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WASHINGTON — Resolving a close split among the federal courts of appeals, the U.S. Supreme Court on March 27 held that federal bankruptcy law does not prevent claims for attorney fees incurred by creditors in the litigation of bankruptcy issues. A unanimous high court, led by Justice Samuel A. Alito Jr, rejected the so-called Fobian rule of the 9th U.S. Circuit Court of Appeals, 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.” Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., No. 05-1429. The circuits had split 5-4 on the fee issue, with the 9th Circuit in the minority, according to bankruptcy scholar and litigator G. Eric Brunstad Jr., partner in the Hartford, Conn., office of Bingham McCutchen, who represented the winning party, Travelers Casualty & Surety Co. of America. “Here the 9th Circuit had created this categorical rule, but the Supreme Court said the Bankruptcy Code doesn’t say that,” said Brunstad, who teaches bankruptcy law at Yale Law School and has argued five high court cases. “It’s an important structural decision about what is the right role of federal courts. The Supreme Court is reinforcing the principle that the courts should not be creating these rules. It’s up to Congress.” Travelers had issued a $100 million surety bond on behalf of Pacific Gas & Electric Co. (PG&E) to the California Department of Industrial Relations, guaranteeing PG&E’s payment of state workers’ compensation benefits. In connection with the bond, PG&E executed indemnity agreements in favor of Travelers, including an agreement to pay attorney fees incurred in protecting Travelers’ rights. After PG&E filed for Chapter 11 bankruptcy, Travelers asserted a claim in the bankruptcy action to protect itself in case PG&E defaulted. Protective language was inserted into the reorganization plan and disclosure statement, but more litigation ensued over the negotiated language. When Travelers filed a claim for fees, PG&E objected, citing the Fobian rule. ‘Fatal’ to rule Justice Alito said the absence of any support in the code’s text was “fatal” to the Fobian rule. “Consistent with our prior statements regarding creditors’ entitlements in bankruptcy, we generally presume that claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed,” he wrote. Brunstad said, “Often in bankruptcy, creditors don’t bother to assert claims for attorney’s fees even though contracts give them that right. Often it’s not worth it. Distributions in bankruptcy are low. But in cases like this one it is worth it.” But PG&E’s counsel, E. Joshua Rosenkranz, a partner at Heller Ehrman, said the 9th Circuit rule was consistent with congressional intent. “Congress wanted unsecured creditors themselves to be getting equal shares of the pie and it did not want the most powerful creditors to be paying their lawyers out of the hides of all the other unsecured creditors,” he said.

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