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An Oversecured Creditor’s Post-Petition Attorneys’ Fees: Determined by Federal Law or State Law?

 

Charles Lazo

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

Recently, in Wells Fargo Bank, N.A. v. 804 Congress, L.L.C. (In re 804 Congress, L.L.C.),[i] the Fifth Circuit held that federal law governs an oversecured creditor’s recovery of post-petition attorneys’ fees from the proceeds from the sale of the creditor’s collateral.[ii]  In In re 804 Congress, L.L.C., a bank financed the debtor’s purchase of an office building.[iii]  The loan was secured by a deed of trust.[iv]  The deed of trust provided, among other things, that the debtor was required to pay the bank it attorneys’ fees following a foreclosure of the property.[v]  After the bank scheduled a foreclosure sale of the property, the debtor filed for bankruptcy.[vi]  Subsequently, the bankruptcy court granted the bank’s motion for relief from the automatic stay in order to complete the non-judicial foreclosure sale.[vii]  Following the sale, the bankruptcy court exercised jurisdiction over the sales proceeds, and therefore, the bank filed proofs of claim for the amount it was owed under the deed of trust.[viii]  The debtor objected to the bank’s proofs of claims and moved to require the trustee under the deed of trust to distribute the principal and interest due the bank and a second-lien holder and to pay the remaining amount to the debtor pending resolution of the claims against those funds.[ix]  The bankruptcy court ruled that (1) the second-lien holder was entitled to be paid in full, (2) the bank was entitled to full payment except for the attorneys’ fees because the bank did not file the “proper application for [the] fees” and “provided no supporting documentation or testimony that the fees were reasonable”[x] under section 506(b),[xi] and (3) the trustee was entitled to a fee in the amount equal to twenty hours at her hourly rate instead of five percent of the total sale price.[xii]  On appeal, “[t]he district court remanded ‘for further proceedings with instructions that [trustee] disburse the foreclosure-sale proceeds in accordance with Texas law and the [d]eed of [t]rust.’”[xiii]  On appeal to the Fifth Circuit, the bank argued that state law governed its recovery of attorneys’ and other fees from the sale proceeds or, in the alternative, that the attorney fees should be recoverable under section 502.[xiv]  The Fifth Circuit reversed the district court, concluding that “[b]ased on this record, [the court could not] say that the bankruptcy court erred in finding under [section] 506(b) that the amount of attorneys’ fees [the bank] sought [were] not substantiated and therefore [were] not shown to be reasonable.”[xv]  Further, since it was unclear whether the issue had been raised below, the Fifth Circuit remanded the case to the bankruptcy court to determine whether the bank was entitled to an unsecured claim for its attorneys’ fees under section 502.[xvi]

Currently, there is a split among courts as to whether state or federal law governs an oversecured creditor’s claim for attorneys’ fees in bankruptcy.[xvii]  On one hand, the majority of courts have held that federal law—specifically, section 506(b) of the bankruptcy code—preempts state law.[xviii]  Section 506(b) states that an oversecured claimant “shall be allowed . . . any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.”[xix]  Relying on the plain language of section 506(b), the majority courts stress that, unlike other provisions of the Bankruptcy Code, section 506(b) does not direct courts to allow secured claims in accordance with state law.[xx]  Further, the majority of courts maintain that section 506(b)’s legislative history indicates that federal law preempts state law.[xxi]  On the other hand, the minority of courts held that state law governs an oversecured creditor’s claim for attorneys’ fees.  These courts reasoned that state law determines the underlying contractual rights and property rights, even in bankruptcy cases, and therefore, the validity and construction of cost recovery contract clauses must be assessed under state law.[xxii]  Thus, minority courts opine, any contractual indebtedness is “not subject to statutory limitations on reimbursement for expenses of administering the estate.”[xxiii]

In In re 804 Congress, L.L.C., the Fifth Circuit joined the majority of courts and determined that the bankruptcy court did not abuse its discretion by denying the creditor bank’s attorneys’ fees under section 506(b) of the Bankruptcy Code.[xxiv]  First, the Fifth Circuit held that “[section 506(b)] governs what is to be distributed to [an oversecured claimant.]”[xxv]  The Fifth Circuit reasoned that section 506(b) evidenced Congress’s intent to prevent first-priority creditors from “extracting attorneys’ fees in excess of what could legitimately be demanded in a bankruptcy proceeding.”[xxvi]  The Fifth Circuit further reasoned that section 506(b)’s legislative history indicated “‘that [section 506(b)] should govern the enforcement of attorneys’ fees provisions, notwithstanding state law.’”[xxvii]  Second, the Fifth Circuit held that the bankruptcy court could engage in a reasonableness analysis under section 506(b) for attorneys’ fees even if the attorneys’ fees would be valid under state law.[xxviii]  The Fifth Circuit found that section 506(b)’s plain language does not indicate that a fee agreement, enforceable under state law, should be exempt from section 506(b)’s reasonable standard.[xxix]  Therefore, the Fifth Circuit held, the bankruptcy court was within its discretion in determining that the bank did not substantiate its attorneys’ fees and, thus, were unreasonable.[xxx]

In re 804 Congress, L.L.C. is significant because it supports the majority view that federal law governs an oversecured creditor’s attorneys’ fees, which can lead to the oversecured creditor recovering less fees than it would have had state law governed.  In particular, notwithstanding state law, section 506(b) requires that any contract clauses regarding fees, costs, and charges must be reasonable.  As In re 804 Congress, L.L.C. demonstrates, oversecured creditors should be prepared to demonstrate that any post-petition attorneys’ fees are reasonable, which requires documentation or testimony evidencing the fees’ reasonableness.[xxxi] Accordingly, under the majority rule, since federal law might vary significantly from state law, an oversecured creditor might not be able entitled to a secured claim for its “unreasonable” attorneys’ fees, even though such fees would be recoverable under state law.  That, however, does not necessarily mean that an oversecured creditor will be unable to recover at least some of the  “unreasonable” portion of it attorneys’ fees.  Specifically, although the In re 804 Congress, L.L.C. court did not rule on the issue, even under the majority rule[xxxii], an oversecured creditor may be entitled to an unsecured claim for the “unreasonable” portion of it attorneys’ fees under section 502.[xxxiii]



[i] Wells Fargo Bank v. 804 Cong., L.L.C. (In re 804 Cong., L.L.C.), 756 F.3d 368 (5th Cir. 2014).

[ii] Id. at 371 (“[F]ederal law governs what is to be distributed to a secured claimant that is oversecured.”)

[iii] Id.

[iv] Id. (“[T]o secure the [Real Estate Lien Note], 804 Congress executed a ‘Deed of Trust Security Agreement/Financing Statement’ (the Deed of Trust), which granted Wells Fargo a first priority lien on the property.”)

[v] Id. at n.2

The Deed of Trust directed the trustee to distribute the proceeds of the foreclosure sale in following order, consistent with Texas law: a. expenses of foreclosure, including a commission to Trustee of 5% of the bid; b. to [Wells Fargo], the full amount of principal, interest, attorney's fees, and other charges due and unpaid; c. any amounts required by law to be paid before payment to [804 Congress]; and d. to [804 Congress], any balance.

[vi] Id. at 371.

[vii] Id.

[viii] Id. at 372.

[ix] Id.

[x] Id.

[xi] See 11 U.S.C. 506(b) (2014).

[xii] In re 804 Cong., L.L.C., 756 F.3d at 372.

[xiii] Id. (citation omitted).

[xiv] Id. at 378.

[xv] Id. at 377.

[xvi] Id. at 380.

[xvii] See Welzel v. Advocate Realty Inv. LLC (In re Welzel), 275 F.3d 1308, 1320 (11th Cir. 2001) (holding section 506(b)’s reasonableness standard applied even when contractual attorneys’ fees were enforceable under state law); First W. Bank & Trust v. Drewes (In re Schriock Constr., Inc.), 104 F.3d 200, 202 (8th Cir.1997) (allowing attorneys’ fees under section 506(b) despite state statute expressly stating attorneys’ fees in any debt instrument are void); Blackburn-Bliss Trust v. Hudson Shipbuilders, Inc. (In re Hudson Shipbuilders, Inc.), 794 F.2d 1051 (5th Cir. 1986) (holding federal law governs enforcement of attorneys' fees provisions in secured claims in bankruptcy). But see In re Chateaugay Corp., 150 B.R. 529 (Bankr. S.D.N.Y. 1993) aff'd, 170 B.R. 551 (S.D.N.Y. 1994) (holding state law governs determines whether oversecured creditors were entitled to interest on interest); In re Lagasse, 71 B.R. 551, 554 (Bankr. D. Conn. 1987) (holding state standards applies in determining what constitutes as reasonable attorneys’ fees arising from contract); In re Hart Ski Mfg. Co., 9 B.R. 397, 400 (Bankr. D. Minn. 1981) (holding commercially reasonable standard, not federal standard, applies in determining the reasonableness of attorneys’ fees); In re Minnesota Distillers, Inc., 45 B.R. 131, 136 (Bankr. D. Minn. 1984) (same).

[xviii] Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268, Ltd.), 789 F.2d 674, 675 (9th Cir. 1986) (holding “section 506(b) preempts state law governing availability of attorneys’ fees as part of a secured claim.”).

[xix] 11 U.S.C. 506(b).

[xx] In re Schriock Constr., 104 F.3d at 202 (“Section 506(b) itself does not direct us to state law.”); In re Ctr., 282 B.R. 561, 566 (Bankr. D.N.H. 2002) (“Section 506(b) makes no reference to state law.”)

[xxi] In re 268 Ltd., 789 F.2d at 676 (“Section 506(b)'s legislative history also favors reading the statute as preempting the state law governing the reasonableness of fee provisions.”)

[xxii] In re United Merchants & Mfrs., Inc., 674 F.2d 134, 139 (2d Cir. 1982) (“The Court recognized that ‘(t)he validity and construction of the (contract clause providing for recovery of costs) must …  be judged according to (state) law….’” (quoting In re Cont'l Vending Mach. Corp., 543 F.2d 986, 993 (2d Cir. 1976))).

[xxiii] Id.

[xxiv] In re 804 Cong., L.L.C., 756 F.3d at 377.

[xxv] Id. at 373.

[xxvi] Id. at 374.

[xxvii] Id. at 374 (quoting In re Hudson Shipbuilders, Inc., 794 F.2d at 1056).

[xxviii] Id. at 376.

[xxix] Id. (citation omitted)

[xxx] Id. at 377 (“[T]he bankruptcy court was within its discretion in finding that there was no documentation of the time that was spent and no testimony as to what was a reasonable fee.”).

[xxxi] Id. at 372 (suggesting proper applications for attorneys’ fees and supporting documentation and testimony will evidence reasonableness under section 506(b)).

[xxxii] Id. at 378 (“Several courts have concluded that § 506(b) deals with the priority of secured claims, not allowance of claims.44 These same courts have indicated that certain claims for amounts found not to be reasonable under § 506(b) may be recoverable under § 502.”).

[xxxiii] See 11 U.S.C. 502 (2012). Section 502 indicates that a claim filed under section 501 the Bankruptcy Code is deemed allowed unless a party of interest objects. If an objection arises, section 502 shall allow that claim unless the claim meets one of the exceptions enumerated in section 502(b).