Under the “American Rule” concerning the recovery of attorney’s fees in pursuing breach of contract litigation, the prevailing party is awarded fees if the contract or an applicable statute provides for such recovery. Some states also allow a judgment creditor to recover fees incurred in enforcing the judgment, if the judgment was based on a contract or statute that authorized fees in the original litigation. See, e.g., California Code of Civil Procedure § 685.040.

But to be recoverable, do these fees have to be incurred in the usual kinds of enforcement process, such as execution, examination of a judgment debtor or writ practice? A recent California case extends recovery to fees and costs incurred in a bankruptcy case.

A California Court of Appeal held that California state law permitted recovery of attorney’s fees and costs post-judgment incurred by the judgment creditor in a bankruptcy case filed by the defendant and judgment debtor after suffering the judgment. Chinese Yellow Pages Co. v. Chinese Overseas Mktg. Serv. Corp., 170 Cal.App.4th 868 (2009). Lawsuits & Bankruptcy

The facts are complex but boil down to this: In Case 1, Chinese Yellow Pages (CYP) sued Chinese Overseas Marketing Service Corporation (COMSC) for false advertising and unfair competition, and the case was settled for a substantial sum and certain “good conduct” promises. The settlement agreement also included a provision for awarding attorney’s fees to the prevailing party in any action later brought to enforce or interpret the settlement agreement. A judgment based on the settlement agreement and including a permanent injunction was entered by the court in Case 1.

After several years, CYP filed Case 2 in state court against COMSC, alleging a violation of the “good conduct” terms of the settlement agreement. Case 2 was tried, and CYP won a judgment against COMSC for $4.25 million in compensatory damages, plus $750,000 in punitive damages.

COMSC filed a chapter 11 bankruptcy petition. The bankruptcy case also was hotly contested by CYP. While the bankruptcy litigation proceeded, CYP filed in state trial court pursuant to Case 2 a supplemental cost memorandum seeking approximately $500,000 in additional attorney’s fees and costs for work performed in the bankruptcy case, citing California Code of Civil Procedure § 685.040.

The judgment debtor and the appointed bankruptcy trustee in the Chapter 11 case opposed the motion on the grounds that a decision as to the entitlement and amount of any such fees or costs should be made by the bankruptcy court rather than the state trial court. While that motion was pending, the bankruptcy court entered a formal order dismissing the Chapter 11 case, so no decision on the motion was made by the bankruptcy court. In addition, the bankruptcy court, relying on its dismissal of the chapter 11 case, declined the state trial court’s request to advise it as to whether an attorney’s fees award would be proper.

The state trial court then heard and denied the attorney’s fees motions on the grounds that it lacked authority to award attorney’s fees for work done in the bankruptcy case.

Literal Reading

On appeal, the California Court of Appeal ruled that neither the bankruptcy code nor the pendency of the bankruptcy case precluded the state trial court from ruling on the merits of the creditor’s motion under California Code of Civil Procedure § 685.040. The Court of Appeal determined that the trial court was not precluded from awarding attorney’s fees and costs incurred to enforce the multimillion-dollar judgment in Case 2, even though those expenses were for work in the bankruptcy case.

The court applied a literal reading to section 685.040 (“Attorneys incurred in enforcing a judgment are [recoverable] . . . if the underlying judgment includes an award of attorney’s fees to the judgment creditor . . .”). It also relied on an earlier decision by a different California Court of Appeal, Circle Star Center Assoc., L.P. vs. Liberate Tech., 147 Cal. App. 4th 1203 (2007), in which a plaintiff leased space to a defendant that filed a bankruptcy petition. The plaintiff was able to secure dismissal of the defendant’s bankruptcy case by motion in the bankruptcy court, and subsequently sought an award in state court under the attorney’s fees clause in the lease.

The Circle Star court approved this procedure and affirmed the judgment. Based on this analysis, the Chinese Yellow Pages court reversed the trial court’s refusal to enter a judgment for attorney’s fees and costs.

Unexpected Consequences

It is difficult to argue with the logic of these decisions, but the consequences for some litigants in bankruptcy court may be unexpected. For example, can a party engaged in state court specific performance litigation over a contract with an attorney’s fees clause obtain an award of attorney’s fees for its costs in successfully obtaining relief from stay by motion in the bankruptcy court?

Suppose a party successfully contests the confirmation of a chapter 11 plan of reorganization that would have treated its creditor’s claim based on a state court judgment (with an attorney’s fee award) as a nonpriority unsecured claim, thereby gaining priority unsecured status instead? Can this party then return to state court to obtain a supplemental award of attorney’s fees for winning the battle over the confirmation of the plan—which also will be treated as priority?

Look at another example: A debtor makes a payment on a partly secured obligation established by a state court judgment in an action involving the interpretation of a security agreement with an attorney’s fees clause. What if the debtor then sues on behalf of the bankruptcy estate, to recover this payment as a pre-bankruptcy preferential transfer? If the creditor/recipient of the transfer successfully defends the preference recovery action by litigating to establishing that the value of the collateral well exceeds the amount transferred, can the creditor then approach the state court to obtain a supplemental award, also to be paid as secured from the estate’s property?

As these examples demonstrate, the holding in Chinese Yellow Pages has the potential to shift significantly the burden of bankruptcy court litigation costs.