The following is a case update written by Dean T. Kirby, Jr. a member of the firm of Kirby & McGuinn, A P.C., analyzing a recent decision of interest:
A California bankruptcy court has awarded $605,937.40 in attorneys’ fees to a Chapter 11 debtor which prevailed in a fiercely contested motion to assume a commercial real property lease. The case is In re Hawkeye Entertainment, LLC, 2021 WL 665734 (Bankr. C.D. Cal. February 19, 2021). In a detailed opinion, the Court analyzed both the attorney fee provision and California Civil Code section 1717, which operates to make recovery of attorney fees a reciprocal remedy between landlord and tenant.
A copy of the opinion may be found here.
The Debtor, Hawkeye Entertainment, is the tenant under a lease of the first four floors of the Pacific Stock Exchange Building in downtown Los Angeles. The lease dates from 2009, and Hawkeye filed its first Chapter 11 petition in 2013. A motion to assume the lease in that first bankruptcy was resolved by a settlement agreement. Ownership of the building later changed hands, and there were ongoing disputes between the Debtor and its new landlord, culminating in the service of a three day notice to quit. In response, the Debtor filed its second Chapter 11 petition, followed by a motion to assume the lease.
While the assumption motion was pending, the Debtor filed a series of motions, all of which were opposed by the landlord, and all of which were granted. These included motions: (1) to authorize the Debtor to hold rent payments in trust pending the resolution of the assumption motion; (2) to authorize the use of the leased premises for religious service events; (3) to authorize post-petition financing; and (4) to authorize the use of the leased premises for virtual music events and film shoots.
The Debtor contended that it was not in default under the Lease in the first place. The motion also sought permission to modify an existing sublease. The landlord contended that a default existed, claimed that the Debtor had not offered adequate assurance of future performance, and claimed that the sublease was prohibited under its lease. After a lengthy period of discovery, the Bankruptcy Judge Maureen Tighe conducted a five day trial. Judge Tighe granted the motion, finding that there was no default under the lease.
The Debtor then filed a motion seeking an award of $813,531.97 in attorney fees, based upon a lease provision stating in part that “[i]n the event that … either Landlord or Tenant shall institute any action or proceeding against the other relating to the provisions of this Lease or any default hereunder, the party not prevailing in such action or proceeding shall reimburse the prevailing party for its actual attorneys’ fees . . . .” The Court found that the Debtor was not entitled to recover fees incurred in making the four motions listed above, even though each of these was opposed by the landlord. The Court further reduced the fees incurred in relation to the assumption motion. An addendum is attached to the opinion which itemizes $207,179.50 in disallowed fees. The Court awarded $605,937.40 in fees to the Debtor.
The opinion addresses two primary legal questions: (1) was there an “action or proceeding” by one party against the other, within the meaning of the lease’s attorney fee provision; and (2) was the action or proceeding “on a contract” within the meaning of California Civil Code section 1717(a). That section provides in part that “[i]n any action on a contract, where the contract specifically provides that attorney’s fees and costs, which are incurred to enforce that contract, shall be awarded . . . to the prevailing party, then the party who is determined to be the party prevailing on the contract . . . shall be entitled to reasonable attorney’s fees . . . .”
The Court first concluded that the notice of default and the eviction notices served on the Debtor pre-petition did not commence an “action or proceeding.” The Court then held that although the bankruptcy petition did commence a “proceeding” it was not a proceeding “against the other [i.e., the landlord]” within the meaning of the attorney fee clause. The Court concluded that only the Debtor’s motion to assume the lease was a legal proceeding to which the attorney fee provision applied.
The opinion cites Penrod v. AmeriCredit Financial Services, Inc., 802 F.3d 1084 (9th Cir. 2015), in which the Ninth Circuit upheld an award of fees to a debtor who had successfully overcome creditor objections to a Chapter 13 plan, and noted that Penrod was distinguished in a later Ninth Circuit case, Bos v. Bd. of Trustees, 818 F. 3d 486, 488 (9th Cir. 2016). In Bos, a creditor was denied attorney fees after successfully prosecuting a non-dischargeability action brought under 11 U.S.C. §523(a)(4), proving that the debt arose from “fraud or defalcation while acting in a fiduciary capacity . . ..” The Court concluded that “the distinguishing factor is not the specific relief sought in the bankruptcy action but to what extent contract enforceability determines the outcome of the issue under the Bankruptcy Code . . .. Even if the proceeding is under the rubric of a bankruptcy procedure, the critical question may be to consider how to enforce a contract rather than considerations unique to bankruptcy.”
The Court went on to consider whether the Debtor’s motion to assume the lease was “on a contract” within the meaning of Civil Code section 1717. The Court noted that the question of whether an action is “on a contract” is liberally construed by California courts, such that “so long as a dispute ‘involves’ a contract, or ‘arises out of, is based upon, or relates to an agreement by seeking to define or interpret its terms or to determine or enforce a party’s rights or duties under the agreement,” the dispute is an action ‘on a contract’ for purposes of section 1717.
In Nighthawk, the primary issue in the assumption motion was whether a default under the lease existed in the first place. The opinion does not expressly state this, but a review of the papers filed on the docket shows that the primary asserted defaults were the (allegedly prohibited) use of the leased premises for religious services and filming, and the (allegedly unauthorized) sublease. Since the terms of the lease were at the core of the assumption dispute, the Court concluded that it had been called upon primarily to decide the same issues as would have been decided in a state court unlawful detainer dispute. Thus, the assumption motion should be deemed to be an action or proceeding “on the contract.”
However, the Court concluded, the motions brought by the Debtor to obtain permission to hold religious services and filming during the bankruptcy case were not proceedings “on the contract” because they related “more to the global concerns of administering the bankruptcy estate.”
One could question the Court’s refusal to award fees to the Debtor for prevailing in its motions for permission to hold religious services and to use the premises for filming, which were both opposed by the landlord. Both these motions, and the assumption motion, involved the primary question of whether these activities were prohibited by the lease.
The Court labored unnecessarily on the question of whether the assumption motion was an action “on the contract” within the meaning of Civil Code section 1717. Its conclusions on that issue are dicta. The function of section 1717 is to turn unilateral attorney fee clauses, for example one which provides only that the landlord could recover attorney fees, into reciprocal provisions, in which either landlord or tenant could recover fees if they prevailed. The above-quoted attorney fee provision in the Nighthawk lease was already reciprocal. There was no need to invoke section 1717.
When it came to the assumption motion itself, the Court did not attempt to separate fees incurred in litigating state law contract issues from the bankruptcy law issues involved in the assumption motion. At least in theory that might have been possible. For example, the Court noted that the issue of “adequate assurance of future performance,” a prerequisite for assumption under 11 U.S.C. §365(b)(1)(A), was contested by the landlord. The docket makes clear that substantial legal resources were consumed by this issue, which involved a discrete set of facts. The Court did not attempt to cull out those legal fees devoted to contesting what might be regarded as an issue arising only in bankruptcy law. It simply held that the adequate assurance issue was moot where the lease was not in default and no cure was necessary.
How would the Court have awarded fees if, for example, a default in the payment of rent had existed on the date of the assumption motion, and the “adequate assurance” issue was a primary focus? How would fees have been allocated if the Court had found that the Debtor had engaged in prohibited activities on the leased premises but approved the Debtor’s offer to cure those breaches going forward? What if the motion was for assumption and assignment, contrary to the lease provisions but permitted under the 11 U.S.C. §365(f)? Questions like this will continue to arise, and not only in the context of assumption motions. The winner in those attorney fee arguments will be entitled to . . . more attorney fees. The decision in Nighthawk is currently on appeal, and the opinion recognized that a supplemental attorney fee motion was expected.
These materials were written by Dean T. Kirby, Jr. a member of the firm of Kirby & McGuinn, A P.C., located in San Diego, California. Mr. Kirby is a member of the ad hoc group and a member of the Commercial Transactions Committee of the Business Law Section. Editorial contributions were made by the Honorable Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.