Ex-Spouse’s Law Firm Not Able to Assert Basis for Non-Dischargeablity

The Court’s decision in In re Brooks, ___B.R. ___, 2007 WL 2083834 (Bkrtcy.N.D.Tex. July 19, 2007)(Lynn J.) dealt with an adversary proceeding by the law firm of debtor’s ex-spouse to determine a claim against the debtor for attorneys’ fees as non-dischargeable pursuant to 523(a)(5) or (a)(15). The law firm held a judgment against the debtor for their legal services rendered to his ex-spouse, inter alia, in obtaining and enforcing spousal support. Notably, the ex-spouse was not liable for this amount nor was the debtor liable for a certain other amount owed to the law firm by the ex-spouse. The debtor contended that the law firm lacked “standing” to assert a claim under section 523(a)(5) or (15) and moved to dismiss for failure to state a cause of action. The Court granted the debtor’s motion to dismiss as it found that the law firm could not assert a basis for its claim to be excepted from discharge under 523(a)(5) or (a)(15).

Section 523(a)(5) provides that a discharge under section 727 does not discharge an individual debtor for a domestic support obligation (“DSO”). Section 523(a)(15) provides that a debt to a spouse, former spouse, or child not of the kind described in (a)(5) incurred in the course of a divorce or separation or in connection with a separation agreement, divorce decree or other order of court is not dischargeable. The law firm claimed that the firm’s fee are non-dischargeable on the basis that they were so intertwined with support that they constitute a DSO pursuant to 523(a)(5) or in the alternative that they are a non-dischargeable divorce-related debt under section 523(a)(15). The court looked to the definition of DSO in section 101(14A) and found that the law firm’s fee were not a DSO as they were not owed to a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative or to a governmental unit. Furthermore, the court found that the law firm’s debt was not non-dischargeable under section 523(a)(15) as it was not a debtor to a spouse, former spouse or child of the debtor.

The court rejected the argument to deem the legal fees as a DSO if the amounts were “recoverable” by a former spouse as it found that Congress did not intend to turn a debtor’s family members into debt recovery associates. The court also noted the inapplicability of the cases cited by the law firm under the pre-BAPCPA version of section 523(a)(15). The court noted that it would read the exceptions to discharge narrowly in balancing the two public policies found in sections 523(a)(5) and (a)(15)–that of providing a fresh start to the deserving debtor and the importance of a debtor’s obligations to his family. Marama v. Citizens Bank, ___ U.S. ___ (2007)(“The principal purpose of the Bankruptcy Code is to grant a ‘fresh start’ to the ‘honest but unfortunate debtor.’) The court noted that Congress did not intend for sections 523(a)(5) or (15) to aid in a law firm’s collection efforts but only for the other party to the divorce or separation.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

Unsecured and Undersecured Creditors Not Entitled to Post-Petition Attorneys’ Fees and Costs

On July 6, 2007, the court in In re Electric Machinery Enterprises, Inc., ___ B.R. ___, 2007 WL 3031445 (Bkrtcy.M.D.Fla.)(Williamson J.) issued its decision holding that unsecured creditors are not entitled to collect post-petition attorneys’ fees, costs, and other similar charges even if there is an underlying contractual right to them.

The court noted that the majority of the courts have concluded that unsecured and undersecured creditors are not entitled to recover post-petition attorneys’ fees, costs, and other charges. The court stated that there are four primary reasons for this view. First, a number of court have focused on the plain language of section 506(b) and applied the legal maxim of expressio unius est exclusio alterius. Section 506(b) provides that to the extent that an allowed secured claim is oversecured, there shall be allowed to the holder of such claim, interest and any reasonable fees, costs and charges. Second, is the Supreme Court’s opinion and reasoning in United Saving Ass’n v. Timbers, 484 U.S. 365 (1988), which permitted post-petition interest to be paid only out of an equity cushion and ruling that an undersecured creditor without an equity cushion fell within the general rule of disallowing post-petition interest. Timber’s rationale would then apply equally to unsecured and undersecured creditors. Third, courts rely on the plain language of section 502(b) which provides that the court shall determine the amont of the claim “as of the date of the filing of the petition” and that the time for determining the amount of the claim is as it existed as of the time of the filing of the case without the inclusion of post-petition interest, attorneys’ fees or costs unless the claim is oversecured where such amounts are allowed under section 506(b). Fourth, courts rely on equitable considerations and policy of providing equality of distribution among similary situated creditors according to the priorites set out in the Bankruptcy Code. Thereby, unsecured creditors with attorney fees provisions in their contracts are not allowed to recover their fees just as unsecured tort claimants are not able.

The court adopted the majority view even though the Supreme Court recently declined to express an opinion as to whether unsecured creditors are entitled to post-petition attorneys’ fees in a case under the Bankruptcy Code. Travelers Casualty & Surety Co. of America v. Pacific Gas & Elec. Co., ___ U.S. ___ (2007). The court stated that there is existing Supreme Court precedent under pre-Code law to support he majority view. “Specifically, in Randolph v. Scruggs, 190 U.S. 533 (1903), the Supreme Court formulated the requirement of “benefit to the estate” for the allowance of unsecured creditor’s contract claims for post-petition legal fees.” The court disagreed with the creditor’s contention that the Eleventh Circuit implicity recognized an unsecured creditor’s entitlement to attorney’s fees in In re Welzel, 275 F.3d 1308 (11th Cir.2001).

Robert Eisenbach, III of In the (Red) Business The Bankruptcy Blog points out in a post dated July 26, 2007 that the Middle District of Florida Bankruptcy Court did not cite to the In re Qmect, Inc. May 2007 decision by the Northern District of California Bankruptcy Court which Bob discussed in a previous post. Bob notes that in In re Qmect, Inc.., the California Bankruptcy Court adopted a view opposite to that of the Florida Bankruptcy Court and held that an unsecured creditor could recover post-petition attorneys’ fees as part of its claim if its contract with the debtor provided for recovery of such fees. The court pointed to the policy of the preservation of nonbankruptcy legal rights except to the extent necessary to facilitate the purpose of the bankruptcy proceeding. Bob notes that he expects more decisions to follow on this issue in the wake of the Travelers decision as creditors with attorney’s fees provisions in their contracts seek to include post-petition fees in their unsecured claims.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

US Supreme Court Rules in Allocation of Attorney’s Fees Case

On March 20, 2007, the US Supreme Court issued its decision in Travelers Causalty & Surety Co. of America v. Pacific Gas & Electric Co., ___ US ___ (2007) which was before the Court on a writ of certiorari from the 9th Circuit Court of Appeals. The issue before the Court was “whether federal bankruptcy law precludes an unsecured creditor from recovering attorney’s fees authorized by a prepetition contract and incurred in postpetition litigation.” The 9th Circuit Court of Appeals had held that such fees are categorically prohibited to the extent the litigation involves issues of federal bankruptcy law. The US Supreme Court disagreed and vacated the lower Court’s decision.

In the bankruptcy case, Traveler’s filed a proof of claim that included an amount to recover its attorney’s fees incurred in connection with PG&E’s bankruptcy proceedings. The Bankruptcy Court agreed with PG&E, that Traveler’s was not entitled to recover attorney’s fees incurred while litigating issues of bankruptcy law. The District Court agreed relying on In re Fobian, 951 F.2d 1149 (9th Cir. 1991) which held 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.” The 9th Circuit Court of Appeals affirmed.

The US Supreme Court explained that under the American Rule, the prevailing litigant is ordinarily not entitled to collect attorney’s fees from the loser, unless this rule is overcome by statute or by an enforceable contract allocating attorney’s fees. The Court held that an otherwise enforceable contract is allowable in bankruptcy except where the Bankruptcy Code provides otherwise. The Court further held that the Bankruptcy Code does not disallow a contract-based claim for attorney’s fees based solely on the fact that the fees in issue were incurred litigating issues of bankruptcy law. The Court stated that the Fobian rule has no support in the Bankruptcy Code either in section 502 (which is the section dealing with the allowance and disallowance of claims) or in any other code section.

The Court expressed no opinion whether following the demise of the Fobian Rule, other principles of bankruptcy law may provide an independent basis for disallowing the involved attorney’s fees claim. One such argument not addressed by the Court as it was not raised in the Courts below was whether section 506(b) by explicit negation disallows unsecured claims for contractual attorney’s fees. In short, the Court’s holding was a narrow repudiation of the Fobian rule, leaving open the broader question of whether unsecured creditors can collect post-petition attorney’s fees.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983