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Debtor Not Entitled to Attorneys' Fees For Litigation Involving Negative Equity

Wednesday, May 29, 2013
By Stephanie M. Acree

A debtor was not entitled to attorneys' fees for litigation involving the issue of how to treat negative equity associated with the debtor's trade-in vehicle under bankruptcy law, the U.S. District Court for the Northern District of California held May 10 (Penrod v. AmeriCredit Financial Services Inc. (In re Penrod), N.D. Cal., No. 4:12-cv-01548 (YGR), 5/10/13).

Affirming the bankruptcy court, Judge Yvonne Gonzalez Rogers found that the debtor was not entitled to attorneys' fees under California state law because she was not a party “prevailing on the contract.” 

$7,000 in Negative Equity

In September 2005, debtor Marlene Penrod purchased a 2005 Ford Taurus. She traded in her 1999 Ford Explorer as part of the purchase, which was worth $6,000. However, she still owed $13,000 on the Explorer, leaving $7,000 in “negative equity.” After putting approximately $1,000 down for the new vehicle, Penrod financed approximately $31,700 to purchase the Taurus, which cost $25,600. The contract was subsequently assigned to AmeriCredit Financial Services Inc.

The contract contained a provision regarding attorneys' fees which stipulated: “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.” 

Unsecured Claim

Penrod filed for Chapter 13 protection in March 2007, at which time she still owed over $25,000 to AmeriCredit, including the $7,000 of negative equity. In her plan, Penrod sought to treat the negative equity portion of AmeriCredit's claim as unsecured. AmeriCredit objected and argued that its claim was protected from bifurcation.

The bankruptcy court ultimately overruled AmeriCredit's objection, which was affirmed by the U.S. Bankruptcy Appellate Panel for the Ninth Circuit and the U.S. Court of Appeals for the Ninth Circuit (22 BBLR 1058, 8/5/10). The U.S. Supreme Court denied AmeriCredit's petition for writ of certiorari (23 BBLR 1234, 10/6/11).

Penrod then sought to recover her attorneys' fees pursuant to California Civil Code § 1717, which makes a unilateral contractual fee clause a reciprocal obligation in a contract enforcement action. However, the bankruptcy court refused to award Penrod attorneys' fees because it found she had not prevailed “on the contract” pursuant to Section 1717. Penrod appealed to the district court. 

Proper Reliance on Travelers

The court first addressed whether or not the bankruptcy court applied the correct law. Penrod argued that the bankruptcy court “implicitly relied” on In re Fobian, 951 F.2d 1149 (9th Cir. 1991), which “prohibited awards of attorneys' fees when only issues of federal bankruptcy law were litigated in cases involving a contract.” Fobian was later overruled by the U.S. Supreme Court in Travelers Casualty & Surety Co. v. Pacific Gas and Electric Co., 549 U.S. 443 (2007). However, the bankruptcy judge did not specifically reference Fobian and the district court found that the bankruptcy court had not relied on it.

While the bankruptcy court's opinion did not specifically reference Travelers either, the district court noted that the bankruptcy judge mentioned Travelers at oral argument. Therefore, the district court concluded that the bankruptcy court properly relied on Travelers in reaching its decision. The district court also found the bankruptcy court relied on the pertinent state law, specifically Section 1717, in concluding that the fees were not recoverable. 

'On the Contract.'

Secondly, Penrod argued that the bankruptcy court misapplied the state law, arguing that the case giving rise to the attorneys' fees was an action of contract enforcement and therefore the bankruptcy court erred in not awarding her attorneys' fees. Penrod argued that AmeriCredit would have been entitled to attorneys' fees had it prevailed, and therefore under Section 1717 the obligation should be reciprocal. However, the district court said that it appeared Penrod had based AmeriCredit's “purported entitlement to attorneys' fees” on “a provision of the Bankruptcy Code, 11 U.S.C. § 506(b), that provides for recovery of contractual attorneys' fees based on the lender's over-secured status, not the lender's success in the bankruptcy proceeding.”

The district court said that regardless of AmeriCredit's entitlement or lack thereof to attorneys' fees under the Bankruptcy Code, Penrod's right to attorneys' fees must be determined by state law. Therefore, in order for Penrod to be entitled to attorneys' fees, she “must establish that the attorneys' fees at issue were incurred in an action 'on a contract' within the meaning of [Section] 1717.” 

Enforcement Never at Issue

The court said that an action is “on the contract” under Section 1717 when it is “brought to enforce the provisions of the contract.” In this case, Penrod never disputed her liability under the contract or the contract's enforceability. While Penrod argued that by filing a claim AmeriCredit was attempting to collect on the contract, the bankruptcy judge held that “a party who avoids the obligation of a contract through federal bankruptcy law does not prevail on the contract within the meaning of [S]ection 1717.” The district court found that the bankruptcy court did not abuse its discretion in reaching this conclusion.

“The litigation had little to do with the parties' actual contract and concerned only abstract issues of how to treat the negative equity associated with a debtor's trade-in vehicle under bankruptcy law,” the court said. Accordingly, the district court affirmed the decision of the bankruptcy court.

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