April 9, 2007

After Travelers, Bankruptcy Courts Still Need Directions

Holland & Knight Newsletter
John J. Monaghan

Few things can put uncertainty in bankruptcy practice to rest better than a clear and complete unanimous decision by the United States Supreme Court. Conversely, few things can lead to extensive litigation more than the Supreme Court’s defining a bankruptcy battleground and then ducking for cover. In that light, the Supreme Court’s technical basis for expressing no opinion on a central and critical issue relating to the ability of unsecured claimants to add contractually provided attorneys’ fees incurred in post-petition litigation to their claims in Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., No. 05-1429, _____S.Ct. ____, 549 U.S.____, 2007 WL 816795 (March 20, 2007), is close to a bankruptcy lawyer full employment act.

The holding in the case is that Travelers, an unsecured creditor with a claim arising under a prepetition agreement that provided for the recovery of attorneys’ fees incurred in enforcing Travelers’ rights, was not precluded from adding post-petition attorneys’ fees to its general unsecured claim simply because Travelers incurred the fees in connection with bankruptcy law issues rather than contract enforcement matters. The Court premised this holding largely on the lack of any reference to post-petition attorneys’ fees in the enumeration of claims that were not subject to allowance under the United States Bankruptcy Code, 11 U.S.C. §§ 101 et seq. (Bankruptcy Code). Justice Alito’s opinion for the unanimous Court also made clear, however, that little more could be derived from the decision, stating that “we express no opinion with regard to whether … other principles of bankruptcy law might provide an independent basis for disallowing Travelers’ claim for attorney’s fees.”

Prior to filing its chapter 11 petition, Pacific Gas & Electric (PG&E) obtained a surety bond from Travelers to satisfy a California statutory requirement imposed upon employers who self-insure against workers’ compensation obligations. Under the terms of the various agreements evidencing their relationship, PG&E agreed to be responsible for any loss Travelers might incur in connection with the bonds, including attorneys’ fees incurred in pursuing, protecting or litigating Travelers’ rights in connection with the bonds.


Post-Petition Attorneys’ Fees in Prepetition Agreements

During PG&E’s chapter 11 case, Travelers objected to PG&E’s plan of reorganization. The objections were resolved consensually, and a stipulation that reflected the settlement reached by Travelers’ and PG&E was approved by the bankruptcy court. Travelers asserted a right to add the attorneys’ fees incurred in connection with its plan objection and settlement to its already filed claim for prepetition unsecured damages. Travelers based that assertion on the language in its prepetition agreements with PG&E.

PG&E objected to Travelers’ claim for post-petition attorneys’ fees. The bankruptcy court, the district court and the United States Court of Appeals for the Ninth Circuit all sided with PG&E, disallowing Travelers’ claim for such fees. Each of those courts, as well as PG&E, relied on Ninth Circuit precedent, established in the case of In re Fobian, 951 F.2d 1149 (9th Cir. 1991), holding that a contract provision providing for the recovery of attorneys’ fees notwithstanding, “where the litigated issues [in the bankruptcy court] 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.” Id. at 1153.

In Travelers, the Supreme Court vacated the Ninth Circuit’s decision and remanded the case for further proceedings. In doing so, the Court’s principal focus was on eliminating the dichotomy between post-petition fees incurred by an unsecured creditor in connection with litigating basic contract enforcement questions, which the Ninth Circuit would recognize as allowable, and post-petition fees incurred in connection with litigating “issues peculiar to federal bankruptcy law,” which the Ninth Circuit under “the Fobian rule” believed inappropriate and disallowed when sought by Travelers in the PG&E chapter 11 case.

The analysis underlying the Court’s rejection of this dichotomy relied almost exclusively on a textual analysis of the Bankruptcy Code section relating to allowance and disallowance of claims. The Court accurately pointed out that §502(b) of the Bankruptcy Code provides that a timely asserted claim is to be allowed unless one of nine enumerated exceptions to allowance are implicated. That enumeration mandates the disallowance of claims that are, for example, not enforceable under non-bankruptcy law, for unmatured interest or in excess of certain caps established for various identified types of claims. The Court concluded that a claim for contractually allowed legal fees associated with post-petition plan-related litigation did not fall within the scope of any of the enumerated exclusions and, therefore, the “Fobian rule” relied upon by the Ninth Circuit “cannot stand.”


An Unresolved Question

The pinpoint focus of the Travelers opinion left unanswered a broader, more important and more widely-contested question. By focusing on whether Ninth Circuit precedent that drew a distinction between legal fees incurred in contract-related, post-petition litigation and legal fees incurred in post-petition, bankruptcy-specific litigation had a textual basis, the Supreme Court left unresolved the question of whether there is any Bankruptcy Code authority for unsecured creditors to include post-petition legal fees in their claims at all and under any circumstances.

Despite the nominally strict textual approach to its analysis, the Supreme Court never even referenced language in the very section it so painstakingly analyzed requiring that the bankruptcy court “determine the amount of [a] claim in lawful currency of the United States as of the date of the filing of the petition, and shall allow such claim in such amount … .” 11 U.S.C. § 502(b). If the text of the statute requires determination of a claim as of a chapter 11 case’s commencement when the petition is filed, how can fees and expenses incurred after that date properly be added?

The Court also refused to address a Bankruptcy Code provision that expressly sets forth those that are entitled to recover attorneys’ fees incurred post-petition and, by seeming natural implication if not “explicit negation,” those that are not so entitled. Section 506(b) of the Bankruptcy Code provides that a secured creditor with an interest in collateral that has a value in excess of the claim that the collateral secures is entitled to add interest, fees, costs and charges to its claim, including those incurred post-petition. 11 U.S.C. § 506(b). That limitation of the right to add interest and fees to those with “oversecured” claims, has widely been held to mean that creditors who are either “undersecured” or wholly “unsecured” have no such entitlement.

Although PG&E raised the argument that the Bankruptcy Code’s restricted express allowance of attorneys’ fees to those who hold oversecured claims meant that unsecured creditors, such as Travelers, could not make a claim for post-petition attorneys’ fees, the Supreme Court declined to consider the argument because it was apparently not raised before any of the lower courts. Putting aside for a moment the question of why PG&E would make such an argument before the lower courts when the Ninth Circuit had precedent directly on point and supporting its position, the Supreme Court’s retreat to appellate dogmatics leaves the actual ongoing debate unresolved – indeed unadvanced. On remand, the bankruptcy court, the district court on intermediate appeal and the Ninth Circuit will be faced with the very argument about which the Supreme Court “express[ed] no opinion.” They, and perhaps multiple other bankruptcy, district and circuit courts simultaneously faced with the same issue will be guided only by the Supreme Court’s suggestion that “other principles of bankruptcy law might provide an independent basis for disallowing Travelers’ claim for attorney’s fees.”

The battle lines having been drawn, but with no shots having been fired by the Supreme Court, let the litigation begin.

For more information, e-mail John Monaghan at john.monaghan@hklaw.com  or call toll free, 1.888.688.8500.

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