger and more sophisticated creditors who include clauses requiring payment of their attorney fees in their contracts with the debtor. Smaller and less sophisticated creditors may not have included such clauses or may have insufficient bargaining leverage to obtain such a promise. Involuntary creditors such as tort claimants have no ability to obtain such a promise Id. at 373 (citing In re Waterman, 248 B.R. 567, 573 (8th Cir. BAP 2000)). See also Sakowtiz, 110 B.R. at 271 ( [it] should be kept in mind that Section 502(b) speaks in terms of the proof of claim as it existed at the time of the filing of the case. ) (emphasis in original). 97 Id. at Id. at B.R. at Pride Cos., 274 B.R. at 444 (quoting James Gadsden, RECOVERY OF ATTORNEY FEES AS AN UNSECURED CLAIM, 114 BANKING L.J. 594, 603 (1997)). 14

15 5. Other Policy Reasons In addition to the four bases discussed above, there are two additional bases to disallow post-petition attorneys fees to unsecured and undersecured creditors. a. Benefit to Estate A fifth basis to disallow post-petition attorneys fees to unsecured creditors is that pre-travelers and pre-bankruptcy Code precedent from the Supreme Court requires that unsecured creditors seeking post-petition attorneys fees provide a benefit to the estate. 101 This rationale was included in section 503 of the Bankruptcy Code which allows the reimbursement of reasonable attorneys fees to a creditor who made a substantial contribution in a chapter 9 or 11 case. But such instances are rare and only awarded in extraordinary circumstances. 102 b. Litigation Over Fees Would Deplete Debtor s Assets Finally, a practical concern relates to the administration of bankruptcy cases if unsecured creditors were entitled to recover their attorneys fees. One bankruptcy court has argued that: There would be no finality to the claims process as bankruptcy courts would constantly have to revisit the issue of the amount of claims to include everaccruing attorneys fees. The cash registers would ring on a daily basis, as attorneys for unsecured 101 Electric Machinery, 371 B.R. at 552 (citing Randolph v. Scruggs, 190 U.S. 533, 539 (1903) ( [w]e are not prepared to go further than to allow compensation for [legal services] which were beneficial to the estate )); Saper v. John Viviane & Son, Inc., 258 F.2d 826, 828 (2d Cir. 1958) ( As a general rule no compensation or reimbursement can be had unless a tangible benefit has been incurred on the estate to the advantage of the creditors as a whole ); In re Friedman, 232 F.2d 151 (2d Cir. 1956); In re Solar Mfg. Corp., 206 F.2d 780, 781 (3d Cir. 1953) (the work of attorneys for creditors must be at the expense of their clients unless it is some manner beneficial to the estate ); Guerin v. Weil, Gotshal & Manges, 205 F.2d 302, 304 (2d Cir. 1953) (In the absence of benefit to the estate, the bankruptcy court lacks power to grant, and the policy of the [Bankruptcy] Act is against, compensation not expressly provide for by the Act )). 102 See Speights & Runyan v. Celotex Corp. (In re Celotex Corp.), 227 F.3d 1336 (11 th Cir. 2000); In re Consol. Bancshares, Inc., 785 F.2d 1248 (5 th Cir. 1986); In re Lebron, 27 F.3d 937 (3d Cir. 1994); In re Kidron, 278 B.R. 626 (Bankr. M.D. Fla. 2002); In re United Container LLC, 305 B.R. 120 (Bankr. M.D. Fla. 2003); In re Best Prod. Co., Inc., 173 B.R. 862 (Bankr. S.D.N.Y. 1994); In re 9085 E. Mineral Office Bldg., Ltd., 119 B.R. 246 (Bankr. D. Colo. 1990). 15

16 creditors that were active in the case would continually be filing new claims or seeking to reconsider previously allowed claims in order to add post-petition attorneys fees and costs. Essentially, there could be no finality to the claims resolution process if the ever-accruing fees and costs attendant to the representation of unsecured creditors were allowed as part of an unsecured claim. This problem is especially heightened in chapter 11 cases, which not only deal with the two-party disputes involved in the claims resolution process, but also require the adjudication of numerous bankruptcy related separate proceedings that affect all unsecured creditors as a group and often do not affect the allowance of the individual claims of the creditors The practical consequences of such a result would be disastrous for the administration of the bankruptcy system. The administrative inconvenience this would cause in a chapter 11 case would be intolerable. 103 C. SNTL Corp. The Ninth Circuit Bankruptcy Appellate Panel recently agreed with the Qmect court s analysis in Centre Insurance Company v. SNTL Corp. (In re SNTL Corp.) and rejected the majority rationale adopted by Electric Machinery. 104 Specifically, the court held that claims for postpetition attorneys fees cannot be disallowed simply because the claim of the creditor is unsecured. 105 First, the court rejected the argument that section 506(b) only allows attorneys fees to oversecured creditors, adopting the rationale that section 506(b) addresses the portion of attorneys fees to afforded secured status. 106 Next, the court held that the prepetition agreement, which contained an attorneys fee provision, gave rise to a contingent, unliquidated attorney-fee claim that fell within the Bankruptcy Code s broad definition of a claim. 107 The court also held that the Electric Machinery court s reliance on Timbers was misplaced because Timbers dealt with unmatured interest, which is specifically disallowed pursuant to section 502(b)(2), whereas section 103 Elec. Mach., 371 B.R. at WL (9 th Cir. BAP December 19, 2007). 105 Id. at * Id. at *11 (citing Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678 (9 th Cir. 1986). 107 Id. at *12. 16

17 502(b) does not specifically disallow attorneys fees. 108 Further, the court did not address the policy concerns raised in the majority and Electric Machinery cases because it found that the Bankruptcy Code resolves the issue of whether postpetition attorneys fees of unsecured creditors should be allowed. 109 It should be noted that while the court referenced Welzel v. Advocate Realty Invs., LLC (In re Welzel) 110 for the proposition that attorneys fees were allowed as part of a creditor s unsecured claim, 111 it failed to discuss critical distinguishing facts, i.e., the debtor was solvent, the creditor was oversecured and the claim for attorneys fees vested prepetition. 112 The next section of this Article addresses the significance of a debtor s solvency. VI. Does it Matter if Debtor is Solvent? Yes. In cases in which all creditors receive payment in full on their unsecured claims, the policy concern of equality of distribution is not at issue. It will likely be significant on remand that PG&E was and is a solvent debtor. 113 The First, Sixth and Eleventh Circuits have held that where a debtor is solvent, fees, costs or charges may be allowed as an unsecured claim if permitted under nonbankruptcy law. 114 However, the First Circuit explicitly stated that its opinion was not addressing the issue of whether an unsecured creditor could recover post-petition attorneys fees under a contract from an insolvent debtor. 115 Likewise, the Electric Machinery court noted that all but one of the minority of pre- Travelers cases allowing post-petition attorneys fees involved solvent estates Id. at * Id. at ** F.3d 1308, 1318 (11 th Cir. 2001). 111 Id. at See Welzel, 275 F.3d See Reply Brief for Petitioner, at pp. 8, 16, Travelers, 127 S. Ct (2007) (No ). 114 UPS Capital Business Credit v. Gencarelli (In re Gencarelli), 501 F.2d 1, pp. 5 6 (1 st Cir. 2007); Welzel, 275 F.3d at 1318; Official Comm. of Unsecured Creditors v. Dow Corning Corp. (In re Dow Corning Corp.), 456 F.3d 668, 683 (6 th Cir. 2006)). 115 Id. at *15, n. 3 (noting that Travelers reserved the question). 116 Elec. Mach., 371 B.R. at

18 VII. What Does Travelers Teach Us? A. Possible Impact on Consumer Cases i. Chapter 7 Cases There would not likely be a significant impact on the administration of cases as feared by the court in Elec. Machinery with respect to claim amendments in chapter 7 cases since, for the most part, unsecured creditors involvement is limited to filing a proof of claim, responding if the trustee objects, stay relief litigation, and discharge and dischargeability litigation. ii. Chapter 13 Cases However, in chapter 13 cases, if courts interpret Travelers to allow postpetition attorneys fees to unsecured creditors, it is possible to have the administrative nightmare of endless amendments to claims of concern to the Elec. Machinery court. This effect would have a limited time frame as confirmation of chapter 13 cases typically occurs within approximately one year of filing, and post-confirmation attorneys fees are not subject to section 506 and would be governed by non-bankruptcy law. 117 In addition, section 1329 of the Bankruptcy Code only allows for modification of a chapter 13 plan prior to completion of payments under such plan, which would also limit the ability to amend a claim and modify payments to an unsecured creditor under a confirmed chapter 13 plan. iii. Dischargeability Further, while creditors claims for attorneys fees and costs incurred in connection with litigation over dischargeability may become more frequent, any fee award would not paid by the bankruptcy estate because if a creditor prevails in such litigation, the debt remains a liability of the individual debtor. The Bankruptcy Appellate Panel for the Tenth Circuit held so held in the context of a chapter 7 case in Busch v. Hancock (In re Busch). 118 In Busch, the Bankruptcy Appellate Panel ( BAP ) affirmed the bankruptcy court s award of attorneys fees to the debtor s ex-wife in connection with nondischargeability litigation. 119 The court found that the ex-wife would be awarded attorneys fees under the Utah statute for enforcing the terms of a divorce decree in state court and, based upon Travelers, held that the analysis should not be different in the nondischargeability litigation. 120 Significantly, the BAP noted that the attorneys fees awarded by the bankruptcy court cannot be allowed as a claim against the estate because such 117 In re Brooks, 2007 Bankr. LEXIS 1325 (Bankr. N.J. April 12, 2007) B.R. 614 (10 th Cir. BAP 2007). 119 Id. at Id. 18

19 claim would be for a debt that was unmatured on the date of the filing of the petition and is excepted from discharge under 523(a)(5), 121 which is one of the nine exceptions to the allowance of a claim. 122 B. Possible Impact on Chapter 11 Cases One impact Travelers is likely to have on chapter 11 cases is that many more unsecured creditors may include post-petition attorneys fees in their proofs of claim. In turn, this will likely result in increased claim litigation on the issue of whether such claims should be allowed, which will in turn increase a debtor s administrative expenses and diminish recoveries to unsecured creditors. For example, in Travelers, the liquidated debt due to Travelers was $0, yet the attorneys fees it sought to recover in connection with its involvement in the PG&E bankruptcy case amounted to $167,000, and that amount of course does not include the attorneys fees and expenses incurred by PG&E as an administrative expense in dealing with Travelers objections to the disclosure statement and plan, as well as prosecution of its objection to Travelers claim and the appeals. 123 Also, as the Ninth Circuit observed, [i]f unimpaired, non-prevailing creditors were authorized to obtain an attorney fee award in bankruptcy for inquiring about the status of unimpaired inchoate and contingent claims, the system would likely be overwhelmed by fee applications, with no funds available for disbursement to impaired creditors or debtor reorganization. 124 Likewise, the Electric Machinery court expressed its belief that the practical effect of allowing unsecured creditors to recover post-petition attorneys fees as part of an unsecured claim would create intolerable inconvenience. 125 C. Other Issues for Consideration Legal and practical issues or considerations implicated by the allowance of post-petition attorneys fees as part of unsecured claims include: Unsecured creditors who are entitled to recovery of attorneys fees through statute or contract will likely become more active in chapter 11 cases. 121 Id. at 626, fn. 13 (citation omitted). 122 See 11 U.S.C. 502(b)(5). 123 Transcript of Oral Argument at 10, Travelers, 127 S. Ct (2007) Fed.Appx. at Elec. Mach., 371 B.R. at

20 Unsecured creditors will likely include an estimate of post-petition attorneys fees in their proofs of claim. Chapter 11 debtors administrative expenses will increase as debtors litigate the issue of entitlement to attorneys fees under nonbankruptcy law. Should procedures be implemented to minimize multiple amendments to unsecured claims with respect to the addition of attorneys fees incurred in protecting their rights during the administration of a case? Where a debtor is insolvent, will courts impose a reasonableness standard on the attorneys fees and costs allowed as part of an unsecured claim even if a statute or contract does not? Will additional fees and costs be incurred by creditors and debtors in connection with the determination of prevailing party on issues unique to bankruptcy and not directly related to enforcement of a prebankruptcy contract, e.g., statutory cap on landlord s damages, assumption of lease and cure related thereto, avoidance of preferential transfers, relief from automatic stay, confirmation, cash collateral, adequate protection, appointment of trustee, and conversion of cases? D. Parting Thoughts The magnitude of the Travelers decision is unclear. While the Fobian rule has been put to rest, courts can disallow post-petition attorneys fees to unsecured creditors for litigating issues unique to bankruptcy law if they hold that such fees are not allowable under section 506(b). Courts can also hold that such fees would not be allowable under nonbankruptcy law because nonbankruptcy law does not contemplate award of fees for litigating bankruptcy issues. As noted by the Electric Machinery court, if the Travelers decision is interpreted to allow post-petition attorneys fees to unsecured creditors, this could open the floodgates for constant amendments to claims filed by unsecured creditors each time such creditor receives an invoice from its attorney. 126 This could significantly hamper the finality of cases. It could also significantly impact recovery to unsecured creditors, as well as provide an advantage to that category of unsecured creditors who are able to recover their post-petition attorneys fees by virtue of contract or statute. On the other hand, in insolvent-debtor cases where the recovery is pennies on the dollar, general unsecured creditors might not wreak administrative havoc by endlessly amending their proofs of claim because 126 Id. 20

21 the cost of doing so and litigation or motion practice regarding entitlement to attorneys fees may not be cost effective. The best argument for the allowance of an unsecured creditor s postpetition attorneys fees, 127 is that such fees constitute claims under the Bankruptcy Code, albeit contingent, and section 506(b) does not explicitly preclude such fees to unsecured creditors. However, notwithstanding the fact that the Supreme Court refused to answer the ultimate question as not having been raised below, the Supreme Court did nothing to change courts interpretation of section 506(b) that unsecured and undersecured creditors are not entitled to recover their post-petition attorneys fees. As discussed by at least two courts which have published opinions on the issue post Travelers, as well as two law review articles, 128 the bases to deny postpetition attorneys fees to unsecured creditors that were espoused by the pre- Travelers majority continue to be applicable, and denial is the proper result. # v1 127 This argument presumes an allowable substantive claim as well as a contractual or statutory basis for the allowance of attorneys fees and costs relating to such claim. 128 See Jennifer M. Taylor & Christopher J. Mertens, Travelers and the Implications on the Allowability of Unsecured Creditors Claims for Post-Petition Attorneys Fees Against the Bankruptcy Estate, 81 AM. BANKR. L.J. 123, 152 (Spring 2007) and Mark S. Scarberry, Interpreting Bankruptcy Code Sections 502 and 506: Post-Petition Attorneys Fees in a Post-Travelers World, 15 ABI L.R. 611 (Winter 2007). 21