Business Law

BAP rules contract language sufficient to permit award of attorneys’ fees to debtor for defending Section 523(a)(2) action

The following is a case update analyzing a recent case of interest:

SUMMARY

In In re Davis, (unpublished), No. 18-1326, 2019 WL 2931668, 2019 Bankr. LEXIS 2044 (9th Cir. BAP July 3, 2019) the U.S. Bankruptcy Appellate Panel of the Ninth Circuit ruled that generic language in a contract may be sufficient to permit a bankruptcy court to award attorneys fees to the debtor for successful defense of a Section 523(a)(2) action.

To read the published decision, click here.

FACTS

Creditor Asphalt Professionals, Inc. (“API”), a general engineering contractor, sued the debtor, Darin Davis, a property developer, and certain of his corporations in state court for breach of contract and fraud, alleging also that Davis was the alter ego of his corporations.  The Debtor individually, was not a party to the contract.  During the five years of litigation, the debtor filed chapter 7.  The bankruptcy court granted relief from stay to allow the state court litigation to continue.  Ultimately the state court awarded API judgment against the corporate entities for breach of contract and found that the debtor was indeed the alter ego of his entities.  It did not rule on fraud.  Judgment in favor of API for $318,000 was entered, plus $1.5 million for attorney’s fees.   

 API filed a non-dischargeability complaint in the chapter 7 case alleging fraud under Section 523(a)(2)(A).  It also sought denial of the discharge under Section 727 alleging  that the debtor “made false and misleading statements concerning his assets in his bankruptcy schedules and statement of financial affairs . . . ” 

The bankruptcy court first conducted trial on the Section 727 issues and ruled in favor of the debtor.  It then conducted trial on the fraud allegations under Section 523(a)(2)(A) and again ruled for the debtor.  Both rulings were later affirmed by the BAP. 

Following these rulings the debtor requested attorney’s fees of $153,913.89 under California Civil Code (“CCC”) Section 1717 and California Code of Civil Procedure (“CCP”) Section 1021 for defending the adversary proceedings.  The debtor pointed to language in the contract between API and various of his corporations that provided for attorney’s fees, as follows: “In the event that [the debtor’s entity] prevails in any . . . court action arising out of this Agreement or the enforcement or breach thereof, or in any action brought against API by third parties in which [the debtor’s entity] is joined as a party or interpleads, whether the same proceeds to judgment or not, [API] agrees to pay [the debtor’s entity] reasonable attorneys’ fees.  In the event that [API] prevails . . . , [the debtor’s entity] agrees to pay [API] reasonable attorneys’ fees.”   API opposed the motion arguing that it had prevailed in the state court action and therefore the debtor was not the prevailing party “under the contract.”  It also argued that the debtor was not a party to the contract in any event and therefore the contractual provision did not apply.   

The bankruptcy court agreed with the debtor and awarded him $91,390.92 in fees and $956.87 in costs.  It did not award any fees attributable to the Section 727 action. 

REASONING  

Agreeing with the bankruptcy court, the BAP ruled that CCP Section 1717 did not apply because the action in bankruptcy court was not “on the contract.”  The court found, however, that CCP Section 1021 “permits recovery of attorney’s fees by agreement, for tort as well as contract actions,” citing Santisas v. Goodin, 17 Cal. 4th 599, 608 (1998) (quoting Xuereb v. Marcus & Millichap, Inc., 3 Cal. App. 4th 1338, 1341 (1992)).  The BAP ruled that the language “in any court action” included an action for fraud and thus CCP Section 1021 applied.

Further, CCP Section 1032(b) provides “a prevailing party is entitled as a matter of right to recover costs in any action or proceeding.”  “Costs” include “Attorney’s fees, when authorized by . . . Contract.”  CCP Section 1033.5(a)(10).   The debtor prevailed and therefore had the right to his costs which under CCP Section 1033.5(a)(10) included attorney’s fees, since attorney’s fees were “authorized by the contract.”  As to authority, the BAP cited the California Supreme Court:

California Code of Civil Procedure section 1021 provides that, except where specifically provided by statute, parties are free to enter their own agreements regarding payment of fees.  Similarly, a prevailing party may ordinarily recover “costs,” §§ 1021 and 1032(b), and parties may contractually designate fees as recoverable costs, § 1033.5(a)(10).  Pursuant to these provisions, “[p]arties may validly agree that the prevailing party will be awarded attorney fees incurred in any litigation between themselves, whether such litigation sounds in tort or in contract.”  Santisas v. Goodin, 17 Cal. 4th 599 (1998)

Further, following state precedence, the BAP ruled that although the debtor was not a party to the contracts on their face, the state court found him to be the alter ego of the corporations and, therefore, he was a “party to the contracts” for these purposes.  The court noted also that API argued everywhere in state court that the debtor was a party because of the alter ego allegations and therefore it was judicially estopped from arguing otherwise now.    

API had a number of other objections to the fee request, including that the fees were not reasonable, they may have been paid by someone else, and they included fees for related matters and parties.  Judge Kaufman painstakingly removed the fees related to the Section 727 portion of the litigation and, with a few other adjustments, determined that $91,390.92 in fees and $956.87 in costs were appropriate.   The BAP agreed. 

AUTHOR’S COMMENTARY 

In this author’s opinion, the ruling really changes the landscape respecting awards of attorney’s fees.  It is a little surprising, given the generic language in the contract and that there has been a huge reluctance to give the debtor attorney’s fees in successful Section 523 actions, at least for fraud.  In the trial court proceeding, the debtor also “joined” the trustee’s objection to the API proof of claim and Judge Kaufman awarded the debtor $27,000 in additional fees for those successful efforts, based on the same contractual language.  The fees for the appeals have not yet been requested but are certainly coming.  As expected, API has appealed the BAP affirmation to the U.S. Court of Appeals for the Ninth Circuit. 

These materials were written by M. Jonathan Hayes of Resnik Hayes Moradi LLP in Los Angeles (jhayes@rhmfirm.com).  Editorial contributions were provided by Hon. Meredith Jury, United States Bankruptcy Judge, C.D. Cal. Ret. (majury470@gmail.com).  Mr. Hayes and Judge Jury are members of the Insolvency Law Committee.

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