United States: Creditor's Claim For Attorney Fees Not Entitled To Secured Status

The "American rule" is a well-defined legal principle applied by courts throughout the United States that holds each party to a dispute responsible for paying its own attorney fees. This principle is, however, subject to a number of exceptions that effectively allow a prevailing party to recover its own attorney fees from a losing party. For example, federal and state statutes increasingly authorize a prevailing party to recover costs from its adversary in certain types of actions. Likewise, contracting parties often incorporate "fee shifting" terms that provide for recovery of litigation costs by one party in the event of litigation on the contract. In other circumstances, a court exercising its own discretion may award a prevailing party its attorney fees as part of the judgment.

For a judgment creditor whose judgment includes an award for prospective attorney fees, the bankruptcy of the judgment debtor will create numerous obstacles to execution. In particular, while the judgment creditor will normally have an allowed claim against the judgment debtor's bankruptcy estate for the principal portion of its judgment award pursuant to Section 502 of the Bankruptcy Code, it is not clear whether such a claim can properly include attorney fees and costs incurred post-petition. Similarly, even if the judgment creditor's claim is fully secured, it is unlikely that the portion of the claim attributable to post-petition attorney fees will be entitled to secured status pursuant to Section 506(b). Instead, the balance attributable to post-petition attorney fees will likely be considered an unsecured claim.

These issues were recently presented to the bankruptcy court in In re Rubin Family Irrevocable Stock Trust, 516 B.R. 221 (Bankr. E.D.N.Y. 2014). There, the court considered whether an oversecured creditor can assert a claim for post-petition attorney fees and costs in a Chapter 11 case, where the creditor's right to such fees and costs is derived from an enforceable and final prepetition judgment against the debtor. The court concluded that the creditor could assert a secured claim only for the principal amount of the judgment, together with interest and fees, with the balance attributable to post-petition attorney fees being an unsecured claim.

Rubin involved a judgment entered by the U.S. District Court for the District of Utah in favor of ACE Investors LLC against the debtor almost three years before the debtor's bankruptcy filing. The judgment totaled approximately $1.1 million. The judgment also awarded, prospectively and in an unliquidated amount, "attorney fees to collect the judgment." ACE subsequently domesticated the Utah judgment in the U.S. District Court for the Southern District of New York and pursued enforcement proceedings against the debtor and related entities. In April 2013, the New York court entered an order and judgment adding interest to the Utah judgment and augmenting that award "to add all attorney fees and costs related to collection of the judgment through the present proceedings." The augmented judgment totaled approximately $3.4 million, plus future collection costs. Four days later, the debtor filed for protection under Chapter 11 of the Bankruptcy Code.

In February, ACE filed a secured proof of claim in the debtor's bankruptcy case in the amount of the augmented judgment. While the claim did not expressly include amounts attributable to post-petition attorney fees and costs, ACE asserted that it was entitled to such amounts pursuant to the judgment. ACE thereafter amended its proof of claim to include post-petition attorney fees, expenses and interest in the amount of approximately $5.1 million.

The debtor objected to ACE's proof of claim, but solely to the extent that ACE sought post-petition attorney fees and costs incurred to collect on the judgment. The debtor argued that its bankruptcy filing prohibited ACE's recovery of such post-petition amounts. ACE responded to the debtor's objection, arguing that the New York court's order awarding attorney fees and costs through the date of collection was res judicata, and that any action denying ACE the ability to assert such a claim would constitute an improper collateral attack on an otherwise valid and enforceable order. ACE further argued that absent any basis for finding its claim unenforceable outside of bankruptcy, the debtor was constrained to show "some basis under the Bankruptcy Code to disallow a claim for post-petition attorney fees and costs."

Addressing whether ACE could properly assert a claim for post-petition attorney fees and costs awarded as part of a prepetition judgment and, if so, whether such a claim could be considered to be secured, the court first looked to Section 502 of the Bankruptcy Code, which governs the allowance of claims against a debtor's bankruptcy estate. Relying on the language of this section, the bankruptcy court acknowledged that "claims enforceable under applicable non-bankruptcy law will be allowed in bankruptcy unless they are expressly disallowed under Section 502." The court then looked to the U.S. Supreme Court's holding in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric, 549 U.S. 443 (2007), in which the court held that a creditor is not precluded from asserting an unsecured claim for post-petition attorney fees, so long as that creditor has an enforceable basis to assert such a claim. In Travelers, the court found that a prepetition contract between the debtor and creditor provided an enforceable basis for the creditor's unsecured claim for post-petition attorney fees. The Rubin court also relied on Ogle v. Fidelity & Deposit Co. of Maryland, 586 F.3d 143, 147 (2d Cir. 2009), wherein the U.S. Court of Appeals for the Second Circuit held that "an unsecured claim for post-petition fees, authorized by a valid prepetition contract, is allowable under Section 502(b) and is deemed to have arisen prepetition."

The Rubin court recognized that although Travelers and Ogle relied upon prepetition contracts as the "enforceable basis" for the respective creditors' unsecured claims for post-petition attorney fees, "the holdings of those cases also extend to claims for attorney fees and costs which are based upon statute," citing Travelers, for the proposition that "the 'American rule' can be overcome by statute or enforceable contract." In Rubin, however, the "enforceable basis" for ACE's post-petition attorney fees claim was a prepetition judgment—a circumstance not contemplated in Travelers or Ogle. Nevertheless, the court held that "the very logic of the[se] opinions ... seems to make clear that a creditor's claim predicated on a final and enforceable pre-petition judgment must be treated the same way." Accordingly, the court held that the judgment underlying ACE's claim, inclusive of amounts attributable to prospective or post-petition attorney fees, created an enforceable right to payment. Because the debtor had failed to establish any basis upon which such claim should be disallowed, the court ruled that ACE's claim would be allowed pursuant to Section 502. Having decided that ACE could properly assert a claim for costs attributable to its post-petition collection efforts, the court then considered whether the claim was entitled to secured status. The parties agreed that ACE held a secured claim for the principal judgment amount, and had also stipulated that the collateral securing ACE's claim had a value greater than ACE's claim. The court therefore considered ACE's claim in light of Section 506(b) of the Bankruptcy Code, which provides "to the extent that an allowed secured claim is secured by property the value of which ... is greater than the amount of such claim, there shall be allowed to the holder of such claim ... any reasonable fees, costs, or charges provided for under the agreement or state statute under which such claim arose." Importantly, as the Rubin court recognized, the language of this section only affords secured status to fees and costs "provided for under the agreement or state statute under which such claim arose." Given the express language of the section, the court held that because ACE's claim for post-petition attorney fees arose from a judgment—and not from an agreement or state statute—Section 506(b) does not afford such claim secured status. Interestingly, the Rubin court specifically noted that the language of Section 506(b) does not "dictate the conclusion that unless a creditor qualifies under Section 506(b), that creditor cannot be entitled to post-petition fees and costs," citing In re SNTL, 380 B.R. 204 (9th Cir. BAP 2007), finding Section 506 to be "irrelevant to determining the allowability of an unsecured claim," and relying solely on Section 502 to determine allowance of post-petition attorney fees. While other courts have held to the contrary (see, e.g., In re Seda France, 2011 Bankr. LEXIS 2874 (Bankr. W.D. Tex. July 22, 2011)), Rubin affirms that, at least in the Second Circuit, judgment creditors can assert viable—if unsecured—claims for post-petition attorney fees awarded pursuant to a prepetition judgment.

This article originally appeared in The Legal Intelligencer

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights. Jarret P. Hitchings is an associate in the firm's Wilmington, Del., office and practices in the area of business reorganization and financial restructuring.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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