Issues
Can a litigant recover attorney fees pursuant to a private contract when the issues litigated involve matter exclusively governed by federal bankruptcy law?
Travelers Casualty & Surety Company of America (“Travelers”) is appealing a Ninth Circuit decision denying it attorney fees for claims governed entirely by federal bankruptcy law. Travelers maintains that it is entitled to the indemnity rights it negotiated for under its private contract with Pacific Gas and Electric (“Pacific Gas”). Travelers relies on precedent to conclude that the substantive rights under a private contract are governed by state law and therefore the Ninth Circuit decision is wrongly decided and should be reversed. Pacific Gas argues that the Ninth Circuit correctly concluded in prior cases that attorneys’ fees pursuant to a private contract may be granted in cases where the rights are governed by state law, but not when they are peculiar to federal bankruptcy law. The Ninth Circuit reasoned that state law cannot govern federal issues such as indemnity of attorney fees for claims resulting from objections to debt restructuring plans and disclosure statements implemented by a company under Chapter 11 bankruptcy. The Ninth Circuit is concerned that a decision in support of non-prevailing creditors whose conditional rights have not been triggered or impaired in cases where the debtor has not defaulted in bankruptcy cases would flood the court dockets with these premature claims. The Supreme Court decision will resolve whether private parties can contract for rights which have not been explicitly granted by federal bankruptcy law. The decision will impact the legal protective strategies that creditors use to shield their investments from debtors who have filed for bankruptcy.
Questions as Framed for the Court by the Parties
Whether a litigant may recover attorneys’ fees under a contract or state statute where the issues litigated involve matters of federal bankruptcy law?
Facts
This matter arises out of a Chapter 11 bankruptcy case initiated by Pacific Gas & Electric Company (“Pacific Gas”), Respondent. Before Respondent commenced its bankruptcy case, Travelers Casualty & Surety Company (“Travelers”), Petitioner, issued surety bonds to various third parties on Pacific Gas’s behalf. One of these bonds was a $100 million surety bond issued to the California Department of Industrial Relations. This bond guarantees Pacific Gas’ payment of state workers compensation benefits to injured employees.
In conjunction with the issuance of the surety bonds, Pacific Gas entered into and executed a series of indemnity agreements in favor of Travelers that applied in the event of default. Among many issues covered, the agreements specifically provide that Pacific Gas is responsible for any loss that Travelers may suffer in connection to the surety bonds it issued on Pacific Gas’s behalf. The possible losses accounted for in the indemnity agreements include any attorneys’ fees that Travelers incurred in pursuing, protecting, or litigating its rights in connection with the surety bonds.
At the time of the district court decision, Pacific Gas had not defaulted on its obligations to continue payment of workers compensation benefits, and Travelers had not had to assume any sort of liability in connection with a default on the bonds it issued on Pacific Gas’ behalf. In fact, when Pacific Gas filed its bankruptcy claim, it also obtained an order from the bankruptcy that gave Pacific Gas the authority to continue making its workers compensation payments in accordance with its prior obligations.
Nevertheless, prior to the bar date for claims in bankruptcy court, Travelers filed a protective proof of claim in Pacific Gas’s bankruptcy case, asserting a claim for future reimbursement and subrogation rights that it possessed under the bonds and indemnity agreements, and not asserting a claim of default by Pacific Gas. Travelers’ goal was to protect is subrogation and indemnification rights in the event that Pacific Gas defaulted on its workers compensation payments in the future. Additionally, when Pacific Gas filed its first plan of reorganization and disclosure statement, Travelers objected, claiming that these documents failed to provide sufficient information regarding Pacific Gas’s obligations under the bonds.
Eventually, the parties agreed that additional language would be added to the reorganization documents to address and satisfy Travelers’ concerns with the adequacy of the information provided by Pacific Gas. Pacific Gas filed these amended documents a few months later. Pacific Gas subsequently filed an objection to Travelers’ claim for its future rights under the bonds, arguing that such a claim should be disallowed under bankruptcy law. In response, Travelers argued that Pacific Gas’ objection and its amended reorganization plan sought to impair Travelers’ rights. This dispute about Travelers’ claim was eventually resolved between the parties, with Travelers stipulating that its claim was disallowed by bankruptcy law. This disallowance, however, did not apply to Travelers’ claim for attorneys’ fees.
On January 6, 2003, Travelers submitted a proof of claim for attorneys’ fees and costs totaling over $167,000. According to Travelers, it had incurred attorneys’ fees and costs in the course of asserting its rights, objecting to its treatment under Pacific Gas’s Chapter 11 plan and disclosure statement, and defending litigation that Pacific Gas brought against Travelers in connection with the surety bonds. Pacific Gas objected on several bases, including that Travelers failed to provide sufficient support for its claim, that the fees were not compensable under the bonds or indemnity agreements, that the fees were not reimbursable based on federal bankruptcy law, and that the fees were unreasonable.
The bankruptcy court and the the federal court found for Pacific Gas and held that Travelers was not entitled to an award of attorney’s fees. The case was appealed to the Court of Appeals. Adhering to its prior decision in Fobian v. Western Farm Credit Bank (In re Fobian), 951, F.2d 1149 (9th Cir. 1991), the Ninth Circuit Court of Appeals affirmed the lower district court’s decision, holding that Travelers did not have a claim for its attorneys’ fees as a matter of law. The Ninth Circuit reasoned that, although parties are permitted to contractually allocate between them, the burden of attorneys’ fees incurred in litigating state law issues, the same freedom does not extend to the parties with respect to litigating federal issues unless federal law specifically authorizes such an allocation.
The Ninth Circuit reasoned that the resolution of all of the proceedings was governed entirely by federal bankruptcy law, and that federal bankruptcy law does not expressly authorize the allocation of attorneys’ fees among the parties. Because other federal circuit courts have applied a different rule and would have arrived at the opposite outcome, Travelers objected to the Ninth Circuit decision to refuse to award attorneys’ fees as a matter of law and appealed the decision to the Supreme Court of the United States. The Supreme Court granted certiorari on October 6, 2006.
Analysis
The issue that will be addressed by the Supreme Court is whether Travelers’s costs were incurred as a result of the measures it took to protect its rights under its private contract with Pacific Gas may be awarded pursuant to an indemnity clause in the contract or must be denied because proof of claims and objections to restructuring plans and disclosure statements are matters exclusively governed by federal bankruptcy law?
Indemnity: Governed by Private Contract and State law, Not Governed by Federal Bankruptcy Law
Travelers argues that under the indemnity clause in its contract with Pacific Gas, it is entitled to indemnity if “Travelers ever has to pay workers’ compensation benefits under the bond” and if it incurs attorney fees in asserting or protecting its rights under the contract. Opening Brief of Appellant on Appeal from District Court Decision at 1. The attorneys’ fees Travelers is seeking indemnity for resulted from entering its proof of claim and objections to Pacific Gas’s disclosure statements to the court. Id. Travelers argues that both the bankruptcy court and the District Court wrongly decided that, as a matter of federal law, Travelers was not entitled to indemnity under a private contract when the issues addressed by the court were peculiar to federal bankruptcy law.
In Fobian v. Western Farm Credit Bank the Ninth Circuit held that that “Where a contract or statute provides for an award of attorneys' fees, a creditor may be entitled to such fees in bankruptcy proceedings. Such an award is governed by state law. However, 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.” 951 F.2d 1149, 1153. Travelers states that the precedent set by the Ninth Circuit in Fobian is wrong for two reasons. First, the Supreme Court has held that “whether a claimant holds a valid contractual right to attorney fees is, in the first instance, a question of state law.” Security Mortgage Co. v. Powers (In re Florida Furniture Co.), 278 U.S. 149, 154 (1928); Reply Brief of Appellant, p. 1. The second reason why the lower court decisions are wrong is that “there is no general federal common law governing the validity of contractual rights to attorney’s fees in bankruptcy.” Id. Moreover, Travelers argues that the Ninth Circuit took a position that supports Travelers arguments in Cohen v. De La Cruz. In Cohen the court held that “Under § 101 of the Code, a contractual right to attorneys fees that is valid under state law unquestionably constitutes a claim for bankruptcy purposes irrespective of whether the claimant incurred fees before or after the debtor commenced the bankruptcy case.” Id. Since private contracts are governed by state law and there has been no challenge to the validity of the private contract under state law, the Cohen decision supports the conclusion that Travelers has a valid indemnity claim.
Lower courts should be upheld since precedent, congressional intent, and policy concerns contradict Travelers’ Arguments
Pacific Gas first points to general rules of law espoused by Supreme Court holdings which state that “when a cause of action is federal, ...[courts] ordinarily do not look to state law in considering whether to award attorneys fees.” Brief in opposition to Writ of certiorari, p. 26. Travelers argues that the lack of a bankruptcy code granting a creditor the right to attorneys fees prohibits the court from making new law by denying creditors attorneys fees in bankruptcy cases. On the other hand, Pacific Gas takes omission of a law granting creditors, especially those who have pressed “meritless” losing claims against a debtor who has not defaulted, the right to attorney fees as demonstrative of there being no indemnity right in federal bankruptcy law since congress would have explicitly given creditors such a right if they wanted such a right to exist. Id.
After interpreting the absence of a bankruptcy law granting attorneys, Pacific Gas proceeds to highlight the weaknesses in Travelers’s arguments. Travelers relies upon Security Mortgage Co. v. Power to conclude that state law governs the issue of attorneys’ fees. 278 U.S. 149 (1928). However, this is a problematic case for Travelers to rely upon for several reasons. Security Mortgage was not only decided seventy-five years ago, but also decided under the 1898 Bankruptcy Act, which has been repealed. Brief in Opposition at 27. Other problems with relying on this case lie in the facts of the case being different from the situation in which Travelers finds itself. Id. The most significant difference between the two cases is that the debtor in Security Mortgage defaulted while Pacific Gas never defaulted on its obligations nor caused Travelers to incur any costs related to paying workers compensation under the bond it posted for Pacific Gas. Id. Although the court in Security Mortgageawarded the creditor attorneys fees, they were costs incurred as a result of the debtor defaulting on his obligations. Id. Moreover, there was a state statute that specifically granted attorneys fees in state court collection actions. Id. Pacific Gas implies that the difference in the facts between the cases makes the holding in Security Mortgage inapplicable to Travelers’ position.
Pacific Gas disagrees with Travelers’ reading of Fobian and maintains that it was correctly decided. According to Travelers, the Fobian decision says that federal law could trump an indemnity right negotiated for under a private contract. However, Pacific Gas interprets the Fobian decision as preventing the award of attorney fees in cases where the debtor has not defaulted and the creditors “intervention” or protective measures have not been accepted by the court. Brief in Opposition at 28-29. The basis of the Fobian decision is not “new federal common law rule of decision” as Travelers argues. Id. at 29. Instead, the Fobian decision is based on policy concerns and principles of statutory construction. Id. The court was concerned that awarding attorneys fees for frivolous intervention measures submitted by a creditor to the court when a debtor has not defaulted would flood the courts with claims from creditors claiming to be protecting their interests. The Fobian court and the lower courts in this case also believed that Congress did not intend to award attorney fees for creditors with unimpaired, inchoate, and contingent claims. Id.; 11 U.S.C.A. § 1125; Travelers Casualty and Surety Company v. Pacific Gas Electric Company, 167 Fed.Appx 593, 594 (Ninth Circ, 2006).
The Supreme Court Decision
Pacific Gas points out several weaknesses in Travelers’ arguments. However, Travelers makes important arguments regarding rights that individuals in America consider to be basic: the right to make private contracts and the right to protect one’s economic interests. The lower court decisions in Travelers were based on factors that are often balanced by courts against individual interests: judicial efficiency, policy concerns and congressional intent. A debtor filing for Chapter 11, may make a creditor believe that his interests are in danger. Although it is understandable that the court wants to clear the court docket of frivolous claims and uphold congress’s intent in promulgating bankruptcy laws, it is also understandable that creditors want the right to be able to intervene and be part of bankruptcy proceedings without incurring the additional costs of attorneys fees to protect their interests as soon as possible, especially when they have contracted for these rights. Despite the importance of the interests of creditors, debtors, and the courts being on the line, the Supreme Court is likely to rule in favor of Pacific Gas since they not only pose stronger arguments than Travelers but it is unlikely that the Supreme Court will make a decision that would award attorney fees in cases where creditor rights have not been impaired since this would encourage premature claims that could flood court dockets.
Discussion
The Supreme Court’s decision in this case will have broad implications on the interpretation of agreements between parties that allocate the cost of attorneys’ fees among the parties. This decision will have a strong impact on the entrenched conflict that currently exists among the circuit courts. In denying Travelers’ claim for attorneys’ fees, the Ninth Circuit followed its precedent in Fobian, holding that a party cannot puruse a previoulsy allocated contractual right to attorneys’ fees if the issues being litigated involve questions of federal law, unless federal law expressly authorizes such an arrangement.
Three other courts of appeals also apply the Fobian rule in the context of litigating bankruptcy matters, denying the validy of contractual arrangements among the parties that concern the allocation of attorneys’ fees. In contrast, five courts of appeals take the opposite approach, rejecting the Fobian rule and reasoning that Fobian analysis inappropriately focuses on the presence of issues that are peculiar to federal bankruptcy law, rather than on whether the attorneys’ fees were allocated by means of a mutual, contractual arrangement between the parties that is valid under applicable state law.
According to Travelers, the Ninth Circuit adopted a “rule [that] is plainly wrong and has the analysis exactly backwards.”Petition for Writ of Certiorari at 13. Petioner objects to the Ninth Circuit’s decision to adopt a rule that is grounded on whether Congress expressly authorized the allocation of responsibility for a party’s litigation expenses in some manner. Id. The correct rule in this situation, contends Travelers, is that “contracts that are valid under state law may allocate litigation costs among the parties unless Congress has expressly prohibited them from doing so.” Id. Travelers points to other precedent in the Supreme Court, explaining that the Court has always regarded a party’s right to attorneys’ fees is a matter of state law. Id. at 24.
Respondent Pacific Gas, on the other hand, contends that the Ninth Circuit correctly applied the Fobian rule and arrived at the appropriate decision in this case. More specifically, Respondent objects to the way in which Petitioner became a part of the bankruptcy proceedings, incurring attorneys’ fees in a case where Respondent had not yet defaulted on its obligations, and securing for itself rights that it already had by operation of law. Brief in Opposition at 10. Thus, Respondent argues that the issue is much narrower, and that no circuit conflict exists where a creditor like Travelers attempts to recover attorneys’ fees incurred while litigating unsuccessful demands. Id. Finally, Respondent argues that the Ninth Circuit correctly concluded that “Congress did not intend to allow private parties to adjust the rule barring the award of attorneys’ fees in connection with the enforecement of rights or obligations created purely as a matter of federal bankruptcy law.” Id. at 29.
A decision for Petitioner Travelers would, argues Petitioner, would preserve the long-standing practice of permitting parties to allocate contractual rights amongst themselves, under applicable state law, without worrying about intrustion from federal courts. Brief for Petitioner at 5. Travelers contends that a contrary decision would impermissibly federalize contractual rights, which have traditionally been the sole domain of state law. Id. Also, in the bankruptcy context, a contrary decision that would invalidate the allocation of attorneys’ fees among the parties would result in inequitable discrimination, giving preference to creditors with claims that do not involve atorneys’ fees. Id. Such a decision would improperly influence and limit the types of contractual bargains that can be created among creditors and debtors.
Additionally, a decision upholding the Ninth Circuit determination of this case would risk inviting litigants to forum shop. Amicus Curiae Brief AIA at 2. When initially entering into a contractual relationship, the parties are governed by applicable state, nonbankruptcy law. But, if the Ninth Circuit decision stands, both parties might try to file bankruptcy claims, under federal law, to get a more favorable determination of their state law claim. Id. For example, if bankruptcy law provides a more generous scheme for the allowance of claims, then creditors that are unhappy with the substantive state law governing their contractual arrangement would have a perverse incentive to file a bankruptcy claim with intent of gaining a friendlier forum for their claim. Id. The same is true for a debtor who, if a valid state law claim would be disallowed in bankruptcy, might have an incentive to seek bankruptcy protection in order to gain a litigation advantage over a creditor. Id.
Conversely, Respondent Pacific Gas argues that a decision in its favor would counteract the potential of false claims and frivolous litigation that would arise if the Supreme Court decides in favor of Petioner. According to Pacific Gas, permitting Travelers to collect its attorneys’ fees in this case would be an unwarranted extension of the rule permitting collection of attorneys’ fees in general, not to mention that fact, Respondent argues, that such an allocation of attorneys’ fees it is impermissible under bankruptcy law. Pacific Gas contends that Travelers should not be entitled to attorneys’ fees at all because it incurred those fees by unnecessarily becoming involved in a bankruptcy claim where Pacific Gas had not yet defaulted and where Travelers was merely seeking to enforce assure enforcement of rights it was already assured by law.
Finally, permitting recovery in such a case, says Pacific Gas, would open the door to a mass of litigation and would increase the likelihood of fraudulent claims being filed during bankruptcy proceedings in response to a decision that would permit such filers to recover attorneys’ fees under original contractual arrangments, whether the claim was legitimate or not legitimate. In a situation where Pacific Gas had not yet defaulted on its obligations and Travelers’ stipulated that its claim was not permitted by bankruptcy law, Pacific Gas believes the Supreme Court should protect its interests. Even if the Supreme Court disagrees on this point, Respondent argues that the Supreme Court should read into Congress’ intent and not permit a recovery of attorneys’ fees under federal bankruptcy law.
Conclusion
The Supreme Court’s decision in this case will have a significant impact on the course of contractual agreements allocating attorneys’ fees between parties where the potential for litigation exists, and that litigation might involve rights that arise substantially out of federal law. A decision for Petitioner Travelers will reverse the lower court decision and uphold the sanctity of the prior contractual allocation agreed upon by both Travelers and Pacific Gas. A decision for Pacific Gas will give substantial weight to the theory that the right to attorneys’ fees may not be allocated between the parties in a way that is not expressly permitted by federal law. Furthermore, a decision one way or the other will affect the types of claims and the frequency of claims that will be brought into bankruptcy court involving the allocation of attorneys’ fees.
Written by: Heidy Abreu & Miguel Loza
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