In a recent decision,[1] the U.S. Bankruptcy Court for the Northern District of California granted an adversary proceeding for the defendant’s motion for allowance and payment of a secured claim for attorneys’ fees incurred defending the adversary proceeding. While this may be just an isolated case, the decision could mark the start of a new wave of defendants prophylactically crafting contracts with attorneys’ fees provisions related to adversary proceedings, and attempting to enforce them.
Case Background
On Jan. 6, 2012, an involuntary chapter 7 petition was filed against Mac-Go Corp. (Mac-Go).[2] An order for relief was entered on Feb. 12, 2012, and a trustee was duly appointed to administer the estate.[3] As part of his duties, the trustee filed an adversary proceeding against defendant First National Bank (FNB). The trustee sought the recovery of payments made to FNB pursuant to Bankruptcy Code §§ 547, 548 and 549.
Prior to the petition date, the debtor operated a wholesale auto parts and oil business at several locations. As part of its business, Mac-Go obtained a loan with FNB, and also guaranteed two loans FNB had made to the owners of Mac-Go.[4] The payments at issue in the trial of the adversary proceeding were the payments made by Mac-Go to satisfy its guarantee obligation.[5]
To say that this adversary proceeding was heavily litigated would be an understatement. FNB moved three times to have the complaint dismissed. Only after the third motion to dismiss was denied did FNB file an answer to the complaint.[6] FNB then moved for summary judgment to reduce the issues for trial, which the court partially granted.[7] Specifically, the court dismissed all counts relating to payments that the debtor had made on its own loans with FNB, because they were secured. As to the payments the debtor made as guarantor, the court granted summary judgment in favor of FNB on the § 548 count, finding that the debtor received reasonably equivalent value in exchange for the transfers.[8] The case then proceeded to trial on the remaining issues — i.e., whether the remaining transfers could be avoided under §§ 547 and 549.
In its decision,[9] although the court determined that the trustee met his prima facie case to avoid the pre-petition transfers under § 547, it nonetheless found that the payments were not avoidable because FNB had successfully established the ordinary-course-of-business defense under § 547(c)(2). But the court found that FNB failed to establish any defense to the post-petition payments, and that these payments were avoidable by the trustee.[10] Accordingly, judgment was entered denying the trustee relief as to § 547, but entering judgment in favor of the trustee under § 549.
Court’s Analysis in Awarding Fees
Two weeks after the entry of judgment in the adversary proceeding, FNB filed a motion in the main bankruptcy case seeking the allowance and payment of its attorney’s fees incurred in defending the adversary proceeding, paid as a secured claim.[11] The bank asserted that it was entitled to payment because the debtor had signed loan documents that provided for payment of the bank’s attorneys’ fees in connection with its enforcement of the note and security agreement, including expenses in bankruptcy proceedings.
The bankruptcy court agreed with FNB, holding that it was entitled to payment of its secured claim. Looking to California law to determine the scope of the fee clauses in the loan documents, the court noted that under California law, parties can agree to the method and mode of compensation of attorneys. The court declined to decide whether §§ 547, 548 and 549 claims were sufficiently related to enforcement of the underlying contract such that California Civil Code § 1717 (concerning attorney’s fees in contract enforcement) would apply. Instead, the court examined whether California Code of Civil Procedure § 1021, which allows a party to recover attorneys’ fees in situations other than contract enforcement so long as the fee clause was sufficiently broad to cover such claims, applied.[12]
The court examined each claim to determine whether the fee clause was broad enough to include attorneys’ fees incurred in litigation. As to the fraudulent conveyance claims, FNB asserted that the contract’s underlying provisions applied to establish that it had given reasonably equivalent value, which is a defense to a constructively fraudulent transfer claim.[13] Finding that the attorneys’ fees incurred in defending an action by asserting the validity of the underlying contract was essentially “enforcement” of the contract, the court found the attorneys’ fees to be appropriate.[14] The court also found the attorneys’ fees provision applicable to the § 547 count, as the bank had to establish that its secured claim was valid, and thus the trustee could not satisfy his case in chief.[15] Similarly, the bank asserted its secured status in support of its § 549 defense, as a payment to a fully secured creditor does not affect other creditors or impermissibly diminish the estate. The court stated that by establishing its secured status for purposes of defeating the § 549 claim, the bank was enforcing the contract as well.[16] Accordingly, the court held that the bank could recover the fees incurred in defending against the trustee’s claims for relief.
Implications for Future Cases
The success of the defendant in this case should give pause to professionals representing trustees, as it leaves the potential for the depletion of estate assets while trustees are attempting to marshal assets through avoidance actions. It is especially concerning that the decision ties enforcement of a contract with preference actions under chapter 5, which are statutory creatures that only arise via a debtor’s bankruptcy filing. Given the court’s ruling, it would not be surprising to see lenders start shoring up contractual language in loan documents to explicitly provide for the recovery of attorneys’ fees in defending avoidance actions.
That being said, the scope of this decision may be limited in two respects. First, this case was decided under California law, and other state statutes may not be as broad in scope. Second, the fees sought in the motion were related only to the causes of action for which the trustee later conceded the bank had a full defense as a fully secured creditor; the bank did not seek enforcement of attorney’s fees related to the guarantor payments, for which they presented defenses not based on their secured status. Accordingly, there is a reduced likelihood that a garden-variety preference case would be seen as “enforcing” a contract. As of the date of this article, the issue is still alive, as the trustee filed a motion for reconsideration of the decision.
[1] In re Mac-Go Corp., 2015 WL 1372717, Case. No. 14-44181, (Bankr. N.D. Cal. March 20, 2015).
[2] Poonja v. First Nat’l. Bank (In re Mac-Go Corp.), 2014 WL 5785091, *1 (Bankr. N.D. Cal. Nov. 5, 2014).
[3] Id.
[4] Id.
[5] The trustee originally sought to avoid payments made by Mac-Go on its own loans, not just the payments made as guarantor. The court dismissed these prior to trial. The fees incurred litigating these dismissed claims are the fees that the bank sought as an allowed secured claim.
[6] Adv. Pro. 14-4148, D.I. 5- 44.
[7] Id., D.I. 64-80.
[8] Id., D.I. 80.
[9] In re Mac-Go Corp., 2014 WL 5785091 (Bankr. N.D. Cal. Nov. 5, 2014).
[10] In re Mac-Go Corp., 2014 WL 5785091 at *4.
[11]Bankr. Case No. 14-44181, D.I. 225-229. Interestingly, FNB only sought payment of fees incurred from litigating the payments made by the debtor on its own loan, which at summary judgment the trustee admitted were secured and should be dismissed. Had the trustee dropped these claims earlier and focused solely on the guarantor payments, perhaps the defendant would not have brought the motion for allowance of the claim.
[12] In re Mac-Go Corp., 2015 WL 1372717, *3 (Bankr. N.D. Cal. March 20, 2015).
[13] Id. at *4.
[14] Id. at *6.
[15] Id.
[16] Id. at *7.