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The U.S. Supreme Court’s March decision allowing unsecured creditors to collect attorney fees in bankruptcy left questions about just how far the ruling reaches into the bankruptcy debtors’ pockets for attorney fees arising from a prebankruptcy contract. The opinion was a wake-up call to attorneys who draft contracts to be more specific about providing for fee recovery should debtors someday file for bankruptcy. And until lower courts sort out the breadth of the decision, it is likely to result in more work for bankruptcy lawyers. The first chance to address the unanswered statutory questions from the March ruling comes later this year, when the 9th U.S. Circuit Court of Appeals will hear arguments in the closely watched remand from the U.S. Supreme Court in Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 127 S. Ct. 1199. High stakes The Travelers ruling allows recovery of attorney fees for legal work done during bankruptcy litigation arising from a contract reached before the bankruptcy filing. That already has creditors’ lawyers advising clients to include claims for lawyer fees from debtors. On the horizon is the likelihood that creditors will employ more lawyers more frequently to monitor and defend their claims aggressively in high-end corporate cases. For creditors, “clearly the calculus of whether to spend the next dollar will change because they will get a refund, so the stakes are high,” said Joshua Rosencrantz, an attorney in the New York office of Heller Ehrman who represents Pacific Gas & Electric (PG&E) in Travelers. Traditionally, unsecured creditors are at the bottom of the bankruptcy food chain, receiving pennies for every dollar in pro rata shares of the debtor’s assets in reorganization. At the top of the heap, those paid in full, are the trustees and lawyers reorganizing the debtor, followed by creditors whose money is secured by real estate, equipment or other assets. By leaving open a significant question about the full scope of its ruling, the high court has prompted bankruptcy specialists to advise corporate clients to tack onto their bankruptcy claims a bill for attorney fees incurred in the course of defending their claims. At stake is a greater use of lawyers by well-heeled and powerful creditors to defend their claims, while smaller mom-and-pop businesses will simply have to hope for a reasonable share of the pie. “It will be either the age-old rule � all creditors are treated the same � that remains the rule, or there is a preferred class of unsecured creditors who get to bloat their claims by tacking on attorney fees,” said Heller’s Rosencrantz. Eric Brunstad, a Travelers’ attorney in the Hartford, Conn., office of Bingham McCutchen, countered, “Contractual rights to attorney fees are defined by state law, not federal law. Why should large companies, like PG&E, be able to shed themselves of contractual obligations?” he asked. If there is not enough to pay unsecured creditors in full they get pro rata shares and that would apply to contractual claims by lawyers as well, he said. Travelers is not asserting that it has the same priority claims as secured creditors, only that it should be allowed to recover attorney fees when it defends its rights in bankruptcy, he said. Matter of state law? The insurance industry weighed in on the issue as well, arguing that whether a creditor’s claim should be honored from a pre-existing contract is a matter of state law governing the contracts. This has significance because of the potential that corporate policyholders with mass tort liability will seek bankruptcy protection, rather than submitting liability questions to a state court system, according to Craig Goldblatt, attorney who provided an amicus brief for the American Insurance Association in the Supreme Court case. Goldblatt said there are currently tort claims cases pending in the 3d Circuit that may be affected by the outcome. “It is not unfair to say that the stakes for the insurance industry, where insureds are driven into bankruptcy on account of asbestos liability, is billions of dollars,” said Goldblatt of Wilmer Cutler Pickering Hale and Dorr’s Washington office. Travelers issued unsecured surety bonds to PG&E for $100 million to cover any potential default on workers’ compensation payments. Included in the pact was Travelers’ right to recover attorney fees if PG&E filed for bankruptcy. In April 2001, PG&E filed a record-breaking $9 billion utility bankruptcy in the wake of energy-market manipulations that set off the California energy crisis. Ultimately, the solvent PG&E reorganized with agreements to pay all creditors in full, with interest. During the bankruptcy proceedings, Travelers filed a protective claim against the potential default on its bond and included attorney fees of $167,000 incurred during the bankruptcy disputes, even though Travelers suffered no losses and PG&E did not default on any payments. “In the world according to Travelers, an unsecured creditor gets to collect fees for a claim worth zero,” said Rosencrantz. “So Travelers had no claim but spent $167,000 on attorney fees. One million dollars later, they are still fighting this. If that is the shape of things to come, we can expect all contractual creditors to behave the same way,” he said. Law Professor Lynn Lopucki of University of California at Los Angeles School of Law said: “Every time the Supreme Court comes into the world of bankruptcy . . . they leave the bankruptcy world puzzled. The Travelers case is a classic example of that.” The Supreme Court “literally answered a question they were not asked. They don’t know how the system works,” he said. Lopucki also warned against overestimating the magnitude of costs. He said that in the majority of business reorganizations, unlike in the Travelers case, unsecured creditors receive pennies on the dollar. Piling on attorney fees, if only a fraction will be repaid, is imprudent. The Travelers case, with full repayment, allows for intense litigation of the issue because “real money” is involved, not pro rata shares, he said. The Supreme Court’s decision sided with the 4th Circuit against the 9th, and held that claims against a debtor are allowed unless the claim falls under one of nine expressly defined exceptions in Section 502(b) of the Bankruptcy Code. It found no support in the code for the 9th Circuit’s holding that contract-based attorney fees incurred solely litigating bankruptcy issues were disallowed. But the Supreme Court’s decision was not an open-ended invitation to seek attorney fees by unsecured creditors. When the 9th Circuit re-examines the case on remand, it must look at questions the Supreme Court declined to consider because PG&E failed to raise them. The 9th Circuit must decide whether Section 506(b) of the code, which specifically authorizes claims for contractual attorney fees by oversecured creditors, prohibits recovery by unsecured Travelers. Because 506(b) omits any reference to unsecured creditors, does that amount to a categorical denial of Travelers’ right to claim the fees? The court must also decide if Travelers’ attorney costs were reasonable in protecting its rights and how to interpret the statute, given the Supreme Court’s guidance. “It really boils down to what it is the Bankruptcy Code is designed to do,” said Rosencrantz. “In our view, Congress singled out only one group, the oversecured creditor,” as having rights to collect attorney fees.

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