In re Penrod, ___F.3d ___, 2015 Westlaw 5730425 (9th Cir. 2015)
In re Penrod, ___F.3d ___, 2015 Westlaw 5730425 (9th Cir. 2015): The Ninth Circuit has held that a Chapter 13 debtor was entitled to recover $245,000 in fees from a secured lender because she defeated a $7,000 portion of the lender’s claim. [.]
FACTS: A consumer borrowed $32,000 to buy a car worth $25,000. The difference ($7000) was used to pay off the “negative equity” in her old vehicle. Less than two years later, she filed a Chapter 13 petition. The lender asserted a secured claim for $26,000, the amount she still owed on the loan. The debtor proposed a Chapter 13 plan that bifurcated the lender’s claim into a secured claim for the value of the car and an unsecured claim for the “negative equity.”
The lender argued that its entire claim should be treated as a "purchase-money security interest" and should therefore be viewed as a secured claim. Construing the infamous "hanging paragraph" of 11 U.S.C.A. § 1325(a), the bankruptcy court ruled that the lender’s claim was "purchase-money" only to the extent of the value of the car ($19,000) and was unsecured for the balance ($7,000) because the "negative equity" could not be included in the purchase-money characterization. Eventually, that ruling was affirmed by the BAP and then by the Ninth Circuit.
Having prevailed on that issue, the debtor then sought to recover $245,000 in attorney’s fees from the lender, citing California Civil Code §1717, which transmutes unilateral fee clauses into reciprocal fee clauses for actions based on a contract. The clause contained in the lender’s documentation stated: "You will pay our reasonable costs to collect what you owe, including attorney fees, court costs, collection agency fees, and fees paid for other reasonable collection efforts." But the bankruptcy court held that she could not collect her fees because she had not prevailed on the contract per se, since her success against the lender had turned on a question of federal bankruptcy law, rather than on an interpretation of the contract or on state law. The district court affirmed.
REASONING: The Ninth Circuit reversed, holding that her victory was indeed "on the contract" for purposes of § 1717 because the lender was seeking to enforce the contract against her:
[The lender] sought to enforce the provisions of its contract with [the debtor] when it objected to confirmation of her proposed Chapter 13 plan. The plan treated [the lender’s] claim as only partially secured, but [the lender] insisted that it was entitled to have its claim treated as fully secured. The only possible source of that asserted right was the contract—in particular, the provision in which [the debtor] granted a security interest in her [new car] to secure "payment of all you owe on this contract." (Had the contract not granted [the lender] a security interest in the car, [the lender] could not have asserted a secured claim for any amount . . . .) The security interest conveyed by the contract covered not just the funds [the debtor] borrowed to pay for the [new car], but also the funds she borrowed to refinance the negative equity in [her old car]. The sole issue in the hanging-paragraph litigation was whether this provision of the contract should be enforced according to its terms, or whether its enforceability was limited by bankruptcy law to exclude the negative-equity portion of the loan . . . . By prevailing in that litigation, [the debtor] obtained a ruling that precluded [the lender] from fully enforcing the terms of the contract.
Citing Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. 443, 127 S.Ct. 1199, 167 L.Ed.2d 178 (2007), the court noted that contractual fee clauses can be enforced in bankruptcy, even where the issues litigated are questions of federal law, rather than state law or factual issues. Further, under §1717, fees can be awarded even if the outcome depends on purely legal issues:
Nothing in the text of § 1717 limits its application to actions in which the court is required to resolve disputed factual issues relating to the contract. A party who obtains (or defeats) enforcement of a contract on purely legal grounds, as by prevailing on a motion to dismiss with prejudice or by showing that a defendant’s contract-based defenses are barred by federal statute or federal common law, still prevails in an action "on a contract."
The court concluded its analysis by noting that the lender could have recovered its fees if it had prevailed, thus justifying a reciprocal recovery by the prevailing debtor:
The contract included—no doubt for [the lender’s]—an attorney’s fees provision quite broad in scope. The provision was not limited, for example, to actions to determine whether the terms of the contract had been breached. It instead stated that, in the event of default, [the debtor] would be obligated to pay the reasonable attorney’s fees [the lender] incurred in attempting "to collect what you owe." That provision encompasses [the lender’s] efforts . . . to establish that it held a fully secured rather than a partially secured claim. AmeriCredit wanted to prevail on that issue to ensure that it would collect 100% of what it was owed on the loan. [The lender] had no reason to litigate that issue other than as part of an attempt to collect from [the debtor] what she owed. Whether [the lender] actually would have sought attorney’s fees had it prevailed (something it denies) is immaterial. What matters is whether it could have sought fees under the contract, and here it could indeed have done so.
COMMENT: Note that the Supreme Court’s Travelers decision, cited by the circuit court, was nominally a victory for creditors. (For a discussion of that case, see 2007 Comm. Fin. News. 23, Unsecured Creditor May Claim Contractual Attorney’s Fees Even Though Litigation Involves Purely Bankruptcy-Related Issues.) But many commentators (including myself) noted that Travelers was really a disguised defeat for creditors. This is from my 2007 discussion of that case:
In California, and in other states with reciprocal fee statutes such as Civil Code §1717, the decision in this case may result in an ironic result when the creditor is not the prevailing party in the bankruptcy litigation. Since the creditor would have been entitled to a fee award under the contractual fee provision, the debtor (as the prevailing party) should be able to invoke the reciprocal fee statute to obtain recovery from the creditor. The irony, of course, is that although the creditor’s unsecured fee claim against the debtor would have been worth very little in most cases, the debtor’s fee claim against the creditor will often be fully recoverable. In other words, if I am reading this opinion correctly, the real benefit of this opinion will flow to debtors, not to creditors.
As predicted, we now have the result in Penrod: the lender that unsuccessfully litigated a $7,000 claim is hit with a §1717 fee award of $245,000. As predicted, the rule in Travelers is not a two-edged sword. It is a sword with one sharp edge and one dull edge. If the creditor prevails, the fee clause is almost useless, since the debtor cannot pay the fees. If the debtor prevails, the creditor has to pay in real dollars.
I have long urged that it does not make sense for creditors to include broad contractual attorney’s fee clauses that encompass fees incurred during bankruptcy proceedings. The only possible exception is in a commercial lending context when the lender is absolutely certain that it will be unassailably perfected and amply oversecured, if and when the borrower files a bankruptcy petition. And in the wake of the 2008 “mortgage meltdown,” can anyone ever be certain of oversecured status?
For discussions of related issues, see 2015-30 Comm. Fin. News. NL 61, Debtor Receives Award of Attorney’s Fees After Defeating Lender’s Motion for Relief from Stay, Even Though Debtor is Not a Signatory to Loan Documents Containing Fee Clause, and 2015-15 Comm. Fin. News. NL 30, Secured Creditor’s Successful Defense Against Avoidance Claims Constitutes "Enforcement" of Loan Agreements Under Attorneys’ Fee Clause.
For a discussion of an earlier opinion in the Penrod saga, see 2008 Comm. Fin. News. 85, "Negative Equity" Does Not Destroy Purchase Money Status of Automobile Loan Under "Dual Status" Rule, but "Negative Equity" Cannot Enlarge Secured Claim of Purchase-Money Lender.
Foregoing analysis is as reported in 10/20/15 e-newsletter of California State Bar Business Law Section Insolvency Law Committee.