Trend Allowing Unsecured Claims for Contractual Attorneys’ Fees Continues

Earlier this year, the U.S. Court of Appeals for the Fourth Circuit considered whether the Bankruptcy Code bars a creditor from asserting an unsecured claim for attorneys’ fees incurred post-petition but provided for in a pre-petition contract. The Fourth Circuit reversed the lower court’s ruling and joined other federal circuit courts in holding that such claims may be allowed in bankruptcy.

In SummitBridge National Investors III LLC v. Faison, [1] a secured creditor filed an unsecured claim to recover attorneys’ fees that, when added to the secured portion of their claim, exceeded the value of their security interest. The debtor objected and argued that the Bankruptcy Code does not provide for allowance of an unsecured claim for post-petition attorneys’ fees or costs. The U.S. Bankruptcy Court for the Eastern District of North Carolina agreed with the debtor, even though a pre-petition contract between the debtor and creditor specified that the debtor would pay reasonable attorneys’ fees. The U.S. District Court for the Eastern District of North Carolina affirmed the bankruptcy court’s decision on appeal.

Previous Treatment of Claims for Post-Petition Attorneys’ Fees

Courts across the country have long disagreed on whether creditors may assert unsecured claims for post-petition attorneys’ fees arising from pre-petition contracts.[2] Most courts disallowing the claims reasoned that § 506(b) of the Bankruptcy Code, which allows oversecured creditors to add interest and reasonable attorneys’ fees to their claims, does not address claims of unsecured and undersecured creditors for attorneys’ fees and therefore are disallowed. Others disallowing claims for post-petition attorneys’ fees relied on § 502(b) of the Bankruptcy Code, which provides for the bankruptcy court’s determination of whether unsecured claims are allowed in bankruptcy. Those courts concluded that post-petition claims for attorneys’ fees were not allowed because they arose after the petition date. Still, other courts reached different outcomes, generally holding that contractual rights pre-bankruptcy will be recognized if valid under state law.

Following decades of conflicting rulings across federal jurisdictions, the Supreme Court considered the issue in Travelers v. Pacific Gas & Electric Co. and held that post-petition attorneys’ fees should not be disallowed even if such fees were incurred while litigating issues of federal bankruptcy law. The Ninth Circuit, considering the issue in the first PG&E bankruptcy filed in 2001, disallowed a creditor’s claims for post-petition attorneys’ fees even after a court-approved stipulation stated that the creditor would be able to assert a general unsecured claim for attorneys’ fees, which were authorized by the parties’ original indemnity agreements. The Supreme Court in Travelers overturned the Ninth Circuit’s decision and held that claims under applicable state law are generally presumed allowable in bankruptcy unless they are expressly disallowed by the Bankruptcy Code.[3]

In Travelers, neither the courts below nor the debtor presented any reason as to why attorneys’ fees incurred while litigating issues of bankruptcy law would overcome the presumption that such claims are enforceable. Moreover, the Travelers Court reasoned that nothing in the Bankruptcy Code disallowed claims for post-petition attorneys’ fees that are incurred in connection with litigating bankruptcy law issues. The Supreme Court specifically rejected the Fobian rule, annunciated by the Ninth Circuit in In re Fobian,[4] holding that attorneys’ fees are not recoverable in bankruptcy for litigating issues “peculiar to federal bankruptcy law.”[5] Recognizing that under the American Rule “the prevailing litigant is ordinarily not entitled to collect a reasonable attorneys’ fee from the loser,” Travelers nonetheless held that this default rule can be overcome by either statute or an enforceable contract providing for attorneys’ fees.

Consequently, the Supreme Court concluded that the Ninth Circuit erred by disallowing the claims for agreed-upon post-petition attorneys’ fees. Yet, notwithstanding the Court’s statement that claims in bankruptcy are generally presumed allowable based on applicable state law, some interpreted the Travelers holding very narrowly, saying that the Bankruptcy Code did not prevent claims for post-petition attorneys’ fees incurred while litigating federal bankruptcy law issues, rather than using an expansive interpretation that would allow post-petition fees in other contexts.

Following the Travelers decision, both the Second and Ninth Circuits determined that the Bankruptcy Code does not bar unsecured claims for post-petition attorneys’ fees arising out of pre-petition contracts. In Ogle v. Fidelity & Deposit Co. of Maryland,[6] the Second Circuit adopted a broad interpretation of the Travelers holding, observing that Travelers is “equally applicable to post-petition costs arising out of pre-petition contracts more generally.” The Second Circuit’s decision in Ogle emphasized the importance of Travelers to the validity of pre-petition contracts overall.

Similarly, in In re SNTL Corp.,[7] the Ninth Circuit expanded the Travelers decision by holding that claims for post-petition attorneys’ fees cannot be disallowed simply because the claim of the creditor is unsecured. SNTL noted that the Bankruptcy Code does not specifically disallow post-petition fees, and policy concerns regarding outcomes for bankruptcy creditors must be decided by Congress, rather than the courts. While Travelers set the framework, both the Ogle and SNTL decisions significantly expanded its reach with regard to legitimizing pre-petition contracts for post-petition fees.

Lower Courts’ Findings in SummitBridge

Like other courts that found that unsecured claims for post-petition attorneys’ fees based on valid pre-petition contracts are expressly disallowed by the Bankruptcy Code, the lower courts in SummitBridge primarily cited §§ 502(b) and 506(b) of the Bankruptcy Code as their basis for disallowing SummitBridge’s claim for attorneys’ fees. Section 506 of the Bankruptcy Code covers the determination of secured status and treatment of secured claims. Specifically, § 506(b) provides that oversecured creditors may add both interest and reasonable attorneys’ fees to their secured claims. The district court in SummitBridge agreed with the bankruptcy court’s interpretation of § 506(b), holding that it is the only means within the Bankruptcy Code in which a secured creditor is entitled to post-petition attorneys’ fees. Therefore, SummitBridge, as a secured creditor, could not assert an unsecured claim for post-petition attorneys’ fees on the basis that such fees are separate from its secured claim.

Section 502 of the Bankruptcy Code governs the allowance of claims or interests in bankruptcy proceedings. Section 502(b) provides that a claim shall not be allowed if it is unenforceable against the debtor and the property of the debtor under an agreement or applicable law. Based on these principles, the district court stated that the Bankruptcy Code expressly awards post-petition professional fees under certain circumstances such as professional fees under §§ 327 and 328 of the Bankruptcy Code, but does not award post-petition attorneys’ fees to an unsecured or undersecured creditor. Consequently, the court determined that it is reasonable to conclude that, notwithstanding Travelers, unsecured creditors are not entitled to post-petition attorneys’ fees.

In addition to §§ 502 and 506, the district court cited equitable considerations in support of its decision to affirm the bankruptcy court’s determination. Agreeing with the debtor, the district court reasoned that allowing a secured creditor to file an unsecured claim to recover post-petition attorneys’ fees would reduce the pool of assets available to other unsecured creditors. Thus, the district court concluded that the equities “clearly weigh in favor of the protection of assets for distribution to all creditors.”

The Fourth Circuit’s SummitBridge Holding

Analyzing the SummitBridge debtor’s arguments made for both §§ 502(b) and 506(b), the Fourth Circuit determined that neither section expressly disallows a creditor from asserting an unsecured claim for post-petition attorneys’ fees based on a valid pre-petition contract. The SummitBridge debtor argued that § 506’s express allowance of attorneys’ fees to oversecured creditors implies that creditors who are either undersecured or unsecured may not assert such claims. However, the Fourth Circuit focused on Travelers’s ruling that claims enforceable under state law are presumed allowable, and that presumption may only be overcome by an express disallowance in the Bankruptcy Code. Because § 506 does not disallow unsecured claims for post-petition attorneys’ fees, the Fourth Circuit reasoned that such fees must be presumed to be allowable.

The Fourth Circuit also rejected the debtor’s arguments with respect to § 502. As long as creditors meet two conditions, § 502(b) will not bar the recovery of claimed amounts. First, creditors must have stated a “claim” as of the petition date. Second, the claim must not fall within any of the enumerated exceptions. In SummitBridge, the debtor did not allege that any of the exceptions applied. Therefore, the only question considered by the Fourth Circuit was whether the creditor had a “claim” under the Bankruptcy Code for post-petition attorneys’ fees as of the petition date.

The SummitBridge debtor’s primary argument in support of its contention that the creditor did not have a valid claim for fees on the petition date was that such attorneys’ fees were not incurred until after the bankruptcy proceedings began. The Fourth Circuit disagreed and stated that the Bankruptcy Code defines “claim” broadly and noted that § 101(5)(A) of the Bankruptcy Code expressly includes “right[s] to payment” that are “contingent.” Therefore, the Fourth Circuit concluded that the question determining whether claims are valid is not when those claims were incurred, but rather when the right to those claims arose. As long as the right to the claimed fees arose pre-petition, the Fourth Circuit reasoned that the fees are considered a contingent pre-petition obligation that became fixed post-petition. Because SummitBridge’s promissory notes that guaranteed the payment of attorneys’ fees were signed pre-petition, it had a valid claim as of the petition date. With both elements of § 502(b) satisfied, the Fourth Circuit concluded that SummitBridge’s claim for attorneys’ fees would be allowed.

Although the Fourth Circuit determined that § 502(b) could not preclude the creditor’s claim for attorneys’ fees, the SummitBridge debtor also argued that because a bankruptcy court must determine the amount of the claim as of the petition date under § 502(b), that amount must remain zero because the post-petition fees were incurred after the petition date. Similar to the Second Circuit in Ogle, the Fourth Circuit in SummitBridge held that the requirement for determining claim amounts as of the petition date does not bar recovery of post-petition attorneys’ fees. For support, the court looked to § 502(c), which directs bankruptcy courts to estimate the value of claims that are contingent or unliquidated. If the value of a claim were required to be fixed as of the petition date, then such estimates would be unnecessary. Instead, the Fourth Circuit concluded that § 502(c) confirms that post-petition attorneys’ fees based on a pre-petition contract should not be disallowed.

Finally, the Fourth Circuit addressed arguments made by the debtor concerning policy considerations. The SummitBridge debtor reasoned that because the creditor was already secured, it would be unfair to also assert unsecured claims for attorneys’ fees, as such claims would reduce the pool of assets available to wholly unsecured creditors. Invoking Travelers, the Fourth Circuit referred once again to §§ 502 and 506 of the Bankruptcy Code, determining that as neither section specifically disallowed post-petition fees, the court could not reach a contrary result based on equitable considerations. Additionally, the court reasoned that secured creditors are privileged over unsecured creditors. Allowing unsecured but not undersecured creditors to assert claims for post-petition attorneys’ fees would place unsecured creditors in a more protected position than that of secured creditors.

Conclusion

The SummitBridge decision continues a trend that began with the Second Circuit in Ogle and the Ninth Circuit in SNTL. These circuit courts have taken an expansive view of Travelers in holding that neither §§ 502(b) nor 506(b) prevent allowance of a claim for post-petition attorneys’ fees based on a valid pre-petition contract. A review of bankruptcy and district court decisions post-SummitBridge reveals a further continuation of this trend.[8] These decisions collectively provide more support for enforcing pre-petition agreements regarding payment of post-petition attorneys’ fees.