On January 17, 2007, we wrote about the case of Travelers Casualty and Surety Co. v. Pacific Gas and Electric Co., 549 U.S. ___ (2007), which was argued before the U.S. Supreme Court on January 16. The Supreme Court issued an opinion on the matter today and held that the Court of Appeals for the Ninth Circuit erred in disallowing claims of Travelers for attorney’s fees.

As we wrote previously, Travelers filed an unsecured claim in the PG&E bankruptcy to recover attorney fees sustained in litigation concerning agreements between Travelers and PG&E. In a pre-bankruptcy agreement between the two, Travelers had negotiated for the right to collect attorney’s fees in enforcing its rights. In order to protect its rights, Travelers had objected to PG&E’s plan of reorganization and a disclosure statement. Following this claims objection, Travelers filed a claim seeking attorney’s fees for the related litigation. The Bankruptcy Court granted the objection to the claim based on the Fobian rule which disallows attorney’s fees for issues litigated as purely federal bankruptcy issues rather than contract issues. See In re Fobian, 951 F.2d 1149 (9th Cir. 1991) which held that “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 District Court and the Court of Appeals for the 9th Circuit affirmed the Bankruptcy Court’s decision. The Supreme Court reversed that decision and by its ruling, threw out the Fobian rule.

Justice Alito delivered the opinion of the unanimous court. The case required the Court to consider whether the Bankruptcy Code disallows contract based claims for attorney’s fees based solely on the fact that the fees were incurred litigating issues of bankruptcy law.

The Court stated that while the prevailing litigant is ordinarily not entitled to collect attorney’s fees, this can be overcome by statute or an enforceable contract which specifically allows it. The Court looked to the Bankruptcy Code definition of a claim, which is a “right to payment” against the debtor’s estate. 11 U.S.C. §105(5)(A). The Court said that once a proof of claim is filed, the court must determine whether the claim is allowed under section 502 of the Code. Under section 502, a claim is deemed allowed unless a party in interest objects.

The Court then went further and said that even if a party in interest objects, the court “shall allow” the claim except to the extent that the claim implicates any of the nine exceptions to allowable claims under section 502(b). The Court found that none of the exceptions under section 502(b)(2) - (9) applied and focused solely on section 502(b)(1) which disallows any claim that is “unenforceable against the debtor and property of the debtor, under any agreement or applicable law for a reason other than because such claim is contingent or unmatured.”

The Court said that the basic federal rule in bankruptcy is that “state law governs the substance of claims” or that when the Bankruptcy Code uses the word claim, it usually refers to a right to payment recognized under state law. The Court said that the Court of Appeals did not conclude that Travelers’ claim was unenforceable under section 502(b)(1) as a matter of applicable nonbankruptcy law, nor did it conclude that the claim was rendered unenforceable by any provision of the Code. The Court said that the Ninth Circuit denied Travelers’ claim solely on the Fobian rule.

The Court said that the Court of Appeals erred in denying the claim solely on the Fobian rule, which was a rule of the 9th Circuit’s own creation. The Court further says that the Fobian rule has no support in the Bankruptcy Code and states “[t]he absence of textual support is fatal for the Fobian rule.” The Court further states that claims which are enforceable under applicable state law are presumed to be allowed in bankruptcy unless expressly disallowed. The Court struck down the Fobian rule, vacated the judgement of the Ninth Circuit Appeals Court and remanded for further proceedings consistent with its opinion.

Ray

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