Fourth Circuit Allows Unsecured Creditors to Assert Claims for Attorneys’ Fees In Bankruptcy Cases

Lawyers who represent debtors in bankruptcy cases, supported by rulings from many bankruptcy judges, have long taken the position that creditors with unsecured claims whose agreements with their debtors provide for payment of the creditors’ enforcement expenses, including attorneys’ fees, are not entitled to assert claims for such expenses in bankruptcy cases.  This view has been based largely on Section 506(b) of the Bankruptcy Code.  That section provides that:

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, interest on such claim, and any reasonable costs, fees, or charges provided for under the agreement or State statute under which such claim arose.

If secured creditors are only allowed claims for costs, fees, or charges to the extent that the value of their collateral exceeds the principal amounts they are owed, the thinking goes, then since unsecured creditors have no collateral at all, they must not be entitled to claim any fees or expenses.

In 2007, in Traveler’s Casualty & Surety Co. v. Pacific Gas & Electric Co., the United States Supreme Court reversed a decision of the Ninth Circuit Court of Appeals that an unsecured creditor was not entitled to assert a claim for attorneys’ fees “where the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law.”  The Supreme Court framed the issue that it was deciding narrowly as “whether the Bankruptcy Code disallows contract-based claims for attorney’s fees based solely on the fact that the fees at issue were incurred litigating issues of bankruptcy law.”  In concluding that it did not, the Supreme Court expressly declined to consider the debtor’s argument that unsecured creditors were not entitled to assert claims for any attorneys’ fees on the grounds that the debtor had not made that argument in the lower courts.  In light of the fact that lower courts had not considered the broader question of whether unsecured creditors were entitled to assert claims for attorneys’ fees generally, the Supreme Court said:

[W]e 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. We conclude only that the Court of Appeals erred in disallowing that claim based on the fact that the fees at issue were incurred litigating issues of bankruptcy law.

Despite its language about the limited scope of the issue it was deciding, the Supreme Court’s analysis of that issue started with the general proposition that “we generally presume that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed.”  It then examined the bases for disallowing claims found in Section 502 of the Bankruptcy Code.  The Court concluded that the Ninth Circuit’s decision was wrong because disallowance of claims for attorneys’ fees incurred litigating issues of bankruptcy law was not one of them.

Of course, the only mention of claims for any kind of attorneys’ fees in Section 502 is provision disallowing claims “for services of an…attorney of the debtor [if] such claim exceeds the reasonable value of such services.”  That, coupled with the presumption in favor of allowance of claims valid under state law recognized in Traveler’s, strongly suggests that claims for attorneys’ fees under a valid contract should be allowable in bankruptcy cases.  Nevertheless, seizing upon the fact that the Supreme Court expressly declined to opine on the allowance of attorneys’ fees generally, most courts have continued to disallow claims of unsecured creditors for attorneys’ fees.  In the twelve years since Traveler’s was decided, only two Circuit Courts, the Second and the Ninth, had concluded that unsecured creditors were entitled to assert claims for attorneys’ fees in bankruptcy cases. 

On February 8, the Fourth Circuit addressed the issue that the Supreme Court declined to address in Traveler’s.  In Summitbridge Investments III, LLC v. Faison, the Fourth Circuit concluded that application of the Supreme Court’s reasoning in Traveler’s led inexorably to the conclusion that unsecured creditors are entitled to assert claims for attorneys’ fees if their claims are based on contracts or statutes that provide for payment of their attorneys’ fees.

Although it acknowledged the limited holding in Traveler’s, the Fourth Circuit called the Supreme Court’s statement in Traveler’s that claims enforceable under state law are enforceable in bankruptcy unless expressly disallowed as “a presumption of broader significance.”  The Fourth Circuit said that Traveler’s instructed it to “turn to the text of the Code, and… consider whether it expressly disallows unsecured claims for post-petition attorneys’ fees based on valid pre-petition contracts.”  (Emphasis in original).  Looking first to Section 502, the Fourth Circuit concluded that it did not expressly disallow such claims because only claims of an attorney for the debtor that exceeded the reasonable value of the services rendered were addressed by that Section.

The Fourth Circuit then moved to an analysis of Section 506(b).  Rejecting the argument that allowance of secured claims for attorneys’ fees under that Section to the extent of the value of collateral must mean that unsecured creditors are not entitled to assert such claims, the Fourth Circuit said that “this kind of argument by negative inference cannot carry the day under Traveler’s.”  Section 506(b), the Fourth Circuit said, “never mentions, let alone expressly disallows, unsecured claims for post-petition attorneys’ fees.”  The Fourth Circuit said that Section 506(b) “has nothing to do with the allowance or disallowance of claims.”  Disallowance of claims, the Court said, is governed solely by Section 502, “aptly titled “[a]llowance of claims or interests.” According to the Court, Section 506(b), entitled “secured status,” simply addresses “the ‘secured status’ of claims already allowed or presumed allowed.”

Although Summitbridge is good news for creditors asserting claims under agreements or statutes requiring debtors to pay their attorneys’ fees, creditors must bear in mind that being able to assert unsecured claims for attorneys’ fees in bankruptcy cases does not mean that those fees will be paid.  Unsecured creditors rarely receive more than pennies on the dollar on account of their unsecured claims.  What unsecured creditors are paid in a bankruptcy case is generally governed by what the debtor can afford to pay rather than by how much the debtor owes.  Although Summitbridge may result in some reallocation of the limited funds available to pay unsecured claims in favor of creditors who are entitled to add attorneys’ fees to their claims, in most cases, it is unlikely to increase significantly the amounts that unsecured creditors are paid on account of their claims.