The U.S. Supreme Court Rejects The Fobian Rule Barring Unsecured Creditors From Recovering Attorney's Fees In Bankruptcy Cases
Attorney's Fees And Unsecured Claims. For more than 15 years, creditors in the Ninth Circuit who sought to include in unsecured claims amounts for attorney's fees incurred post-petition litigating bankruptcy issues have had that portion of their claims disallowed. The reason? A decision by the United States Court of Appeals for the Ninth Circuit in a 1991 case called In re Fobian, 951 F.2d 1149 (9th Cir. 1991).
The Fobian Rule. In In re Fobian, the Ninth Circuit held that even if the parties' underlying contract provided for the prevailing party to recover attorney's fees, "where the litigated issues involve not basic contract enforcement questions, but issues peculiar to federal bankruptcy law, attorney's fees will not be awarded absent bad faith or harassment by the losing party."
The Supreme Court Overrules Fobian. That all changed on Tuesday, March 20, 2007, with the U.S. Supreme Court's unanimous decision in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. (click here for the decision). Neither Travelers nor PG&E sought to defend the Fobian rule, and the Supreme Court had little problem disposing of it:
The Fobian rule finds no support in the Bankruptcy Code, either in §502 or elsewhere. In Fobian, the court did not identify any provision of the Bankruptcy Code as providing support for the new rule. See 951 F. 2d, at 1153. Instead, the court cited three of its own prior decisions, In re Johnson, 756 F. 2d 738 (1985); In re Coast Trading Co., 744 F.2d 686 (1984); and In re Fulwiler, 624 F. 2d 908 (1980) (per curium). Significantly, in none of those cases did the court identify any basis for disallowing a contractual claim for attorney’s fees incurred litigating issues of federal bankruptcy law. Nor did the court have occasion to do so; in each of those cases, the claim for attorney’s fees failed as a matter of state law. See Johnson, supra, at 741–742; Coast Trading, supra, at 693; Fulwiler, supra, at 910. [footnote omitted]
The absence of textual support is fatal for the Fobian rule. Consistent with our prior statements regarding creditors’ entitlements in bankruptcy, see, e.g., Raleigh, 530 U.S., at 20, we generally presume that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed. See 11 U. S. C. §502(b). Neither the court below nor PG&E has offered any reason why the fact that the attorney’s fees in this case were incurred litigating issues of federal bankruptcy law overcomes that presumption.
An Important But Undecided Question. Although the Supreme Court dispatched the Fobian rule, it remanded the case without deciding whether Travelers, an unsecured creditor, could actually recover its attorney's fees. Instead, the Supreme Court held that the remaining arguments had not been raised below. Still to be resolved is whether Section 506(b) of the Bankruptcy Code, which expressly allows attorney's fees to oversecured creditors, means that creditors cannot recover attorney's fees as part of an unsecured claim. For a flavor of the Supreme Court's reactions to this open issue, you may find the transcript of the oral argument, held in January 2007, interesting .