Supreme Court Allows Recovery of Post-Petition Attorney's Fees Based On Pre-Petition Contract

In a unanimous opinion, the Supreme Court ruled that nothing in the Bankruptcy Code prohibits a creditor from asserting an unsecured claim for attorney's fees incurred post-petition where such fees would have been recoverable outside of bankruptcy. Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., No. 05-1429 (U.S. 3/20/07).

Travelers had issued a surety bond to Pacific Gas & Electric. In connection with the bond, the parties executed a series of indemnity agreements which allowed recovery of attorney's fees incurred in protecting Travelers rights. Travelers filed a claim to protect itself in the event that the debtor defaulted in the future. The debtor's plan preserved Travelers right to subrogation and indemnity in the event of a default, but Travelers disputed whether the language was sufficient. As part of a settlement, PG & E agreed that Travelers could assert an unsecured claim for its attorney's fees. However, when Travelers amended its claim to add the attorney's fees, the debtor objected. The Bankruptcy Court sustained the objection based upon a Ninth Circuit decision which held that attorney's fees were not recoverable for litigating issues unique to bankruptcy. In re Fobian, 951 F.2d 1149 (9th Cir. 1991). Not surprisingly, the District Court and the Ninth Circuit affirmed.

The Supreme Court reversed, finding that Sec. 502(b)(1) generally allows claims to the same extent that they would be allowable outside of bankruptcy. The only subsection of Sec. 502(b) which addresses recovery of attorney's fees is Sec. 502(b)(4), which limits claims by an attorney for the debtor to the reasonable value of such services. Thus, where the Code contained a specific limitation on attorney's fees, the Court would not imply a broader one.

The Supreme Court found that Fobian did not have any support in the language of the Bankruptcy Code. Travelers did not attempt to defend the Fobian rule. Instead, it argued that because Sec. 506(b) only allows attorney's fees to oversecured creditors, that unsecured creditors should not be entitled to recover them at all. The Supreme Court declined to address this argument on the basis that it had not been raised in the lower courts.

This ruling is important for what is decides and for what it does not decide. The first important point is that this case was determined with regard to unsecured claims under Sec. 502(b). Even though the litigation in this case took place post-petition, the creditor did not attempt to assert a post-petition administrative claim. The Supreme Court's broad reading of claims allowable under Sec. 502 would not apply to administrative claims under Sec. 503, which have a much narrower scope. Although it was not discussed in the Supreme Court's opinion, it appears that the parties recognized that litigation under a pre-petition contract created a pre-petition claim even though the litigation occurred during the bankruptcy. The Travelers opinion will create more opportunities for parties who could have recovered attorney's fees pre-petition to amend their unsecured claims to include post-petition attorney's fees. For example, if the debtor unsuccessfully objects to a proof of claim which had a contractual attorney's fees provision, the creditor could add the fees for defending the claim to its unsecured claim. In most cases, adding additional amounts to the unsecured pot will not have a major effect on the case. However, the potential for amending claims after the bar date could create administrative headaches in cases.

The opinion also creates potential tension between Sec. 502(b) and Sec. 506(b). Sec. 502(b)(2) disallows claims for unmatured interest, while Sec. 506(b) allows interest to oversecured claimants. Thus, these two sections are consistent. On the other hand, Sec. 502(b) is silent as to allowance of attorney's fees while Sec. 506(b) allows such fees only to oversecured creditors. Thus, there is a potential for claims for post-petition attorney's fees to be allowed under Sec. 502(b) and disallowed under Sec. 506(b). Because the Sec. 506(b) issue on attorney's fees was not addressed by the Supreme Court, lower courts will have to guess at how it would resolve this issue. However, it may be a safe bet to assume that with all nine justices silent, it might be reasonable to assume that the Supreme Court would find a way to reconcile the two statutes as opposed to overruling a recent precedent.