Recovering Contractual Attorneys' Fees in Bankruptcy Litigation

• Publication year: 2020
• Author: Kit J. Gardner

Recovering Contractual Attorneys' Fees in Bankruptcy Litigation

Kit J. Gardner

Kit J. Gardner is the principal of the Law Offices of Kit J. Gardner in San Diego, California. His practice emphasizes Chapter 11 representation of debtors, creditors, and committees, as well as non-dischargeability litigation and defense of avoidance actions.

Many practitioners may remember the "Fobian Rule," eponymously named for the Ninth Circuit's decision in In re Fobian, addressing recovery of contractual attorneys' fees incurred in bankruptcy litigation.¹ In Fobian, the Ninth Circuit denied a lender's request for contractual attorneys' fees after resolving certain contested issues concerning confirmation of the debtors' Chapter 12 plan of reorganization in favor of the lender. The court found that the litigation involved "solely issues of federal bankruptcy law," namely, the debtors' proposed treatment of the lender's claim in the plan. The court declared that "where the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law, attorney's fees will not be awarded absent bad faith or harassment by the losing party."²

The Fobian Rule remained in effect in the Ninth Circuit until the United States Supreme Court expressly overturned it in 2007 in Travelers Casualty and Surety Co. of America v. Pacific Gas and Electric Co.³ In Travelers, the Supreme Court found no support for the Fobian Rule in the text of the Bankruptcy Code "or elsewhere," and held that "an otherwise enforceable contract allocating attorney's fees (i.e., one that is enforceable under substantive, nonbankruptcy law) is allowable in bankruptcy except where the Bankruptcy Code provides otherwise."⁴

In abrogating the Fobian Rule, the Supreme Court directed courts to award contractual attorneys' fees by looking to substantive state law without regard to whether "unique" issues of federal law predominated in the litigation. When the parties' contract is governed by California law, there are two avenues by which to recover attorneys' fees in bankruptcy proceedings after Travelers: (1) where the action can be considered to be "on the contract," or (2) where the parties' contractual attorneys' fee clause is broad enough to encompass the litigation, even if the litigation does not involve contract claims.

Actions on the Contract

The recovery of contractual attorneys' fees in litigation is expressly allowed by California law. Specifically, section 1021 of the California Code of Civil Procedure provides in relevant part that, "[e]xcept as attorney's fees are specifically provided for by statute, the measure and mode of compensation of attorneys . . . is left to the agreement, express or implied, of the parties."⁵ Moreover, section 1717 of the California Civil Code provides that even if the contractual fee provision is written to unilaterally favor only one side, the prevailing party in the litigation will be awarded attorneys' fees, "whether he or she is the party specified in the contract or not."⁶

Attorneys' fees sought pursuant to section 1717 may be awarded only to the party prevailing "on the contract."⁷ Thus, bankruptcy courts applying California law must determine whether the action involved a claim "on a contract" for purposes of awarding contractual attorneys' fees to the prevailing party, as opposed to a non-contract claim, such as a tort claim.

The distinction between an action "on the contract" and other actions is not always clear, though, and the reasoning behind the Fobian Rule may easily creep back in. So it was when, approximately six years after Travelers was decided, the bankruptcy court in In re Penrod⁸ denied a debtor her attorneys' fees after she prevailed in litigation involving the meaning and effect of the "hanging paragraph" in section 1325(a) of the Bankruptcy Code.⁹ The hanging paragraph (so named because it follows section 1325(a)(9) but has no direct connection to that subsection), prohibits debtors from using other sections of the Bankruptcy Code to "bifurcate" i.e., divide a creditor's lien into secured and unsecured portions with respect to motor vehicles purchased by a debtor within 910 days preceding the bankruptcy filing.¹⁰ The debtor in Penrod financed the purchase of a new car from an automobile dealer within 910 days of the debtor's bankruptcy filing. The dealer also paid off the remaining debt still owed on the debtor's old, trade-in vehicle, known in the trade as "negative equity," and included the negative equity in the total loan amount.¹¹ The dealer then assigned its loan to AmeriCredit Financial Services, Inc. ("AmeriCredit"). When the debtor filed bankruptcy, AmeriCredit filed a secured claim for the entire amount of the loan—that is, the amount used to purchase the new vehicle as well as the "negative equity" that was also wrapped into the loan.¹²

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The debtor, though, proposed a Chapter 13 plan that bifurcated AmeriCredit's claim into a secured claim for the estimated value of the car and an unsecured claim for the rest, including the negative equity. After much litigation and several appeals, the bankruptcy court authorized bifurcation of AmeriCredit's claim in the manner proposed by the debtor. In the meantime, the debtor had incurred approximately $245,000 in attorneys' fees litigating the matter.¹³

The bankruptcy court declined to award the debtor her attorneys' fees pursuant to the parties' contract,¹⁴ finding that the litigation had little to do with the contract itself, and instead involved questions of federal bankruptcy law. Specifically, the bankruptcy court stated, "Debtor did not contest the amount due under the Installment Sales Contract, the meaning of that contract, or the enforceability of that contract under state law. Instead, Debtor sought to modify the terms of the contract under federal bankruptcy law."¹⁵ On appeal, the district court agreed.¹⁶

On further appeal to the Ninth Circuit, the panel reversed, holding that under California law, an action is "on a contract" when a party "seeks to enforce, or avoid enforcement of, the provisions of a contract."¹⁷ The Ninth Circuit found that AmeriCredit sought to enforce the provisions of its contract when it objected to confirmation of the debtor's Chapter 13 plan, and...