The Supreme Court has held that a creditor may not be precluded from including contractual attorney’s fees as part of its prepetition claim. In Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 127 S.Ct. 1199 (2007), the Court resolved a conflict between the Fourth and Ninth Circuits and held that contractual rights to attorney’s fees, if allowed under state law, may be included as part of a creditor’s prepetition claim, unless the claim falls under one of the exceptions found in Section 506(b) of the Bankruptcy Code.
Previously, the Ninth Circuit had held in In re Fobian, 951 F.2d 1149 (9th Cir. 1991) that where the litigated matters involve issues related to federal bankruptcy law as opposed to strict contract enforcement questions, attorneys’ fees will not be awarded unless there is bad faith or harassment on the part of the losing party. Traditionally, issues of contract enforcement, including any provisions that may allow the award of attorneys’ fees, are first matters of state law and, therefore, whether a claim for such attorneys’ fees is allowable in bankruptcy largely will turn on the interpretation of a state statute addressing the entitlement of a prevailing party to attorneys’ fees.
In Travelers, the claimant was a surety company that had issued a bond on behalf of the debtor utility company prior to its bankruptcy filing to guarantee the debtor’s payment of state workers’ compensation benefits. In conjunction with the issuance of the bond, the debtor had executed indemnity agreements that provided for the reimbursement of attorneys’ fees in the event that the surety had to litigate its rights with respect to the bond. As part of the plan confirmation process, a dispute arose between the claimant and the debtor (eventually escalating into litigation) with regard to language that the claimant wanted inserted into the debtor’s plan of reorganization and disclosure statement to protect the claimant’s interests in the event that the debtor defaulted on its obligations to pay the workers’ compensation benefits. The dispute was resolved via a bankruptcy court approved stipulation, which provided that the claimant could assert a general unsecured claim for the attorney’s fees that it incurred against the debtor’s bankruptcy estate. However, after the claimant filed its amended claim for attorneys’ fees, the bankruptcy court rejected the claim on the basis of the Fobian decision. The district court and the Ninth Circuit affirmed.
In abrogating the ruling in Fobian, the Supreme Court did, nonetheless, leave open the question of whether section 506(b) of the Bankruptcy Code, which authorizes the inclusion of contractual attorneys’ fees for allowed claims of oversecured creditors but does not address the claims of unsecured creditors, prohibits an unsecured claimant’s recovery of its attorneys’ fees. Also left for the lower courts to decide was whether the amount of the attorneys’ fees incurred by the claimant were reasonable if the claim was otherwise permissible.
The courts that have addressed whether attorneys’ fees provisions that are contractually or statutorily permitted under state law are enforceable in bankruptcy since Travelers have generally remained able to skirt the §506(b) issue on state law grounds. Most recently, in In re Busch, 369 B.R. 614 (BAP 10th Cir. 2007), the BAP upheld the decision of the bankruptcy court that awarded attorneys’ fees to a chapter 7 debtor’s former wife in connection with the former wife’s participation in the debtor’s bankruptcy case pursuant to a state statute allowing attorneys’ fees to be awarded to a prevailing party to an enforcement of a divorce decree action.
From a practical standpoint, the change that the Travelers decision has brought to the bankruptcy world is that bankruptcy courts will now have more reason to look to the language in the parties’ contract and/or to applicable state law to determine whether attorneys’ fees are authorized under "nonbankruptcy law"—before deciding whether attorneys’ fees are allowed under the Bankruptcy Code. Thus, broad contract terms permitting the recovery of attorneys’ fees, including those incurred in the protection of rights in bankruptcy, should be included in agreements in order to maximize the potential for recovery.
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