US Supreme Court Decision Changes the Determination of Claims for Attorneys’ Fees in Bankruptcy Cases

By Christian D. Jinkerson

In Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co. (2007), the United States Supreme Court recently ruled that attorneys’ fees can be recovered in connection with an unsecured or undersecured claim pursuant to a contractual or statutory right in the context of a bankruptcy case. The Supreme Court’s decision overruled the Ninth Circuit Court of Appeals and changed the law with respect to all bankruptcy cases in California.

The decision arose out of the Chapter 11 bankruptcy case of Pacific Gas & Electric Co. (“PG&E”). During the course of the bankruptcy case, PG&E and Travelers Casualty & Surety Co. (“Travelers”) entered into a stipulation which provided for an unsecured claim for attorneys’ fees. Upon successfully litigating their claim in bankruptcy court, Travelers filed an amended proof of claim and asserted a contractual right to recover the attorneys’ fees it incurred in litigating its underlying claim. Travelers’ claim was disallowed by the Bankruptcy Court, the District Court, and the Ninth Circuit Court of Appeals. The primary rationale for not allowing the fees was previous Ninth Circuit authority to the effect that creditors are not entitled to attorneys’ fees where “the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law.” In re Fobian, 951 F.2d 1149, 1153 (9th Cir. 1991). The dispute over Travelers’ right to recover attorneys’ fees went all the way up the Supreme Court.

The unanimous opinion of the Supreme Court was written by the newest member of the Court: Associate Justice Samuel A. Alito, Jr. In a carefully reasoned opinion, the Court held:

  1. Under § 502(a) of the Bankruptcy Code, a properly filed creditor claim is allowed against the debtor unless a party in interest objects.
  2. Even where a party in interest objects, the court “shall allow” the claim “except to the extent that” the claim implicates an exception enumerated in § 502(b).
  3. The applicable exception to a claim for reasonable attorneys’ fees is § 502(b)(1), which disallows claims which are “unenforceable against the debtor . . . under any agreement or applicable law.” For instance, if a claim is based on a contract and the contract is unenforceable, then the claim is disallowed.
  4. Section 502(b)(1) is consistent with the well-established legal principle that, unless curtailed by provisions in the Bankruptcy Code, claims in bankruptcy are based on the underlying substantive law that creates the claim, which is often times state law. Therefore, if the claim is valid under state law, it is valid in bankruptcy unless there is something in the Bankruptcy Code to the contrary.
  5. The Supreme Court rejected the Fobian rule on the ground that the Fobian rule is not supported by the text of the Bankruptcy Code.

The Travelers decision simply means that a creditor’s right to reasonable attorneys’ fees is not affected by the filing of a bankruptcy case. A creditor’s right to attorneys’ fees is created and defined by statute or contract. That right is no longer abridged by attorneys’ fees incurred in connection with litigation that is “peculiar to federal bankruptcy law.” Significantly, in California, if one party to a contract has an attorneys’ fees provision, it is automatically deemed mutual. Cal. Civ. Code § 1717. Therefore, if a secured lender had a one-sided attorneys’ fee provision in a promissory note, then, by operation of law, the debtor has the same fee provision upon which to claim attorneys’ fees in post-bankruptcy litigation.

There are some stabilizing mechanisms to this increased availability of attorneys’ fees in the context of bankruptcy, both legal and practical. As a legal matter, under § 502(b)(4), any claim for attorneys’ fees must be “reasonable.” Therefore, the court will not award fees for unnecessary, excessive or overpriced legal work. As a practical matter, because bankruptcy, by definition, involves situations in which resources are limited, a creditor claim for attorneys’ fees under § 502(b) will probably not be paid 100 cents on the dollar, and could possibly not be paid at all.

Another potential ramification of the Travelers decision is that, in situations where a right to attorneys’ fees exists, there is a built-in incentive for both creditors and debtors to avoid contentious litigation. The stakes are increased because of the newfound ability to seek attorneys’ fees in bankruptcy if there is a contractual or statutory basis for doing so. Accordingly, both creditors and debtors will likely be more cautious in how they proceed in bankruptcy disputes. For example, creditors will be more likely to investigate and verify the amount and validity of their claim before filing a proof of claim or an adversary proceeding. Conversely, debtors will need to be especially discerning with respect to objecting to claims or filing adversary proceedings in connection with claims.