In Travelers Cas. and Sur. Co. of America v. Pacific Gas & Electric Co., 127 S. Ct. 199 (2007) ("Travelers"), the United States Supreme Court overturned a Ninth Circuit Court of Appeals opinion that had made pre-petition contractual provisions awarding attorneys’ fees to the prevailing party unenforceable in bankruptcy to the extent the parties litigated issues peculiar to bankruptcy law. The Ninth Circuit opinion, Fobian v. Western Farm Credit Bank (In re Fobian), 951 F.2d 1149 (9th Cir. 1991) ("Fobian"), was in conflict with other circuit courts that did not impose the same limitation on such contractual provisions in bankruptcy. The Supreme Court held that the Bankruptcy Code did not support the limitation and unanimously overruled Fobian.

The Ninth Circuit based its holding in Fobian on the following cases: Collingwood Grain, Inc. v. Coast Trading Co. (In re Coast Trading Co.), 744 F.2d 626 (9th Cir. 1984) ("Coast Trading"); Grove v. Fulwiler (In re Fulwiler), 624 F.2d 908 (9th Cir. 1980) ("Fulwiler"); and Johnson v. Righetti (In re Johnson), 951 F.2d 1149 (9th Cir. 1985) ("Johnson").

Fulwiler had held that non-dischargeability proceedings under Section 17 of the Bankruptcy Act were neither actions sounding in tort nor contract. As a consequence, an Oregon state statute making enforceable contractual awards of attorneys’ fees for enforcement of the contract was inapplicable and no attorneys’ fees were awarded.

In Coast Trading, the Ninth Circuit held, in part, that neither party in a contract rescission action was entitled to attorneys’ fees because no Oregon state statute providing for allocation of attorneys’ fees was applicable since the parties were not seeking to enforce the contract. The Coast Trading court relied on Fulwiler in further holding that contracts providing for attorneys’ fees for enforcement of the contract are not available for litigation of "federal bankruptcy issues."

Fobian also relied on Johnson, in which the Ninth Circuit held that litigation arising out of one party’s motion for relief from the automatic stay was litigation purely associated with federal bankruptcy law. According to the panel in Johnson, because the issues being litigated were solely governed by federal law, the California state statute enforcing contractual provisions awarding of attorneys’ fees for enforcing the contract was held to be inapplicable. In Johnson, the Ninth Circuit relied on both Coast Trading and Fulwiler.

The Ninth Circuit had relied on these three cases in Fobian when it announced the following rule: "Where litigated issues involve not basic contract enforcement questions, but issues peculiar to bankruptcy law, attorneys’ fees will not be awarded absent bad faith or harassment by the losing party."

When the Supreme Court reviewed the Fobian rule, it determined that there was no textual support in the Bankruptcy Code for it. The Supreme Court began with the premise that all claims against a debtor in bankruptcy are allowed unless the claim falls within one of nine enumerated exceptions in Bankruptcy Code § 502(b). Going through each of the exceptions, the Supreme Court found that none applied to a contract awarding attorneys’ fees to the party seeking to enforce the contract. The Supreme Court held that since there was no Bankruptcy Code provision disallowing such claims, and if they are otherwise valid under state law, then they cannot be disallowed by the judicially-made rule in Fobian.

The Supreme Court refused to consider the argument that Bankruptcy Code § 506(b) precludes the recovery of attorneys’ fees because the party advancing the argument failed to raise it in any lower court. The argument is that § 506(b), which provides attorneys’ fees to an over-secured creditor, disallows them in all other circumstances because the section does not mention that attorneys’ fees are allowable in any other context. Even though the Supreme Court did not reach the merits of the argument, considering there is no support in the Bankruptcy Code for the proposition that an unsecured creditor cannot get attorneys’ fees pursuant to a contractual provision that is valid under state law, the Supreme Court would probably not have changed the outcome of its decision.

With Fobian overruled, the rule that attorneys’ fees cannot be awarded when the fees are purely bankruptcy-related no longer exists. However, the Supreme Court decision makes it clear that the award of attorneys’ fees must be valid under state law. Transactional attorneys will want to review the language of their attorney fee provisions either to broaden or narrow them, since courts will first look to the contractual language itself. Inevitably though, there still will be litigation regarding whether the award of attorneys’ fees is valid in bankruptcy. Another issue Travelers raises is how to determine in the bankruptcy context which party prevails in an action. It is unclear whether the court will announce it, or whether the determination of who is a prevailing party will give rise to even more litigation. Travelers‘s overruling of Fobian will have important and likely unforeseen consequences in bankruptcy cases in the Ninth Circuit.

Authored by:

M. Reed Mercado

(213) 617-5410