Post-Travelers Decisions Continue the Debate Regarding the Allowability of Unsecured Creditors Claims for Postpetition Attorneys Fees

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1 Post-Travelers Decisions Continue the Debate Regarding the Allowability of Unsecured Creditors Claims for Postpetition Attorneys Fees September/October 2007 Ross S. Barr Recently, in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., the U.S. Supreme Court resolved a conflict among the circuit courts of appeal by overruling the Ninth Circuit s Fobian rule, which dictated that attorneys fees are not recoverable in bankruptcy for litigating issues peculiar to federal bankruptcy law. In reaching its decision, the Supreme Court reasoned that the Fobian rule s limitations on attorneys fees find no support in either section 502 of the Bankruptcy Code or elsewhere. Perhaps more importantly, however, because the debtor did not raise such arguments below, the Supreme Court declined to express an opinion regarding whether other principles of bankruptcy law might provide an independent basis for disallowing the claims of an unsecured creditor for postpetition attorneys fees. As a result, Travelers will force an ongoing debate regarding the allowability of such claims. Interestingly, following Travelers, two bankruptcy courts have already issued contrary opinions on this issue, thus signaling that there is no end in sight to the debate over this important issue. Pre-Travelers Decisions Prior to Travelers, the majority of courts that had considered the issue held that an unsecured or undersecured creditor is not entitled to recover postpetition attorneys fees and other costs as part of its claim. Such courts relied on all or some of the following four primary reasons for denying such claims:

2 (1) Construing the plain language of section 506(b) of the Bankruptcy Code under the legal maxim of expressio unius est exclusio alterius (i.e., the express mention of one thing excludes all others) dictates such a result. Section 506(b) of the Bankruptcy Code provides, in pertinent part, that [t]o the extent that an allowed secured claim is [oversecured], 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 (italicized text added in 2005). Thus, such courts held that because Congress mandated that creditors are entitled to postpetition fees and costs, including attorneys fees, only to the extent that their claims are oversecured, it implicitly denied such fees and costs to creditors whose claims are not oversecured. (2) The Supreme Court s opinion and reasoning in United Savings Assoc. of Texas v. Timbers of Inwood Forest Assocs., Ltd. mandate the conclusion that unsecured creditors are not entitled to such fees and costs. In Timbers, the Supreme Court held that postpetition fees and costs could be paid only out of a creditor s equity cushion, such that an undersecured creditor was not entitled to payment of such fees and costs. (3) The plain language of section 502(b) of the Bankruptcy Code supports this conclusion: [I]f an objection to claim is filed, the court shall determine the amount of such claim... as of the date of the filing of the petition. Thus, if an unsecured creditor s claim is determined as of the petition date, it cannot, by definition, include postpetition fees and costs. (4) Allowing certain types of creditors (such as contract claimants that had prepetition agreements with the debtor that contained attorneys fees provisions) to recover their fees, while other unsecured creditors (such as tort claimants and trade creditors) cannot recover such fees as part of their unsecured claims would be inequitable, and contrary to the important bankruptcy principle of equality of distribution. Still, prior to Travelers, other courts (albeit a minority thereof) had held that unsecured creditors could include postpetition attorneys fees in their claims where appropriate. In doing so, those courts relied on all or some of the following reasons for their holdings: (1) The Bankruptcy Code broadly defines the word claim in section 101(5) to include contingent claims. As of the petition date, attorneys fees allowed pursuant to a prepetition agreement are contingent claims that fit within such definition. 2

3 (2) Section 502(c) of the Bankruptcy Code authorizes courts to estimate and allow contingent claims as of the petition date. (3) Attorneys fees are not one of the exceptions to the allowability of claims enumerated in section 502(b). Thus, they must be allowable pursuant to section 502. (4) Section 506(b) is not relevant to an unsecured creditor s claim because that section concerns only claims of secured creditors. Accordingly, such courts held that where the creditor had a prepetition agreement with the debtor that provided for attorneys fees, its fee claim was contingent as of the petition date and thus allowable. Post-Travelers Decisions Only two days following the issuance of Travelers, an Idaho bankruptcy court denied a creditor s claim for attorneys fees in In re Astle. However, Astle concerned the claim of an oversecured creditor, not an undersecured or unsecured creditor. Nevertheless, Astle merits discussion because it construed language added to section 506(b) of the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of Section 506(b) now provides, in pertinent part, that an oversecured creditor may claim any reasonable fees, costs, or charges provided under the agreement or State statute under which such claim arose. Prior to 2005, the provision omitted any reference to State statute. In Astle, a power company, which was granted a lien during the case and, as a result, became an oversecured creditor as adequate assurance of the debtor's payment of its electric bills pursuant to section 366 of the Bankruptcy Code, claimed that it was entitled to postpetition attorneys fees incurred in pursuing its claim. Having no prepetition contract with the debtor, the creditor claimed entitlement to attorneys fees under a general Idaho statute providing for the 3

4 recovery of attorneys fees by the prevailing party in any civil action on a commercial transaction. The issue before the court was whether the language under which such claim arose applied not only to an agreement (which is already established), but also to a State statute, such that attorneys fees will be awarded to oversecured creditors only where such entitlement arose from the same statute under which such creditors underlying secured claim arose. The court held that Congress placement of or State statute between agreement and under which such claim arose, and not after the latter phrase, clearly evidenced its intent to provide for an award of fees, costs or charges arising in either an agreement or a statute. Thus, because the creditor s claim arose under federal bankruptcy law (not the general Idaho statute regarding attorneys fees), the court denied its claim for postpetition attorneys fees. Less than two months later, a California bankruptcy court issued a decision regarding a claim for postpetition attorneys fees. This time, however, the claim was that of an unsecured creditor. In In re Qmect, Inc., the court held that an unsecured creditor s allowed claim included postpetition attorneys fees payable in accordance with the provisions of its prepetition contract with the debtor. The court followed the pre-travelers minority position, stating that: (i) the Bankruptcy Code broadly defines a claim to include contingent claims; (ii) as of the petition date, postpetition attorneys fees are contingent claims; and (iii) nothing in section 502(b) dictates that such claims should be disallowed. In addressing the section 506(b) argument left open by the Supreme Court in Travelers, the court reasoned that because the title of section 506(b) is Determination of Secured Status, that provision would not be the logical place to provide for the disallowance of an element of an unsecured claim. Rather, it reasoned that [i]f Congress... 4

5 had wanted to disallow claims for post-petition attorneys fees, the logical place for it to have done so was surely in 11 U.S.C. 502(b). The Qmect court also relied on an equitable reason as support for its holding. In particular, the court stated that [i]t would seem highly inequitable to permit the estate to recover fees incurred in [sic] post-petition with a creditor while at the same time denying the creditor the right even to include its post-petition fees in its unsecured claim. It emphasized that the strongest rationale for prohibiting the inclusion of postpetition attorneys fees in a prepetition unsecured claim is that, unless a debtor is solvent, such inclusion will diminish other unsecured creditors distribution. However, the court noted that this rationale is equally applicable to secured claimants, who clearly can claim postpetition attorneys fees to the extent that they are oversecured. Finally, the court stressed that its holding would further an important policy of bankruptcy law: the preservation of nonbankruptcy legal rights. Shortly thereafter, a Florida bankruptcy court issued a decision in line with the pre-travelers majority position, and contrary to Qmect, in In re Electric Machinery Enterprises. The court first outlined the four primary reasons why courts have concluded that an unsecured creditor is not entitled to attorneys fees (discussed above), and stated that those reasons mandated the same conclusion in the case before it. Importantly, the court added that it was mindful of the implications that a contrary decision would have on the administration of a bankruptcy estate: 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 ever-accruing attorneys fees. The administrative inconvenience this would cause in a chapter 11 case would, in the court's 5

6 estimation, be intolerable. Finally, the court declined to follow the minority view because, among other things, those cases involved solvent estates. With a solvent estate, the court explained, the payment of postpetition attorneys fees to certain unsecured creditors would not diminish other unsecured creditors recoveries, but would be paid out of the surplus that would otherwise be distributed to the debtor. By contrast, the court concluded, the case before it involved a clearly insolvent estate, where creditors would not be paid in full. Conclusion Post-Travelers rulings confirm that the pre-travelers debate regarding the allowability of unsecured creditors claims for postpetition attorneys fees, costs and other similar charges will almost certainly endure until either there is a consensus regarding the issue at the appellate level or the Supreme Court determines to intervene to resolve any split among the circuit courts of appeal. This seemingly peripheral issue can have important implications. If courts construe the Bankruptcy Code to allow unsecured creditors to file claims for postpetition attorneys fees, costs and other similar charges, there could be a significant shift in the composition of recoveries to unsecured creditors. The winners as a result would be contract creditors who are sophisticated enough to bargain for a provision granting them attorneys fees, costs and other charges, and creditors who are fortunate enough to benefit from state statutes that provide for an award of fees and costs in addition to other recoveries. Other unsecured creditors and bankruptcy courts forced to shoulder the administrative burden of processing moving target claims would be the losers. 6

7 Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 127 S. Ct (2007). In re Fobian, 951 F.2d 1149 (9th Cir. 1991). United Savings Assoc. of Texas v. Timbers of Inwood Forest Assocs., Ltd, 484 U.S. 365 (1988). In re Astle, 364 B.R. 743 (Bankr. D. Idaho 2007). In re Qmect, Inc., 368 B.R. 882 (Bankr. N.D. Cal. 2007). In re Electric Machinery Enterprises, 371 B.R. 549 (Bankr. M.D. Fla. 2007). 7