Recent Second Circuit and Ninth Circuit opinions highlight the dispute over whether or not the Bankruptcy Code authorizes allowance of claims for post-petition legal fees incurred by unsecured creditors. Specifically, while not all Circuits agree, in the wake of the 2007 United States Supreme Court decision Travelers Casualty & Surety Co. of North America v. Pacific Gas & Electric Co., 549 U.S. 443 (2007), these recent cases support the theory that unsecured creditors can be paid post-petition legal fees when the contract creating the claim creates a right to payment of fees under applicable state law.
Travelers Casualty & Surety Co. of North America v. Pacific Gas & Electric Co.
The United States Supreme Court in the Travelers case was asked to decide whether "federal bankruptcy law precludes an unsecured creditor from recovering attorneys' fees authorized by a pre-petition contract and incurred in post-petition litigation." Id. at 445. In that case, the 9th Circuit held that such fees were prohibited to the extent that they were incurred in connection with litigation over issues involving federal bankruptcy law. The Supreme Court vacated and remanded.
The Court explained that "we generally presume that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed." Id. at 452. The Court further explained that "an otherwise enforceable contract allocating attorney's fees (i.e., one that is enforceable under substantive, nonbankruptcy law) is allowable in bankruptcy except where the Bankruptcy Code provides otherwise." Id. at 448.
The Court then specifically rejected the "Fobian Rule", which was a rule created by the 9th Circuit that attorneys' fees are not recoverable in bankruptcy for litigating issues peculiar to federal bankruptcy law. Id. at 456.
The Travelers opinion was limited in scope and did not extend beyond rejection of the "Fobian Rule". It thus leaves room for interpretation regarding whether the Bankruptcy Code may contain other valid grounds for disallowance of unsecured claims for post-petition fees. Recent cases have specifically addressed this issue and held that such fees can be allowed so long as they are based on a valid state law claim.
SNTL Corporation, et al. v. Centre Insurance Company
In the SNTL opinion, the 9th Circuit held that attorneys' fees incurred post-petition may be claimed by unsecured creditors when they are based on a pre-petition contract with the debtor. SNTL Corporation, et al. v. Centre Insurance Company, 571 F.3d 826 (9th Cir. 2009). In that case, the trustee of a litigation trust formed in the case objected to the claim of an unsecured creditor based, in part, on the creditor's inclusion of post-petition attorneys' fees in its claim.
a. Section 502(h)
In forming its conclusion that the post-petition attorneys' fees should be allowed, the 9th Circuit first examined Section 502(h) of the Bankruptcy Code. Section 502(h) states that the amount of a pre-petition claim should be determined as of the filing of the petition and the court should allow the claim in that amount. Parties opposing payment of post-petition attorneys' fees to unsecured creditors typically rely on this provision as proof that the Code does not allow payment of such claims.
Conversely, parties asserting a claim for post-petition fees to be paid to unsecured creditors take the analysis further by looking at the definition of "claim" under the Code. They specifically point to the fact that a claim includes a "right to payment or equitable remedy 'whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.'" Id. at 838 quoting 11 U.S.C. § 101(5).
In SNTL, the Court notes that the contract between the debtor and creditor provided for payment of fees upon the occurrence of a contingency or triggering event, and "those contingent claims cannot be disallowed simply because the contingency occurred post-petition." Id. at 838.
b. Section 506(b)
Courts that have denied the payment of post-petition fees to unsecured creditors also have relied on Section 506(b) of the Bankruptcy Code. Section 506(b) provides that claims are to be exclusive of post-petition interest and fees except that such interest and fees shall be allowed to the extent that the claim is oversecured. Thus, the reasoning goes that an unsecured claim is not oversecured and therefore is not permitted to include post-petition fees. See In re Electric Machinery Enter., Inc., 371 B.R. 549, 551 (Bankr. M.D.Fla. 2007); Pride Cos., L.P. v. Johnson, 285 B.R. 366 (Bankr. N.D. Tex. 2002).
That argument was rejected by the 9th Circuit in SNTL on the theory that Section 506(b) limits secured claims, but not unsecured claims. Id. at 842.
Ultimately, the 9th Circuit allowed the unsecured claimant's post-petition attorneys' fees because the claimant was found to have a pre-petition right to payment based on a pre-petition contract authorizing attorneys' fees. The fact that the fees were not actually incurred until after the petition date did not bar inclusion in the creditor's allowed unsecured claim.
Ogle v. Fidelity & Deposit Company of Maryland
Following the 9th Circuit's holding in SNTL, the 2nd Circuit issued an opinion in Ogle v. Fidelity & Deposit Company of Maryland in which it, too, held that an unsecured creditor may recover post-petition attorneys' fees if such fees were authorized by an enforceable pre-petition contract. Ogle v. Fidelity & Deposit Company of Maryland, 586 F.3d 143 (2nd Cir. 2009).
In Ogle, an unsecured creditor incurred post-petition attorneys' fees in connection with enforcement of a pre-petition indemnity agreement. The creditor filed a claim for those fees and the liquidating trustee in the case objected to the claim. Similar to the SNTL trustee, the Ogle trustee acknowledged that state law created a valid right to payment of the fees, but argued that the Bankruptcy Code trumps the state law right and does not allow recovery of post-petition fees by unsecured creditors.
In making its analysis, the 2nd Circuit acknowledged that courts are split on the issue. Specifically, the Ogle opinion referenced 9th and 6th Circuit opinions allowing unsecured post-petition attorneys' fees and also cited 1st and 8th Circuit cases disallowing such claims.
The 2nd Circuit echoed the holding in STNL that Section 506(b) is not a bar to recovery of unsecured claims for post-petition attorneys' fees and such claims are allowable under Section 502(b) so long as they are valid claims under state law. Id. at 147-48. The Ogle opinion is consistent with a prior 2nd Circuit holding in United Merchants & Manufacturers, Inc. v. Equitable Life Assurance Society, 674 F.2d 134 (2nd Cir. 1982), which was decided under the former Bankruptcy Act.
The Circuits continue to be split as to the allowance of unsecured claims for post-petition attorneys' fees. However, recent post-Travelers opinions have allowed such fees. So long as the split remains, it will be important for debtors and creditors alike to be mindful of the applicable Circuit's position on this evolving issue.