Raising the Stakes in Dischargeability Litigation

Everybody, including me, has been blogging over the Supreme Court’s Travelers decision, which overruled the Ninth Circuit case of In re Fobian, 951 F.2d 1149 (9th Cir. 1991). Fobian held that attorney fees are not recoverable in bankruptcy for litigating issues “peculiar to federal bankruptcy law.” In Travelers, 2007 WL 816795, the Supremes went out of their way to overrule Fobian, but ducked an issue which was inexplicably raised late by the Debtor: is recovery of attorney fees by an unsecured creditor barred anyway by implication under the Code? Section 506(b) only allows attorney fees to oversecured creditors, right?

It will therefore remain unclear for now whether unsecured creditors can add attorney fees to their claims when they successfully litigate bankruptcy issues, and if so whether those fees will have administrative priority. In the meantime, the holding in Travelers will impact another area – dischargeability litigation. Section 506(b) governs the allowability of attorney fees as a component of a bankruptcy claim It shouldn’t have any effect on whether these fees can be recovered against an individual debtor, as opposed to the bankruptcy estate.

In re Baroff, 105 F.3d 439 (9th Cir. 1997) applied the Fobian rule in a dischargeability case, leading to a strange result in which the Debtor was awarded fees for successfully defending a fraud claim under §523(a)(2)(a) (fraud in the inducement) but not for defending a breach of fiduciary duty claim under §523(a)(4). The Ninth Circuit later stated in Renfrow v. Draper, 232 F.3d 688 (9th Cir. 2000): “The rule we announced in In re Baroff does not permit a bankruptcy court to award a party attorney's fees for litigating federal law issues in a bankruptcy court whenever state law is ‘integral’ to determining dischargeability. Instead, we held that attorney's fees should be awarded solely to the extent they were incurred in litigating state law issues.”

The Bankruptcy Appellate Panel had already backed away from Baroff following the Supreme Court’s decision in Cohen v. de la Cruz, 118 S.Ct. 1212 (1998), which upheld an award of attorney fees and treble damages in favor of a landlord under a New Jersey statute. In re Pham, 250 B.R. 93 (Bank. App. 9th Cir. 2000) held:

We agree that, after Cohen, the determinative question in cases under §523(a)(2) is whether the successful plaintiff could recover attorney's fees in a non-bankruptcy court. The Ninth Circuit's holdings in Baroff . . . were premised on the view that, under California law, fees in a fraud action for damages could not be recovered via a contractual fee agreement. These holdings were arguably undercut by Santisas v. Goodin, 17 Cal.4th 599, 608, 71 Cal.Rptr.2d 830, 836, 951 P.2d 399 (1998), in which the Supreme Court of California concluded that, depending on the wording of the fee provision, there may be a contractual right to recover attorney's fees in litigating tort claims.

On the issue of attorney fees in dischargeablity cases, Travelers demolishes Ninth Circuit law, but leaves Pham intact. It now seems likely that attorney fee claims in dischargeability litigation will be made with increasing frequency, and that the legal issue will be whether the contractual attorney fee provision involved is broad enough to include fees incurred in litigating tort claims. Adding attorney fee liability to dischargeability cases is a greater problem for creditors than for debtors. Chapter 7 debtors are judgment proof by definition. Creditors are not, and they may begin to think twice before filing a questionable dischargeability claim in the often unfriendly confines of the Bankruptcy Court.