Recovering Attorneys' Fees in Dischargeability Litigation

A new opinion from Judge Tony Davis answers some interesting questions about recovery of attorneys' fees in dischargeability litigation.   Schwertner Backhoe Services, Inc. v. Kirk (In re Kirk), Adv. No. 11-1239 (Bankr. W.D. Tex. 1/28/15), which can be found here.    The Court concluded that a prevailing plaintiff could recover attorneys' fees allowable under state law but could not recover for litigating pure issues of dischargeability.   

The case involved a dischargeability complaint brought under 11 U.S.C. Sec. 523(a)(4) based on the Texas Construction Trust Fund Act.   The Debtor owned a homebuilding company which did not pay one of its subcontractors.   The Debtor's answer was ambiguous as to whether the creditor's underlying debt was owed.   However, when the Debtor's deposition was taken, about two years into the litigation, the Debtor acknowledged that the debt was owed.   Prior to trial, the Debtor stipulated that the underlying debt was non-dischargeable but disputed that the creditor could recover attorneys' fees.

The Court reached several conclusions.   First, it concluded that if a debt includes pre-petition attorneys' fees and is determined to be non-dischargeable, the attorneys' fees are part of the non-dischargeable debt.   Second, the Court concluded that "(s)ince the Bankruptcy Code does not address whether creditors can recover attorney’s fees in nondischargeability cases, they can only do so if allowed by another statute or by contract."    Opinion, p. 6.    

The Court clarified that the recovery of attorneys' fees depended on the specific language of the contract or statute.   In discussing prior Texas bankruptcy cases, the Court noted that where a contractual debt was determined to be non-dischargeable based on fraud, the attorneys' fees were not included in the non-dischargeable debt.   On the other hand, where the contract allowed recovery of fees for "all costs of collection and enforcement," the cost of prosecuting the non-dischargeability action "contributed directly" to the effort to collect and enforce the notes.  

In the specific case, the Court concluded that the Texas Construction Trust Fund Act did not allow for recovery of attorney's fees.   In doing so, the Court was required to choose between competing lines of state court precedent.    However, it did find that under the Texas Civil Practices and Remedies Code, fees could be imposed for fees incurred in establishing the liability for labor and materials provided.    As a result, the Court concluded that the creditor could recover reasonable attorneys' fees for amounts incurred prior to the Debtor's admission that his company was liable for the underlying debt but not afterwards.  

The Court explained:

(F)ees cannot be awarded for litigating defalcation in this case because doing so is essentially the same as establishing Kirk’s liability under the Texas Construction Trust Fund Act; both determinations are predicated on the same facts – that Kirk was a fiduciary, and that he failed to handle funds properly. Put another way, this aspect of what Schwertner Backhoe had to prove is an action for which the Texas legislature has not shifted fees. Cohen renders properly awarded fees nondischargeable; it does not provide an independent basis for awarding fees.

Opinion, p. 14.    As a result, the Court awarded the creditor approximately half of the attorneys' fees that it requested.

The practice point here is that the Debtor should be cautious about disputing liability on the underlying claim asserted in the dischargeability action.    If the Debtor had admitted liability for the underlying debt from the beginning, the creditor could not have recovered its attorneys' fees.

Note:  This is a case which I took over from another attorney.   However, I can't sure that I would have caught the importance of admitting liability on the underlying debt if I had represented the Debtor from the outset.