The Ninth Circuit's Post-Travelers Award Of Attorneys' Fees For Unsecured Creditors

Michael McGrath

Traditionally, courts have not allowed unsecured creditors to recover attorneys' fees, even when such fees are provided for in a pre-petition contract or allowed under state law. When analyzing the issue, courts typically take note of §506(b) of the Bankruptcy Code which allows oversecured creditors to recover attorneys' fees, costs and interest. Since the Code does not contain an equivalent grant of fees to unsecured creditors, courts reason that unsecured creditors are not entitled to recover attorneys' fees, regardless of the circumstances.

Recently, the United States Supreme Court, in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., addressed the issue of whether federal bankruptcy law precludes an unsecured creditor from recovering attorneys' fees authorized by a pre-petition contract that were incurred in post-petition litigation. 549 U.S. 443 (2007). The courts below, relying on the Ninth Circuit case In re Fobian, had all disallowed recovery. Travelers, 549 U.S. at 447. In re Fobian provided that, "where the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law, attorneys' fees will not awarded absent bad faith or harassment by the losing party." 951 F.2d 1149, 1153 (9th Cir. 1991).

The U.S. Supreme Court disagreed with Fobian rule, finding it was not supported by bankruptcy law. Travelers, 549 U.S. at 451-52. Instead, the court reasoned that 11 U.S.C. § 502 governs the allowance of claims in bankruptcy, and, under the plain language of the statute, Travelers' claim must be allowed since none of the statutory exceptions applied, and the claim was not unenforceable within the meaning of § 502(b)(1). Id. at 449-51.

However, the major controversy in the case did not revolve around the Fobian rule. Rather, the debtor (PG&E) argued that, based on 11 U.S.C. § 506, Travelers' claim for attorneys' fees should be denied. Travelers, 549 U.S. at 454. "According to PG & E, this provision authorizes claims for contractual attorney's fees to the extent the creditor is oversecured, but disallows such claims to the extent the creditor is either not oversecured or (like Travelers) completely unsecured." Id. at 454. The Supreme Court refused to address this argument because it had not been raised in the lower courts. Id. at 455. The case was remanded to the Ninth Circuit for rehearing consistent with the Court's opinion. Id. at 456. The case has yet to be considered on remand.

Although the Travelers' remand has not been heard by the Ninth Circuit yet, the court has addressed the issue of whether § 506 precludes unsecured creditors from recovering contractual attorneys' fees. In In re SNTL Corp., the court held that unsecured creditors may claim attorneys' fees incurred post-petition based on a prepetition contract with debtor. In re SNTL Corp., 571 F.3d 826 (9th Cir. 2009). The Ninth Circuit adopted, as its own, the Ninth Circuit Bankruptcy Appellate Panel's opinion written by the Honorable Dennis Natali. Interestingly, the BAP and the Ninth Circuit implement the same analysis typically relied on by courts which come to the opposite conclusion. Those dueling analyses are presented below.

1. Does the language of § 506 require denial of unsecured creditors' claims for post-petition attorneys' fees?

Courts denying fees to unsecured creditors have traditionally found that, at the very least, the plain language of 11 U.S.C. § 506(b) leaves "a strong negative impression with regard to allowance of post-petition fees on unsecured claims." Mark S. Scarberry, Interpreting Bankruptcy Code Sections 502 and 506: Post-Petition Attorneys' Fees in a Post-Travelers World, 15 AM. BANKR. INST. L. REV. 611, 639-40 (2007). Section 506(b) provides

To the extent that a allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, 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.

11 U.S.C. § 506(b). Thus, the Code explicitly allows oversecured creditors to recover "any reasonable fees, costs, or charges." By comparison, the Code does not contain a similar provision for unsecured creditors' claims. Mark S. Scarberry, supra, at 639-40. Many courts have interpreted this fact to mean that unsecured creditors' claims for such fees and costs should be denied. Id.

The Ninth Circuit rejected such a reading of § 506(b) in In re SNTL Corp, finding that it is not logical to read § 506 as having any impact on unsecured claims since it is entitled "Determination of Secured Status." In re SNTL Corp., 571 F.3d at 841. The logical place to address the disallowance of claims would be § 502(b), which is where such claims are otherwise discussed. Id. Further, § 506 does not distinguish between pre-petition and post-petition claims, so if §506 were read as the majority of courts urges, pre-petition attorneys' fees would have to be disallowed as well. Id. at 841. Based on those reasons, the Ninth Circuit held that § 506(b) is "irrelevant to determining the allowability of an unsecured claim." Id. at 843.

2. Does the Supreme Court's decision in United Savings Association v. Timbers require disallowance of post-petition fees, except in favor of oversecured creditors?

Courts taking the traditional position, i.e. that unsecured creditors are not entitled to recover attorneys' fees, also rely on the Supreme Court decision in United Savings Association v. Timbers. Scarberry, 15 AM. BANKR. INST. L. REV. at 640 (citing United Savings Ass'n of Texas v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365 (1988)).

In Timbers, the Supreme Court held that section 506(b) prohibits an unsecured creditor from collecting postpetition interest: "[s]ince this provision [section 506(b)] permits postpetition 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." 484 U.S. 365, 372-73, 108 S.Ct. 626, 631, 98 L. Ed.2d 740 (1988). As section 506(b) clearly prohibits an unsecured creditor from recovering postpetition interest, and since section 506(b) speaks identically to attorney's fees as it does to interest, some courts have concluded that the Supreme Court's Timbers opinion by implication likewise prohibits the recovery by the unsecured creditor of postpetition attorney's fees.

The Ninth Circuit in In re SNTL Corp. found this argument unpersuasive. In re SNTL Corp., 571 F.3d at 844. According to the court, the holding in Timbers is consistent with § 502(b)(2), "which specifically disallows claims for unmatured interest." Id. at 844. Since §502 does not have "a similar prohibition against attorneys' fees," the court declined to extend the Timbers rationale to the issue of whether an unsecured creditor can recover post-petition attorneys' fees. Id.

3. Does § 502(b)'s language, requiring that claims be determined "as of the date of the filing of the petition," prohibit unsecured creditors' claims for attorneys' fees?

In the past, courts have also "argued that section 502(b)'s mandate to determine the amount of a claim ‘as of the date of the filing of the petition,' should be taken seriously at face value. Post-petition attorneys' fees cannot be part of what is owed on the petition date, before they are incurred." Scarberry, 15 AM. BANKR. INST. L. REV. at 641.

The Ninth Circuit countered by arguing that the Bankruptcy Code's broad definition of claim permits the recovery of post-petition fees despite the fact that such fees have not been incurred as of the date of filing. In re SNTL Corp., 571 F.3d at 843. The Code defines a claim as the "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured." 11 U.S.C. § 105(A) (emphasis added). The court latches on to the fact that a claim may be "contingent" as grounds for allowing a claim for post-petition contractual attorneys' fees even though the amount was not determined as of the date of filing. In re SNTL Corp., 571 F.3d at 843.

4. As a matter of policy, is it proper to allow unsecured creditors to recover post-petition attorneys' fees when such fees have been provided for in a pre-petition contract?

Last, courts taking the majority position argue that, as a matter of public policy, it is proper to disallow unsecured creditors' claims for post-petition attorneys' fees. Scarberry, 15 AM. BANKR. INST. L. REV. at 641-43. One policy argument is that allowing such claims would require more administration. Id. at 642. Since there are generally few oversecured creditors in bankruptcy cases, "there could be a serious problem of administration" if post-petition fees were allowed to be claimed by "nearly all the contract creditors in every case." Id. Another policy argument for disallowing unsecured creditors' post-petition attorneys' fees is to ensure that unsecured creditors remain on the same footing. Id. at 642-43. The majority of courts reason that allowing such fees would be unfair because:

The Code does not, on its face, discriminate against tort claimants, except that they are not likely to be oversecured creditors entitled to post-petition interest and fees. . . The minority position, if accepted, would put tort creditors (and others without attorneys' fees clauses) at a real disadvantage, especially in cases in which there are substantial assets available to provide value for unsecured claim holders. The contract creditors who have attorneys' fee clauses could be reimbursed for a substantial part of their cost of participating in the case, but tort creditors would not (unless their claims arose under a statute that provided broadly for fees).

Scarberry, 15 AM. BANKR. INST. L. REV. at 642-43.

The Ninth Circuit declined to address feuding policy arguments presented by other courts. In re SNTL Corp.¸571 F.3d at 845. The court found it unnecessary to reconcile the policy concerns because the Bankruptcy Code provides an answer to the issue of whether unsecured creditors may recover post-petition attorneys' fees. Id. at 845. The court stated that "it is the province of Congress to correct statutory dysfunctions and to resolve difficult policy questions embedded in the statute." Id.

The Precursor to In re SNTL Corp.: In re 268 Ltd.

The Ninth Circuit's decision in SNTL is not surprising given the court's earlier decision in Joseph F. Sanson Investment Co. v. 268 Ltd., (In re 268 Ltd.), 789 F.2d 674, 678 (9th Cir. 1986). Therein, the Ninth Circuit observed that §506(b) is restricted to defining secured claims, and it does not limit unsecured claims:

When read literally, subsection (b) arguably limits the fees available to the oversecured creditor. When read in conjunction with §506(a), however, it may be understood to define the portion of the fees which shall be afforded secured status. We adopt the latter reading.

In re 268 Ltd., 789 F.2d at 678.

Pursuant to a liquidated attorneys' fees provision in its contract, the oversecured creditor in 268 Ltd. sought 5% of the balance due as a post-petition attorneys' fees award. The Ninth Circuit stated that the secured creditor would be allowed only "reasonable" fees pursuant to §506(b) of the Bankruptcy Code, and that the 5% recovery was unreasonable. However, the court further held that §506(b) did not limit the balance of the fees claimed by the creditor as an unsecured claim. Based on that rationale, the court remanded the case to allow the creditor to seek the balance of its fees under §502 as an unsecured claim.

The Ninth Circuit implicitly recognized in 268 Ltd. that §506(b) is not a basis for disallowing claims, but instead only defines secured claims. The 268 Ltd. court recognized that claims would be allowed pursuant to §502 unless they fell within one of the exclusions set forth in §502(b)(1-7).

The Next Frontier:
Allowance of Claims for Attorneys' Fees According to State Law

lthough the Ninth Circuit in 268 Ltd. allowed an undersecured creditor to maintain a claim for attorneys' fees which exceeds the value of its collateral under § 502(b), the court recognized that the creditor's claim for attorneys' fees on an unsecured basis "would still be subject to objection on the merits based on Nevada law." In re SNTL Corp., 571 F.3d 826, 842 n.17 (9th Cir. 2009) (citing In re 268 Ltd., 789 F.2d 674, 678 (9th Cir. 1986)). Thus, the court implicitly recognized that state law plays a part in determining whether undersecured or unsecured creditors may recover attorneys' fees.

As discussed in Travelers and SNTL Corp., § 502(b) governs the allowance of claims in bankruptcy. The statute provides that a bankruptcy court will allow a claim unless:

[s]uch claim is unenforceable against the debtor and the property of the debtor, under any agreement or applicable law for a reason other than because such claim is contingent or unmatured.

11 U.S.C. § 502(b)(1). The inverse of §502(b)(1) is that a claim will be allowed if provided for by agreement or applicable law. Given the Ninth Circuit's holding in SNTL Corp., debtors can no longer rely on § 506(b) to disallow the award of attorneys' fees to an unsecured creditors. However, given the language of § 502(b)(1) and the Ninth Circuit's suggestion that state law impacts the allowability of attorneys' fees in bankruptcy, parties may be able to rely on contractual provisions or state law restrictions as a means of limiting attorneys' fees claims.

In Arizona, one could argue that the recovery of attorneys' fees in bankruptcy is be limited by § 12-341.01 of the Arizona Revised Statutes. Section 12-341.01 restricts the recovery of attorneys' fees to contested actions arising out of contract. Even then, Arizona courts have further limited recovery by requiring that the fees must be reasonable, and that courts will examine the hourly billing rate and other factors in analyzing reasonableness of the fees. Schweiger v. China Doll Restaurant, Inc., 138 Ariz. 183 (1983). Once the prevailing litigant proves its entitlement to attorneys' fees, the losing party has the burden of proving that the requested fees are unreasonable. Nolan v. Starlight Pines Homeowners Association¸ 216 Ariz. 482, 490-91 (Ct. App. 2008).

Conclusion

In re SNTL Corp. has changed the bankruptcy practice within the Ninth Circuit. Debtors can no longer rely on § 506(b) as grounds for objecting to the award of attorneys' fees to unsecured creditors. See generally In re SNTL Corp., 571 F.3d 826 (9th Cir. 2009). Even before SNTL Corp. was decided, the Bankruptcy Court for the Northern District of California came to the same conclusion, holding that § 506(b) determines secured status, not the allowance of claims, and that post-petition attorneys' fees arising out of a pre-petition contract should be allowed as part of a creditor's general unsecured claim under § 502. See In re Qmect, Inc., 2007 W.L. 1463846 (Bankr. N.D. Cal. 2007).

The landscape created by SNTL and Qmect may be impacted when the Ninth Circuit renders its decision on remand in Travelers. Until then, unsecured creditors may rely upon these cases as a basis for including post-petition attorneys' fees as a part of their unsecured claim when a contract or statute provides for the award of fees.

This article was written with the assistance of Christina Morgan, a third-year law student at the University of Arizona, College of Law, and a 2009-10 law clerk at Mesch Clark & Rothschild.

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