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Class Actions and Proofs of Claim The Latest Minefield

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Seeking post-petition attorneys' fees in consumer bankruptcies has become a high-risk activity. Traditionally, oversecured creditors would simply add their bankruptcy counsel fees to proofs of claim. A recent flood of class-action cases challenging creditors' practice of including post-petition attorney fees in proofs of claim has called this simple procedure into question. In the last two years, plaintiff class-action attorneys have filed cases across the country alleging that creditors who wish to seek reimbursement of post-petition attorney fees from the debtor must first file and serve a fee application and have such fees approved by the bankruptcy court pursuant to Bankruptcy Code §§503 and 506(b) and Bankruptcy Rule 2016. Two bankruptcy judges have written decisions addressing this issue in the last year. Each has analyzed the issue slightly differently, with equally unsettling results.

On Oct. 2, 2000, Judge J. Craig Whitley from the Western District of North Carolina in In re Tate, 253 B.R. 653 (Bankr. W.D.N.C. 2000), held that creditors seeking attorney fees under §506(b) must first file and serve a fee application and obtain specific approval of the attorney fees from the bankruptcy court. The court, believing that the claim objection mechanism was not a reasonable substitute for a fee reimbursement application, concluded that the creditor's failure to follow federal procedural law when it inserted the attorney fee into its proof of claim rendered the attorney fees "per se unreasonable."

Almost three months later, on Dec. 29, Judge Margaret Mahoney from the Southern District of Alabama wrestled with the same issues in five separate class-action cases. Harris v. First Union Mortgage Corp., Adv. No. 99-1144; Miller v. First Union Mortgage, Adv. No. 99-1137; Noletto v. Nationsbanc Mortgage Corp., Adv. 99-1120; Sheffield v. HomeSide Lending Inc., Adv. No. 99-1124; and Slick v. Norwest Mortgage Inc., Adv. No. 99-1136. Judge Mahoney rejected the notion that Bankruptcy Rule 2016 applies to creditors seeking reimbursement of attorney fees under §506(b). She reasoned that creditors' fees under §506(b) are not like the claims allowed under §503 because they do not benefit the estate as a whole. She approved of the practice of including the post-petition attorney fees in the proof of claim, but provided that the attorney fee must be "adequately disclosed" in the proof of claim. Otherwise, the creditor must file a fee application under Bankruptcy Rule 2016.

Judge Mahoney added a new twist by concluding that, based on due process concerns, an attorney fee is not adequately disclosed in a proof of claim unless the creditor discloses whether the fee was incurred pre-petition or post-petition.1 The mere characterization of the fee as an "attorney fee" was an insufficient description to give debtors, trustees and other parties in interest notice of the fee and an opportunity to object.

In one of the cases, however, Judge Mahoney found that the use of the term "bankruptcy fee," provided a sufficiently specific description of the nature of the attorney fee for notice purposes since it was clear by that term that the fee was incurred post-petition.

The problem with Judge Mahoney's decision is that it flies in the face of other principles that exist in the Bankruptcy Code and Bankruptcy Rules. First, neither the Bankruptcy Code nor the Bankruptcy Rules direct creditors to specify between pre-petition and post-petition attorney fees. The Official Proof of Claim form merely provides that if the claim includes other charges in addition to the principal amount of the claim, the creditor must itemize any additional charges. Second, the liberal pleading standard, which is generally applied to the interpretation of a proof of claim (see In re O'Malley, 252 B.R. 451, 456 (Bankr. N.D. Ill. 1999)), is converted into a strict unyielding standard by requiring creditors to specify whether an attorney fee is pre- or post-petition. Third, the creditor is deprived of an opportunity to amend its claim to provide more specificity pursuant to Bankruptcy Rule 7015 by determining that the failure to specify renders the claim "per se unreasonable."

Collectively, these decisions by both Judge Whitley and Judge Mahoney seem to obliterate the notion that a claim is deemed allowed unless an objection is filed. These decisions also undermine the claims-objection process where normally, upon the filing of an objection by the debtor, trustee or party in interest, a creditor seeking reimbursement of an attorney fee in a proof of claim would be entitled to a hearing to determine its right to the attorney fees under §506(b) and the reasonableness of its fees.

In neither Judge Whitley's nor Judge Mahoney's analysis is the creditor afforded an opportunity to file an amendment to the proof of claim or a fee application to conform with the specified unwritten practice of the district. The due-process rights of the creditors do not appear to have been considered. As a consequence, these decisions have turned the filing of a proof of claim, which has been deemed a ministerial act by most courts, into a highly risky and potentially expensive activity. The decisions have also caught the attention of class-action attorneys across the country, causing an avalanche of filings of consumer bankruptcy class-action cases on this issue.

In an apparent retreat from the Tate decision, on April 5, 2001, the judges from the Western District of North Carolina, in an en banc decision in Smith v. TMS Mortgage Inc., Adv. Proc. No. 00-3148, issued an order to curb the filing of class-action cases and restore order to the claim objection process. Although the court supported the conclusion in Tate that creditors who seek reimbursement of post-petition attorney fees under §506(b) must first file a fee application under Bankruptcy Rule 2016, it restored the creditors' right to file an application for approval of such fees rather than deeming the fees "per se unreasonable" and subjecting the creditor to damages for failing to follow the proper local procedure. Furthermore, the court denied class certification in the many cases filed in the Western District of North Carolina in the wake of Tate and issued an administrative order on the same date providing notice to all parties of the local practice required in the Western District of North Carolina for the collection of creditor's post-petition attorney fees.2

With the turn of events in North Carolina, creditors and their counsel are hoping that a similar result will be obtained in Alabama.


Footnotes

1 In the Eastern District of Tennessee, such a distinction is meaningless since the bankruptcy court has held that attorney fees that are incurred post-petition, but that arise from a pre-petition contract, are pre-petition fees. In re Keaton, 212 B.R. 587 (E.D. Tenn. 1997), vacated on other grounds, Keaton v. Boatman's Bank of Tennessee, 145 F.3d 1331 (6th Cir. 1998); In re Byrd, 192 B.R. 917 (E.D. Tenn. 1996); Woburn Associates v. Kahn (In re Hemingway Transport), 954 F.2d 1, 8 (1st Cir. 1992). Return to article

2 Similarly, in In re Gifford, 256 B.R. 661, 662 fn. 2 (Bankr. D. Conn. 2000), the bankruptcy court allowed the attorney fees to be included in a secured creditor's proof of claim, but provided that henceforth it would follow the reasoning in Tate and require oversecured creditors that sought reimbursement for attorneys' fees to file an application pursuant to Bankruptcy Rule 2016. Return to article

Journal Date: 
Friday, June 1, 2001

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