On March 20, 2007, the United States Supreme Court ruled in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., case docket no. 127 S.Ct. 1199 (2007), that federal bankruptcy law does not preclude an unsecured creditor from obtaining attorney’s fees authorized by a valid prepetition contract and incurred in postpetition litigation. In reaching this decision, the Supreme Court overruled the Ninth Circuit Court of Appeal’s ruling in Fobian v. Western Farm Credit Bank (In re Fobian), 951 F.2d 1149 (9th Cir. 1991), and, in all probability, fueled what will prove to be a lengthy debate concerning the collection of attorney’s fees in bankruptcy cases. Pacific Gas and Electric Company (PG&E), a large California utility, filed a Chapter 11 bankruptcy case in April of 2001. Prior to filing its petition, Travelers Casualty & Surety Company (Travelers) issued a $100 million surety bond on behalf of PG&E to the California Department of Industrial Relations. The bond guaranteed PG&E’s payment of workers’ compensation benefits as required by California law. The bond made Travelers liable for the payment of workers’ compensation benefits to PG&E’s employees in the event of a default by PG&E. In connection with the bond, PG&E executed a series of indemnity agreements in favor of Travelers, which provided that PG&E would be liable for any loss Travelers might incur in connection with the bond, including attorney’s fees incurred in enforcing, defending or litigating Travelers’ rights thereunder.

Although PG&E did not default, Travelers filed a proof of claim in PG&E’s bankruptcy case to protect itself in the event of a future default. In response thereto, PG&E inserted language into its plan of reorganization that protected Travelers’ indemnity and subrogation rights in the event of a default. Sometime thereafter, however, Travelers claimed that PG&E unilaterally altered the agreed-upon language and materially diminished Travelers’ protections. Litigation then ensued. Ultimately, Travelers and PG&E resolved their dispute and entered into a stipulation that was later approved by the Bankruptcy Court. Notably, the stipulation stated that Travelers could assert its claim for attorney’s fees under the indemnity agreements as a general unsecured claim, subject to PG&E’s defenses.

Travelers subsequently filed an amended proof of claim in an attempt to recoup the attorney’s fees it incurred in connection with PG&E’s bankruptcy. In response, PG&E filed an objection, asserting that Travelers could not recover such attorney’s fees because the issues litigated between the parties were issues that arose solely in connection with the Bankruptcy Code. The Bankruptcy Court sustained PG&E’s objection and was affirmed by the District Court and the Ninth Circuit. See Travelers Casualty and Surety Co. v. Pacific Gas and Electric Co., 167 Fed. Appx. 593 (2006). In its opinion, the Ninth Circuit recognized that in some circumstances, a “‘prevailing party in a bankruptcy proceeding may be entitled to an award of attorney’s fees in accordance with applicable state law if state law governs the substantive issues raised in the proceedings.’” Id. at 594 (citing Ford v. Baroff (In re Baroff), 105 F.3d 439, 441 (9th Cir. 1997)). Nonetheless, the Ninth Circuit concluded that in the case at hand, Travelers could not recover its fees because “attorney fees are not recoverable in bankruptcy for litigating issues ‘peculiar to federal bankruptcy law.’” Id. (quoting Fobian, supra, at 1153). Travelers appealed to the Supreme Court, citing a conflict among the Courts of Appeal between Fobian and Three Sisters Partners, L.L.C. v. Harden (In re Shangra-La, Inc.), 167 F.3d 843 (4th Cir. 1999) regarding whether a litigant may recover attorney’s fees pursuant to a contract or state statute where the On March 20, 2007, the United States Supreme Court ruled in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., case docket no. 127 S.Ct. 1199 (2007), that federal bankruptcy law does not preclude an unsecured creditor from obtaining attorney’s fees authorized by a valid prepetition contract and incurred in postpetition litigation. In reaching this decision, the Supreme Court overruled the Ninth Circuit Court of Appeal’s ruling in Fobian v. Western Farm Credit Bank (In re Fobian), 951 F.2d 1149 (9th Cir. 1991), and, in all probability, fueled what will prove to be a lengthy debate concerning the collection of attorney’s fees in bankruptcy cases.

Pacific Gas and Electric Company (PG&E), a large California utility, filed a Chapter 11 bankruptcy case in April of 2001. Prior to filing its petition, Travelers Casualty & Surety Company (Travelers) issued a $100 million surety bond on behalf of PG&E to the California Department of Industrial Relations. The bond guaranteed PG&E’s payment of workers’ compensation benefits as required by California law. The bond made Travelers liable for the payment of workers’ compensation benefits to PG&E’s employees in the event of a default by PG&E. In connection with the bond, PG&E executed a series of indemnity agreements in favor of Travelers, which provided that PG&E would be liable for any loss Travelers might incur in connection with the bond, including attorney’s fees incurred in enforcing, defending or litigating Travelers’ rights thereunder.

Although PG&E did not default, Travelers filed a proof of claim in PG&E’s bankruptcy case to protect itself in the event of a future default. In response thereto, PG&E inserted language into its plan of reorganization that protected Travelers’ indemnity and subrogation rights in the event of a default. Sometime thereafter, however, Travelers claimed that PG&E unilaterally altered the agreed-upon language and materially diminished Travelers’ protections. Litigation then ensued. Ultimately, Travelers and PG&E resolved their dispute and entered into a stipulation that was later approved by the Bankruptcy Court. Notably, the stipulation stated that Travelers could assert its claim for attorney’s fees under the indemnity agreements as a general unsecured claim, subject to PG&E’s defenses.

Travelers subsequently filed an amended proof of claim in an attempt to recoup the attorney’s fees it incurred in connection with PG&E’s bankruptcy. In response, PG&E filed an objection, asserting that Travelers could not recover such attorney’s fees because the issues litigated between the parties were issues that arose solely in connection with the Bankruptcy Code. The Bankruptcy Court sustained PG&E’s objection and was affirmed by the District Court and the Ninth Circuit. See Travelers Casualty and Surety Co. v. Pacific Gas and Electric Co., 167 Fed. Appx. 593 (2006). In its opinion, the Ninth Circuit recognized that in some circumstances, a “‘prevailing party in a bankruptcy proceeding may be entitled to an award of attorney’s fees in accordance with applicable state law if state law governs the substantive issues raised in the proceedings.’” Id. at 594 (citing Ford v. Baroff (In re Baroff), 105 F.3d 439, 441 (9th Cir. 1997)). Nonetheless, the Ninth Circuit concluded that in the case at hand, Travelers could not recover its fees because “attorney fees are not recoverable in bankruptcy for litigating issues ‘peculiar to federal bankruptcy law.’” Id. (quoting Fobian, supra, at 1153). Travelers appealed to the Supreme Court, citing a conflict among the Courts of Appeal between Fobian and Three Sisters Partners, L.L.C. v. Harden (In re Shangra-La, Inc.), 167 F.3d 843 (4th Cir. 1999) regarding whether a litigant may recover attorney’s fees pursuant to a contract or state statute where the issues litigated involved matters unique to bankruptcy law.1 The Supreme Court granted certiorari.

In a unanimous opinion written by Justice Samuel Alito, the Supreme Court resolved the conflict between the circuits by rejecting Fobian. In reversing the Ninth Circuit, the Supreme Court noted that the Fobian rule is not supported by the express language of the Bankruptcy Code. The Supreme Court reasoned that under Section 502(b) of the Bankruptcy Court, a court must allow a validly filed claim except to the extent that the claim falls into one of the express exceptions set forth in Section 502(b)(1)-(9) of the Bankruptcy Code.2 The Supreme Court concluded that none of these exceptions disallows a claim for attorneys’ fees that is valid under otherwise applicable law. Thus, the Supreme Court concluded that Travelers’ claim for attorneys’ fees should be allowed if enforceable under state law, a question that was not considered by the Ninth Circuit in its decision to affirm the disallowance of Traveler’s claim. Travelers, supra, at pg. 6. Instead, the Supreme Court noted, the Ninth Circuit relied exclusively on the Fobian rule, a principle of its own creation, with no basis in the text of the Bankruptcy Code. See Travelers, supra, at pg. 594. The Supreme Court wrote: The Fobian rule finds no support in the Bankruptcy Code, either in §502 or elsewhere. In Fobian, the court did not identify any provision of the Bankruptcy Code as providing support for the new rule. Instead, the court cited three of its own prior decisions, In re Johnson, 756 F.2d 738 (1985); In re Coast Trading Co., 744 F.2d 686 (1984); and In re Fulweiler, 624 F.2d 908 (1980) (per curium). Significantly, in none of these cases did the court identify any basis for disallowing a contractual claim for attorney’s fees incurred litigating issues of federal bankruptcy law. Travelers, supra, at pg. 8. Additionally, the Supreme Court opined that if Congress wanted to exclude from recovery the type of attorney’s fees that are covered by Fobian, Congress could amend the Bankruptcy Code to do so. However, “because no such provision exists, the Bankruptcy Code provides no basis for disallowing Travelers’ claim on the grounds stated by the Ninth Circuit.” Id. at 9.3 The Supreme Court remanded the case to the Ninth Circuit for further proceedings consistent with its ruling.

Travelers will likely have four significant near term consequences. First, unsecured creditors across the country will include a request for attorney’s fees in their proofs of claim to the extent such fees are authorized by an underlying contract or applicable state statute. Second, attorneys’ fee provisions in contracts will likely become more broadly written to expressly include fees incurred as a result of bankruptcy proceedings. Third, litigation will likely continue regarding when and under what circumstances attorneys’ fees are recoverable in bankruptcy proceedings. In its opinion, the Supreme Court did not consider PG&E’s argument that Section 506 of the Bankruptcy Code implicitly denies attorneys’ fees to unsecured creditors by expressly permitting only oversecured creditors to collect attorneys’ fees. On remand, PG&E can raise those arguments with the Bankruptcy Court. Fourth, unsecured creditors entitled to attorneys’ fees under state law will have a stronger incentive to litigate claim disputes with debtors, especially in cases where the debtor has substantial assets. In short, the Supreme Court’s ruling in Travelers will likely open the door to increased litigation in bankruptcy cases nationwide and is a significant development in bankruptcy jurisprudence.