In Ninth Circuit Bankruptcy Courts, Creditors' Claims May Include Requests for Postpetition Attorneys' Fees

The Ninth Circuit's Bankruptcy Appellate Panel (BAP) has ruled that an unsecured creditor may include attorneys' fees, incurred postpetition but arising from a prepetition contract, as part of its unsecured claim. Centre Insurance Company v. SNTL Corp. et al.(In re SNTL Corp.), BAP No. CC-06-1350.

Pending a contrary decision by the Ninth Circuit Court of Appeals or local District Court, it will become standard practice for unsecured creditors in the Ninth Circuit to include postpetition attorneys' fees as part of their proofs of claim when allowed by the underlying contract. Indeed, unsecured creditors in other jurisdictions around the country may follow the same practice, pending a contrary ruling by their governing courts. If you are interested in the history of this issue and the SNTL court's reasoning, read on.

The SNTL decision is significant in the wake of the U.S. Supreme Court's March 2007 ruling in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549 U.S. ---, 127 S.Ct. 1199. In that case, the Supreme Court overruled the Ninth Circuit's so-called Fobian rule, which generally prohibited claims for attorneys' fees, but left open the issue of whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorneys' fees incurred during the course of the bankruptcy case.

In the aftermath of the Travelers decision, two bankruptcy courts issued decisions on the attorneys' fees issue and reached different conclusions. In May 2007, the U.S. Bankruptcy Court for the Northern District of California held, in In re Qmect, Inc., 368 B.R. 882, that unsecured creditors could recover postpetition attorneys' fees. However, in July 2007, in In re Electric Machinery Enterprises, Inc., 371 B.R. 549, the U.S. Bankruptcy Court for the Middle District of Florida reached the opposite conclusion. Thus, creditors, counsel and experts in the field have been waiting for further clarification on the matter of recovery of attorneys' fees in bankruptcy cases.

Some clarification arrived with the SNTL ruling. On December 19, 2007, the BAP Court, after carefully reviewing Qmect, Electric Machinery and pre-Travelers case law, chose to follow Qmect, holding that "claims for postpetition attorneys' fees cannot be disallowed simply because the claim of the creditor is unsecured." Judge Dennis Montali, writing for the unanimous BAP panel, focused the decision primarily on an analysis of the two relevant statutes, 11 USC § 502 and 11 USC § 506.

Prior to Travelers, most courts held that unsecured creditors could not recover postpetition attorneys' fees on the grounds that “plain language” in Section 506(b) precludes such claims. The Qmect court, however, rejected that analysis, pointing out that Section 506 is entitled “Determination of Secured Status” and declaring: “A statute so entitled would not be a logical place to provide for the disallowance of an element of an unsecured claim. If Congress, in enacting the Bankruptcy Code, had wanted to disallow claims for post-petition attorneys' fees, the logical place for it to have done so was surely in 11 U.S.C. § 502(b) [‘Allowance of claims or interests']. Moreover, 11 U.S.C. § 506(b) does not distinguish between pre-petition and post-petition attorneys' fees. Thus, if 11 U.S.C. § 506(b) is read as an additional ground for objecting to claims, arguably, an unsecured creditor would be prohibited from including its pre-petition attorneys' fees in its claim as well as its postpetition fees.”

In SNTL, the BAP panel ruled that it was not persuaded by the approach of the Electric Machinery court and, like Qmect, rejected the argument that Section 506(b) preempts postpetition attorneys' fees for all except oversecured creditors. The Court found support in Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678 (9th Cir. 1986), where the Ninth Circuit observed that Section 506(b) defines secured claims, does not limit unsecured claims, and “when read in conjunction with § 506(a), . . . may be understood to define the portion of the fees which shall be afforded secured status.” Accordingly, the Court concluded that, in light of Section 506(b)'s apparent irrelevance to determining the allowability of an unsecured claim, it had to look to Section 502 to determine allowability, and that statute does not specifically disallow attorney fees on unsecured claims.

The BAP panel further disagreed with the Electric Machinery decision by holding that the language of Section 502(b)(1) did not preclude postpetition fees and explaining that a 1988 US Supreme Court decision (United Savings Ass'n of Texas v. Timbers of Inwood Forest Assoc., Ltd., 484 U.S. 365), concerning postpetition interest, did not apply. Finally, the BAP held that it was unnecessary to reconcile the competing public policy considerations set forth in Electric Machinery and Qmect because “the Bankruptcy Code itself provides the answer to this issue (by not specifically disallowing postpetition fees).”

Thus, the original ruling of the Central District Bankruptcy Court has been reversed by SNTL, and the case has been remanded back to that court for a determination of whether the unsecured creditor (Centre) is entitled to attorneys' fees under the relevant contracts or state law or whether other grounds exist (apart from Centre's status as an unsecured creditor) for disallowing the postpetition attorneys' fees claim. While BAP decisions are not binding precedent in the Ninth Circuit, this first appellate decision on the open, post- Travelers question is likely to encourage unsecured creditors to include postpetition attorneys' fees as part of their allowed unsecured claims when a contract or statute provides for such fees outside of bankruptcy.