Petard Principle: How Creditors’ Fee Clauses Can Backfire in Bankruptcy

The following is a case update written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, analyzing In re De Guzman, 670 B.R. 567  (Bankr. E.D. Cal. June 9, 2025), a recent case of interest:

Summary

In In re De Guzman, the bankruptcy court held that a creditor’s failure to explicitly reference underlying contracts in a nondischargeability action involving those contracts did not circumvent California’s fee-shifting statute, Civil Code Section 1717. The court subsequently awarded the successful debtor attorney’s fees under that statute. This decision underscores the broad applicability of Section 1717 even within bankruptcy proceedings.

Read the full published decision today.

Facts

In 2019, Junder Joe Basbas De Guzman (“Debtor”) and Elmar Sibayan (“Creditor”), both 50 percent shareholders of a shared home healthcare business, entered into a business agreement.

Disputes arising from the operation of the business led to a negotiated Shareholder Buyout Agreement (“SBA”) in 2021. Under the SBA, Debtor agreed to pay Creditor $275,000: $137,500 in cash and $137,500 secured by a promissory note (“Note”) and deed of trust (“DOT”) on Debtor’s residence. The SBA stipulated that the escrow agent would not record the DOT until Debtor paid the cash portion.

Due to delays stemming from Debtor’s refinancing and subsequent acquisition of other secured debt, the DOT remained unrecorded for more than one year. In the interim, Debtor obtained a $39,400 home equity line of credit on December 15, 2022, as to which a deed of trust was recorded on January 9, 2023.  This further complicated Creditor’s security position as that deed of trust was recorded prior to the DOT, ultimately resulting in Creditor being under-secured. Creditor subsequently initiated foreclosure proceedings against Debtor after he defaulted on the Note.

In 2023, Debtor and his wife filed for Chapter 7 bankruptcy to halt the foreclosure. Creditor then initiated an Adversary Proceeding seeking to declare the debt non-dischargeable under Sections 523(a)(2) and (a)(6) of the Bankruptcy Code, alleging fraud and willful misconduct related to the delayed DOT recording.

Both the Note and DOT contained attorney’s fee provisions pursuant to California Civil Code § 1717 (“Section 1717”), which allows for the prevailing party to recover reasonable attorney fees.

Debtor prevailed in the Adversary Proceeding, with the bankruptcy court finding insufficient evidence of fraud or “malice” to support Creditor’s nondischargeability claims. As the prevailing party, Debtor then sought an award of attorney’s fees pursuant to § 1717, seeking reciprocal attorney fees. In opposition, Creditor contended that the nondischargeability action did not constitute an “action on a contract,” asserting that it solely relied on allegations of fraud and willful misconduct, thus excluding § 1717’s application. The bankruptcy court rejected this argument, awarding Debtor $19,514.40 in attorney fees.

Reasoning

Reciprocal Application of Fee Provisions

As this was a dispute regarding California Civil Code Section 1717, the bankruptcy court started with the statute.  California Civil Code Section 1717(a) provides in relevant part (emphasis added):

In 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 either to one of the parties or to the prevailing party, then the party who is determined to be the party prevailing on the contract, whether he or she is the party specified in the contract or not, shall be entitled to reasonable attorney’s fees in addition to other costs.

The bankruptcy court explained that the law makes reciprocal all attorney fees provisions in contracts. “In other words, all one-sided fee provisions in contracts are reciprocal and entitle the prevailing party to reasonable attorney fees.” Id. at 569  (citing Santisas v. Goodin, 17 Cal. 4th 599, 614 (Calif. 1998) and Penrod v. AmeriCredit Fin. Servs. (In re Penrod), 802 F.3d 1084,1088 (9th Cir. 2015)).

Applicability of Civil Code Section 1717 in Bankruptcy

The scope of California Civil Code Section 1717 extends beyond contractual disputes to encompass tort and noncontractual claims, as demonstrated by Santisas. Moreover, the De Guzman court noted bankruptcy courts have established that state statutes like § 1717 apply in bankruptcy proceedings whenever core state-law issues are central to the litigation at hand.  Id. at  569. 

A pivotal development in this regard was the Supreme Court’s decision in Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. 443, 127 S.Ct. 1199(2007), which overturned the Ninth Circuit’s “Fobian rule” [Fobian v. Western Farm Credit Bank (In re Fobian), 951 F.2d 1149, 1153 (9th Cir. 1991) ] that had prohibited recovery of attorney’s fees incurred in litigating issues of bankruptcy law.  The De Guzman court recognized that Travelers clarified that attorney’s fees can be recovered in accordance with state law, even if such fees involved litigation of bankruptcy law issues.  Id. at 570.

As a direct consequence of Travelers, California Civil Code § 1717 now uniformly applies in bankruptcy litigation where a prevailing party satisfies the essential elements of the statute and has prevailed in an action “on a contract.”  This expanded scope, as acknowledged in the Ninth Circuit’s Penrod decision, underscores the broad reach of § 1717 in contemporary bankruptcy jurisprudence.

The Essential Elements of Section 1717

To prevail under § 1717, a party must demonstrate: (1) an “action on a contract”; (2) a contractual clause providing for attorney’s fees; and (3) status as the prevailing party.  Id. at 570.

First, there must be an “action on a contract,” which is liberally construed in California law. The De Guzman court noted that a claim is deemed an “action on a contract” if the bankruptcy court must determine the enforceability of the contract to determine the bankruptcy law issue, such as the dischargeability of a debt. Id. at *5 (cites omitted).  The Creditor here claimed that because the complaint only pled fraud and willful and malicious conduct, it was not an “action on the contract.”  However, the bankruptcy court pointed out that those claims can only be evaluated by referring to the SBA, and the Note and DOT within it. The bankruptcy court pointed out that Creditor’s nondischargeability claims were premised on Debtor’s breach of the SBA, by failing to cause the DOT to be recorded promptly. The court accordingly concluded that the first element of § 1717 was satisfied because the Adversary Proceedings was an “action on a contract.”  Id. at 572. 

Second, the underlying contract must contain a fees clause.  Here, both the Noteand DOT contained clauses providing for attorney fees.  The bankruptcy court highlighted that § 1717 makes these clauses reciprocal against the Creditor. Thus, the second element is easily satisfied.  Id. at 572. 

Finally, with respect to the third element of § 1717, the court determined Debtor was the prevailing party because he successfully defended against the nondischargeability action, thereby affording him the “greater relief.”   Id. at 573. 

Because all of the elements of § 1717 were satisfied, the court awarded Debtor $19,514.40 in attorney fees.

Author’s Commentary

The De Guzman case illustrates how seemingly protective contractual provisions can unexpectedly shift leverage in litigation.  As the court observed, it exemplifies the principle of being “hoisted by one’s own petard”—a situation where a strategy designed to trap an adversary ultimately leads to the strategist’s own downfall, echoing the fate of Haman in the biblical story of Esther.

For creditors, this decision serves as a significant cautionary tale.  While contractual attorney’s fee clauses may seem advantageous, litigating non-contractual claims that necessitate interpreting the contract risks backfiring spectacularly if the dispute hinges on enforcing or interpreting the contract. Moreover, creditors pursuing non-bankruptcy claims within bankruptcy accordingly should thoroughly assess whether their arguments necessitate examining the underlying contract—a risk that could lead to unexpected attorney’s fee awards against them if they do not prevail in such litigation.

Conversely, for debtors facing litigious and/or financially powerful creditors, De Guzman provides a roadmap. Diligently scrutinizing creditor contracts for attorney’s fee clauses remains essential, but now should be coupled with a proactive consideration of potential contractually based counterclaims if such clauses are present.  Further, a debtor defending a nondischargeability action may recover attorney’s fees if the allegations of their wrongdoing are based on contractual breaches.  Such a threat can provide the debtor with leverage, thereby level the playing field in dischargeability litigation. 

The De Guzman decision is an important reminder that counsel must remain acutely aware of the scope of California Civil Code Section 1717 in bankruptcy litigation, and prepare for its potential application to nominally non-contractual claims, lest they be placed on the very scaffolding they assembled for their adversary.

These materials were written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, representing consumer debtors in the Central District of California, and President of the Central District Consumer Bankruptcy Attorneys Association, with editorial contributions by ILC member Gary M. Kaplan, a partner at Farella Braun + Martel LLP in San Francisco, California, and ILC member Kathleen A. Cashman-Kramer, a director at Fennemore’s San Diego office.

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