Fall 2007 • Issue 26, page 1

US Supreme Court Travelers Ruling May Allow Recovery of Post Petition Attorneys' Fees Incurred in Litigating Pre-Petition Bankruptcy Claims

By Golden, Jeffrey*

(Editor’s Note: This issue marks the beginning of a new regular feature - Bankruptcy Corner - that will deal with an issue of interest to the insolvency community. There is a marked crossover between receiver and insolvency groups: many receivers also serve as bankruptcy trustees and many receivership professionals also provide services to the insolvency community. We hope these pieces will inform and educate without being lethally arcane.)

Suppose a pre-petition creditor owed $25,000 finds itself litigating aggressively with the debtor post-petition, perhaps defending itself against a preference action. The creditor prevails but incurs more than $50,000 in attorneys' fees in doing so. The agreement that created the underlying debt in issue had a broad attorneys' fees provision. Could that creditor add the additional $50,000 in attorneys’ fees to the original $25,000 claim?

This is a significant issue to anyone who may file or deal with unsecured claims in a bankruptcy case based upon contractual agreements.

Until recently Ninth Circuit law was that the unsecured creditor's claim would be limited to the original $25,000. But a recent Supreme Court decision - Travelers Casualty & Surety Company of America v. Pacific Gas & Electric Company - may hold that attorneys' fees incurred post-petition can be recovered by the creditor as part of its unsecured claim, boosting our hypothetical claim to $75,000. Whether this recent ruling does or does not so hold sort of depends upon who you talk to.

The issue - simply put - is whether an unsecured creditor can recover attorneys' fees incurred post-petition based on a contractual agreement which provides that the prevailing party in any litigation over the contract may recover its reasonable attorneys' fees. If the correct interpretation of the Supreme Court ruling is that a creditor can recover such attorneys’ fees, the decision will result in significantly increased creditor claims and may affect litigation strategies (and decisions about whether to litigate) by debtors and creditors facing bankruptcy-related litigation.

Here is how it may change past practice. Typically, at the conclusion of the bankruptcy case, the debtor or the trustee liquidates the assets of the estate and distributes those assets to creditors with allowed proofs of claim. Such unsecured claims historically include all principal debt owing plus any accrued interest and/or attorneys' fees that are otherwise allowable under applicable non bankruptcy law (state law) up to the date the petition was filed. If an unsecured claim were based upon a contract that also entitled the creditor to recover its attorneys' fees as well as interest, such interest and attorneys' fees are calculated up to (and including) the date the petition was filed, but not past that date.1 This was premised upon interpretation of several Bankruptcy Code provisions, including Section 506(c) found in prior cases on the subject.

The 2007 United States Supreme Court Travelers2 decision arguably changes this reasoning. Many bankruptcy professionals believe that Travelers means that unsecured creditors can assert in their claim the full amount of post petition attorneys' fees incurred related to the bankruptcy issues if the underlying contract has an attorneys’ fees provision. But other professionals read the Travelers holding far more narrowly.

The Travelers Decision
On March 20, 2007, the United States Supreme Court unanimously issued its opinion in Travelers holding that it was not appropriate to disallow attorneys' fees solely because the proceeding had been the subject of bankruptcy litigation. The Court reasoned that bankruptcy law does not disallow claims for attorneys' fees based on contract solely because the fees related to litigating bankruptcy issues. The holding reversed the Nonth Circuit’s earlier decision in In re Fobian3, which held that attorneys' fees are not recoverable in bankruptcy for litigating issues unique to bankruptcy law.

In Travelers the debtor Pacific Gas & Electric Company ("PG&E") filed a petition for relief under chapter 11. PG&E had self insured its workers' compensation obligations. Travelers had issued a surety bond to guarantee payment of workers' compensation benefits. Travelers sought to assert a claim in the event the debtor defaulted on future workers' compensation obligations.

Travelers later amended its claim seeking attorneys' fees incurred in connection with the bankruptcy case. PG&E opposed this inclusion, relying on the Ninth Circuit’s holding in Fobian, and the Bankruptcy Court agreed, disallowing the fees. Both the United States District Court and the Ninth Circuit Court of Appeals affirmed the trial court’s ruling. The matter was then appealed to the United States Supreme Court.

The Supreme Court found that Bankruptcy Code § 502 requires that the claim must be allowed in bankruptcy unless the Bankruptcy Code expressly states to the contrary. It found no support for the Ninth Circuit’s Fobian ruling, reasoning that the:

“. . . absence of textual support is fatal for the Fobian rule . . . We generally believe that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed."4

Because Bankruptcy Code section 502(b)(4) expressly disallows certain attorneys' fees, Congress (by implication) did not intend to bar other categories of attorneys' fees recoverable under state law that were not expressly disallowed, the Supreme Court held. Accordingly, claimants are allowed to claim post petition attorneys' fees on bankruptcy matters.

The Supreme Court premised its holding on the "plain language" of the Code rubric. This is consistent with some of the court’s past bankruptcy decisions and inconsistent with others.5 The Supreme Court declined to express an opinion on whether section 506(b) (or any other section) of the Bankruptcy Code could provide a basis for disallowing an unsecured contractual claim for attorneys' fees, however.

The debtor PG&E had argued that while Section 506(b) allows for reasonable attorneys' fees for oversecured creditors pursuant to agreement, but there is no similar section for unsecured creditors. PG&E concluded that unsecured claimants cannot collect attorneys' fees post-petition from the estate since Section 506(b) does not apply to unsecured creditors and is the only provision in the Bankruptcy Code that permits creditors to recover such fees from the estate. Others contend that because nothing in the Bankruptcy Code provides otherwise, such claims are allowable under Section 502, and Section 506(b) by its terms, does not preclude such recovery. In other words, Section 506 does not expressly state that attorneys' fees are impermissible. The Supreme Court did not reach this issue, leaving it for the Bankruptcy Court below to decide.

Pros and Cons
A Narrow Interpretation of Travelers
It may be argued that all the Supreme Court’s Travelers decision holds is that the Bankruptcy Code does not generally prohibit attorneys' fees from being recovered in connection with litigating bankruptcy issues. The holding does not indicate at all whether attorneys' fees are truly allowable because of some other specific policy or statute in the Bankruptcy Code, such as Bankruptcy Code Section 506, some believe.

They argue that the Travelers decision has not changed the law at all, and contend that no post-petition attorneys' fees are permitted given the language and implications of Section 506 and various policies underlying bankruptcy law, such as equality of distribution.6

An Expansive Interpretation of Travelers
Others hold a more expansive interpretation of Travelers.7 They argue that Travelers clearly allows unsecured creditors with contractual attorneys' fees clauses to include their fees as part of their claims. Nothing in the Bankruptcy Code expressly prohibits this, they argue. Even the Supreme Court suggests that the argument that Section 506 bars all such attorneys' fees appears inconsistent with the Fobian rule. If this were the case, the Supreme Court asserts, then all post petition attorneys' fees (not just those relating to the bankruptcy) would cease.

"[Debtors'] new reading of the Code would prohibit all unsecured creditors from recovering contractual, post petition attorneys' fees in bankruptcy proceedings even if those fees were incurred while litigating issues of state law. . . The Fobian rule, by contrast, would allow such a recovery-even by unsecured creditors-so long as the litigation resulting in applying fees did not involve 'issues peculiar to federal bankruptcy law'. . . " 8

The Supreme Court reasoned that such a narrow interpretation is inconsistent with even the Fobian rule, which the Supreme Court expressly struck down.

Another implication of the Travelers decision is that in a Section 365 context (which deals with the rights of lessors of real and personal property) Section 506 of the Bankruptcy Code may not apply at all, removing the impediment to collecting attorneys’ fees on post-petition litigation over lessee’s rights. Lessors own property while secured creditors may hold a security interest in property. Lessors of real and personal property (dealt with under Bankruptcy Code Section 365) are generally not "secured or unsecured creditors" within the meaning of Bankruptcy Code Section 506. The argument may no longer apply that since Section 506 expressly allows such fees only for oversecured creditors, it denies such fees to lessors (and others) by the implication of their omission. Travelers may open the door for lessors to argue that all post petition fees relating to bankruptcy matters in connection with lease default can and should be incorporated into the total amount of the unsecured claim, significantly increasing the dollar amount of lease rejection damages that the estate may face.

Conclusion
More questions were raised than were answered by the Supreme Court’s Travelers decision9. What is clear is that the Ninth Circuit’s holding in Fobian is reversed. And what is certain is that there will be more litigation on these post-petition attorneys’ fees issues.

1 This article only addresses post petition attorneys' fees relating to bankruptcy matters.
2 127 S.Ct. 1199 (2007).
3 951 F.2d 1149 (9th Cir. 1991)
4 127 S.Ct. at 1206.
5 See Howard Delivery Service, Inc. v. Zurich American Insurance Co., 265 S.Ct. 2105 (2006).
6 Equality of distribution is implicated because claims with attorneys' fee provisions would have advantages over unsecured claimants who do not.
7 See In re Qmect, Inc., 2007 WL 1463846 (Bankr. N.D. Cal. 2007) (bankruptcy court allows unsecured creditor post-petition attorneys' fees and costs).
8 127 S.Ct. At 1207, n. 4.
9 For an excellent analysis of the implications of this decision, please see the next edition of the California Bankruptcy Journal, in an article entitled An Analysis of the Supreme Court's Travelers Decision and the Implications on the Availability of Post-Petition Attorneys' Fees for Unsecured Creditors, written by Jennifer M. Taylor and Christopher J. Mertens, currently law clerks for the Honorable Leslie J. Tchaikovsky, United States Bankruptcy Judge for the Northern District of California.

*Jeffrey I. Golden, a founding partner of Weiland, Golden, Smiley, Wang Ekvall & Strok, LLP, is a bankruptcy trustee of the Central District of California and Co-Editor in Chief of the California Bankruptcy Journal. He formerly served as a law clerk to the Honorable Peter M. Ellliott and to the Honorable Calvin K. Ashland, Judges of the United States Bankruptcy Court and the Bankruptcy Appellate Panel, and is a past President of the Orange County Bankruptcy Forum.