lients often ask if they can claim or recover attorneys' fees and collection costs from a debtor in a bankruptcy case. Most commercial contracts have standard provisions authorizing the collection of such fees and costs for the prevailing party. The answer depends on the nature of the claim for attorneys' fees and the jurisdiction. While oversecured² creditors can rely on Bankruptcy Code §506(b) to assert claims for at least the "reasonable" attorneys' fees provided for in loan documents, courts are all over the map on the allowability of attorneys' fees for unsecured and undersecured claims. The majority of courts allow such fees, some courts disallow them completely and others only allow them in limited circumstances.

The Majority View

Attorneys' fees are recoverable if based on a contract enforceable under state law or statute. The majority view—or the view affirmed by the most circuit courts (including the Second, Sixth, Ninth and Eleventh Circuits)—is that attorneys' fees can be included in an unsecured creditors' claim when they are provided for by a specific statute or a contract enforceable under state law.³ For these courts, the primary legal justification for such awards is that such clauses are simply another contract right, and the Bankruptcy Code specifically states that contract rights can be the basis for a claim.⁴ As stated by the Eleven Circuit, "It is established that 'debt' is to be given a broad and expansive reading for the purposes of the Bankruptcy Code...Therefore... "debt"...would appear to include a debtor's contractual obligation to pay a creditor's attorneys' fees." Transouth Financial Corp, supra, 931 F.2d at 1507.

The Second Circuit also held that enforcement of attorneys' fee clauses was fair because "courts should presume...that the creditor gave value, in the form of a contract term favorable to the debtor...in exchange for the collection costs provision." United Merchants, supra, 674 F. 2d at 137.

Under the majority view, when a provision for attorneys' fees or collection costs is specifically included in a contract, the basic rule is that these provisions may be enforced in a bankruptcy court to the extent enforceable under state law. In re Martin, supra, 761 F.2d at 1168. For example, some states impose grace periods in which a debtor can catch up on loan payments before being liable for attorneys' fees, and these will be enforced by the bankruptcy court. In re Welzel, 243 B.R. 916, 918 (S.D. Ga. 1999) (10-day grace period is provided by Georgia law).

In relatively rare cases, an unsecured claim will be made under a statute that includes a fee-shifting provision for the successful plaintiff.⁵ For example, a New Jersey statute enables tenants who have been charged more rent than allowable under rent control ordinances to sue for treble damages and attorneys' fees. A successful plaintiff in such a case can include the attorneys' fees awarded under the statute as part of its bankruptcy claim.⁶

The Minority View

Attorneys' fee clauses are unenforceable. The minority view, which to date appears to have only been adopted by a small number of bankruptcy courts (and by no circuit courts), is that the post-petition attorneys' fees of an unsecured or undersecured creditor in an insolvent bankruptcy are barred by a proper reading of §506(a) and (b).⁷ In the leading case, the court in Sakowitz held that §506(a) and (b) should be read as defining the limits of secured and unsecured claims. The court reasoned that since only §506(b) specifically mentions attorneys' fees, Congress's presumed intent was to permit such fees for secured claims only: "Congress must be presumed to have understood what it was doing. It could easily have provided for attorneys' fees for the unsecured portion of the claim as well as the secured portion—but chose not to." Sakowitz, supra, 110 B.R. at 272. The court rejected the Second Circuit's reasoning that the presence of an attorneys' fee clause means that the creditor has given more value, and noted that "virtually all promissory notes...provide for attorneys' fees" and "under Texas statutory law...a person may recover attorneys' fees, in addition to the valid claim, if the claim is for an oral or written contract." Id. at 271.

It has also been argued that the Sakowitz rule is more administratively convenient. Since "the amount of a claim is determined as of the filing date and non-executory obligations do not continue to mount post-petition," it is inappropriate to add charges for interest or attorneys' fees unless a specific exception, such as that provided in §506(b), has been made.⁸ Another court has suggested that the only justification for the §506(b) provision of attorneys' fees is that an oversecured creditor has a "cushion" that it can eat up with additional fees, and this cushion does not exist for the unsecured or undersecured creditor.⁹

The minority position has come under fire in academic circles¹⁰ and in some recent cases. In In re Keaton, the court called for the minority courts to return to "basic principles." 182 B.R. 203, 207 (Bankr. E.D. Tenn. 1995). The court pointed out that it is the court's duty under §502(c) to estimate contingent and unliquidated claims and to disallow certain claims under §502(b). Since "contingent, unliquidated attorneys' fees are not among those claims that may not be allowed," it is the duty of the court to estimate and allow these fees. The court further reasoned that the sole purpose of §506(b) was not to "define what fees can be included in a creditor's secured claim," but simply to make sure that an oversecured creditor would "realize the benefit of its bargain." Id. at 207-08.¹¹

Limitations on Post-Petition Fees by the "Majority" Courts

Even among the courts that permit awards of post-petition attorneys' fees, courts appear less likely to award attorneys' fees as the arguments stray further from those based on state-law contract rights and move toward pure bankruptcy-law arguments.¹² The "majority" courts are willing to award attorneys' fees for "basic contract enforcement questions," since these are most clearly on the state-law end of the scale. See Abercrombie v. Hayden Corp. (In re Abercrombie), 139 F.3d 755, 756 (9th Cir. 1998) (fees granted for suit over real estate contract). The majority courts also would generally permit fees associated with the preparation and processing of a bankruptcy claim. See, e.g., United Merchants, supra, 674 F. 2d at 134.

Some "majority" courts begin to balk when fees are sought for actions to dispute or enforce Bankruptcy Code rights. Most in dispute are fees incurred in connection with non-dischargeability actions under §523. Under §523(d), if a creditor contests the dischargeability of a consumer debt and the debtor prevails, the debtor is entitled to the attorneys' fees and costs in connection with the proceeding. Recognizing that §523(d) is a one-way provision designed to prevent creditor intimidation of debtors, the court in In re Martin, supra, conceded that it could not be used by creditors. Id., 761 F.2d at 1167-68. Nevertheless, the court concluded that since attorneys' fees provided in a loan contract may be recovered, fees incurred by a creditor in connection with a dischargeability action could constitute part of its claim. Id. at 1168. The Eleventh Circuit agreed, reasoning that "fraudulent conduct" on the part of the debtor would best be discouraged by permitting a successful creditor in a dischargeability action to recover contractually provided attorneys' fees. Transouth Financial Corp., supra, 931 F.2d at 1508-09.

This position has been rejected by other "majority" courts. The court in American Express Travel Related Services Co. Inc v. King (In re King), 135 B.R. 734 (Bankr. W.D.N.Y. 1992), held that permitting a creditor to recover attorneys' fees for a dischargeability action would defeat the entire purpose of §523, which the court characterized as tipping the balance in favor of consumer debtors who are often the targets of abusive lending practices.

The Ninth Circuit's reasoning for refusing to award such fees is even broader: "where the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law, attorneys' fees will not be awarded absent bad faith or harassment by the losing party." Fobian v. Western Farm Credit Bank, supra, 951 F.2d at 1153. In accordance with its "strict" view that attorneys' fees can only be awarded in a "traditional 'action on the contract'," the Ninth Circuit has also rejected attorneys' fees for actions to obtain relief from the automatic stay pursuant to §362 (Johnson v. Righetti (In re Johnson), 756 F.2d 738 (9th Cir. 1985), cert. denied, 475 U.S. 828 (1985)) or actions to reclaim goods pursuant to §546 (Collingwood Grain Inc. v. Coast Trading Co (In re Coast Trading), 744 F.2d 686, 693 (9th Cir. 1984)).

When Can Post-Petition Attorneys' Fees Receive Administrative Priority Status?

Under certain circumstances, post-petition attorneys' fees can qualify for administrative priority status, even though the underlying transaction or contract receives only general creditor status. For example, certain employees who are terminated without sufficient prior notice can assert claims for up to 60 days of lost wages under the Worker Adjustment and Retraining Notification Act (WARN Act), 29 U.S.C. §2901 et seq. Accordingly, the court in In re Jamesway Corp., 242 B.R. 130, 132 (Bankr. S.D.N.Y. 1999), held that both the lost wages and the attorneys' fees provided for in the statute may be asserted as claims against the bankruptcy estate. The Jamesway court also ruled that while the lost wages are not entitled to administrative priority, the associated attorneys' fees should receive this status, since they are awarded pursuant to a fee-shifting statute. The court reasoned that the purpose of a fee-shifting statute is to encourage attorneys to take such cases, and that forcing a successful attorney to stand in line with all other creditors would defeat this incentive. Furthermore, debtors with clear WARN liability would have little incentive to settle "if they knew they could pay the adversaries' legal bills at pennies on the dollar." Id. at 134.

On the other hand, when attorneys' fees are based solely on contract claims, courts appear to be moving away from permitting administrative priority. Generally speaking, for a claim to be awarded administrative priority status, it must arise from a post-petition debt in connection with a transaction with the trustee or debtor-in-possession, and must be incurred to benefit the estate. In re Keegan Utility Contractors Inc., 70 B.R. 87, 89 (Bankr. W.D.N.Y. 1987). Some Ninth Circuit cases held that these three conditions can be satisfied when the trustee initiates or continues a suit against a creditor post-petition. The Ninth Circuit Bankruptcy Appellate Panel found that such a suit "results in injustice" by forcing a creditor to involuntarily become embroiled in a lawsuit, thereby suffering damages. In re Madden, 185 B.R. 815, 818-19 (9th Cir. BAP 1995); see, also, In re Beyond Words Corp., 193 B.R. 540, 546-47 (N.D. Cal. 1996).

A more recent Ninth Circuit decision appears to have overruled Madden. While the court retained the traditional test for awarding administrative priority, it ruled that in order for a transaction to be considered post-petition, it had to be based on a post-petition contract. Abercrombie v. Hayden, supra, 139 F.3d at 757. Attorneys' fees associated with the enforcement of a pre-petition contract could only be treated as "nonprioritized unsecured claims." Id. at 757-58. Other circuits have taken a similar view. See In re Hemingway Transport Inc., 954 F.2d 1 (1st Cir. 1992).

Reasonableness Limitations on Attorneys' Fees

Awards of attorneys' fees face yet another hurdle in many bankruptcy courts—a determination that they are reasonable. Of course, §506(b) specifically provides that only reasonable attorneys' fees are allowable as secured claims, and many states impose reasonableness restrictions on all fees as well. In addition, some courts have assumed that "the bankruptcy court has an independent power to limit...fees to a reasonable amount," and that "the right to object and the court's authority to limit...fees to a reasonable amount is inherent in the bankruptcy process." In re Keaton, supra, 182 B.R. at 209. Thus, in many cases an attorney will have to justify his or her fees under both state and bankruptcy law.¹³

Conclusion

A claim for attorneys' fees and costs can be a significant boost to an unsecured creditor's claim. It can be used as leverage in the context of claims objections, and in some cases, even be classified as an administrative claim. Since there is rarely a downside to asserting a claim for attorneys' fees, unsecured creditors should always include attorneys' fees in their proofs of claim. In addition, creditors should carefully craft the attorneys' fees clauses in their sales and loan contracts both to comply with state law restrictions on attorneys' fees and to specifically state that the fees incurred in a bankruptcy proceeding may be recovered.

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Footnotes

¹ The authors gratefully acknowledge the assistance of David D. Johnson, an associate at Latham & Watkins, in researching and drafting this article. Return to article

² A creditor is "oversecured" if the value of its collateral as of the petition date exceeds the amount of the related debt. A creditor is "undersecured" if the value of its collateral is less than the debt as of the petition date. Return to article

³ United Merchants and Manufacturers Inc. v. Equitable Life Assurance Society of the United States (In re United Merchants and Manufacturers), 674 F. 2d 134 (2nd Cir. 1982); Martin v. Bank of Germantown (In re Martin), 761 F.2d 1163, 1168 (6th Cir. 1985); Fobian v. Western Farm Credit Bank (In re Fobian), 951 F.2d 1149, 1153 (9th Cir. 1991), cert. denied, 505 U.S. 1221 (1992); Transouth Financial Corp. v. Johnson, 931 F.2d 1505, 1507 (11th Cir. 1991). Return to article

⁴ Bankruptcy Code §101(5) provides, in relevant part, that: "claim means...right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured." Return to article

⁵ Under the standard "American rule," each party in a lawsuit pays its own fees. A fee-shifting statute provides an exception to this rule by permitting a successful plaintiff to have its fees paid by the defendant. Return to article

⁶ De la Cruz v. Cohen (In re Cohen), 185 B.R. 171 (Bankr. D. N.J. 1994); 185 B.R. 180 (Bankr. D. N.J. 1994); aff'd., 191 B.R. 599 (D. N.J. 1996); aff'd., 106 F.3d. 52 (3rd Cir. 1997) (debt for fraud "normally includes interest, costs of recovery and attorneys' fees"); aff'd., 118 S.Ct, 1212, 523 U.S. 213 (1998). Return to article

⁷ Sakowitz Inc. v. Chase Bank Int., 110 B.R. 268 (Bankr. S.D. Tex. 1989); In re Woerner, 19 B.R. 708, 713 (Bankr. D. Kan. 1982); In re Mobley, 47 B.R. 62 (Bankr. N.D. Ga. 1985); In re Saunders, 130 B.R. 208, 210-11 (Bankr. W.D. Va. 1991). Return to article

⁸ In re Vulpetti, 182 B.R. 923 (Bankr. S.D. Fla. 1995). Return to article

⁹ In re Woodmere Investors Ltd. Partnership, 178 B.R. 346 (Bankr. S.D.N.Y. 1995). Return to article

¹⁰ See Gadsen, James and Yamasaki, Seigo, "Recovery of Attorneys' Fees as an Unsecured Claim," 114 Banking Law Journal 594 (1997); Geoffrey, Ray, "Show Me the Money: The Debate over Creditors' Post-petition Attorneys' Fees," 14 Bankr. Dev. J. 425 (1998). Return to article

¹¹ The bankruptcy court opinion was affirmed at the district court level (212 B.R. 587 (E.D. Tenn. 1997)) but mooted by the Sixth Circuit (145 F.3d 1331 (6th Cir. 1998)). However, given the position of the Sixth Circuit in In re Martin, supra, it is unlikely that the Sixth Circuit would have overruled the Keaton court if it had reached the merits. Return to article

¹² It should be noted that, in our experience, some courts are more inclined to grant attorneys' fees in a bankruptcy proceeding when the contract specifically states that fees incurred in enforcing rights under the contract in a bankruptcy proceeding may be recovered. Return to article

¹³ Some courts have ruled that attorneys' fees that are allowable under state law but unreasonable under the §506(b) standard should still be allowable as unsecured claims. Sanson Investment Co. v. 268 Limited (In re 268 Limited), 789 F.2d 674 (9th Cir. 1986). Other courts have ruled that since §506(b) applies to the entire fee, the unreasonable portion should simply be disallowed. In re Welzel, 243 B.R. 916 (S.D. Ga. 1999). Return to article