Contributed by Danielle Donovan
In re Coastal Realty Investments, Inc., a recent decision from the United States Bankruptcy Court for the Southern District of Georgia, outlines the Eleventh Circuit’s method for determining whether an oversecured creditor’s fully vested contractually liquidated attorneys’ fees are entitled to secured status under section 506(b) of the Bankruptcy Code. The court adhered to the bifurcation approach adopted by the Eleventh Circuit in In re Welzel, which requires that, as a threshold matter, the court must first determine whether a claim for attorneys’ fees is allowed under section 502 of the Bankruptcy Code. Then the court must proceed with a “reasonableness” analysis pursuant to section 506(b). An oversecured creditor’s allowed claim for attorneys’ fees is bifurcated based on its reasonableness (or lack thereof). Reasonable fees are entitled to secured status, and any remaining fees are treated as a general unsecured claim.
Bank of the Ozarks was the primary secured creditor in the single asset real estate case of Coastal Realty Investments, Inc. The debtor purchased a large condominium complex, which secured approximately $1,148,000 in debt owed to Ozarks. Ozarks was oversecured by approximately $227,000, as the court determined the complex to be worth $1,375,000. Pursuant to section 506(b) of the Bankruptcy Code, Ozarks submitted an application to recover approximately $88,000 in postpetition interest along with attorneys’ fees contractually liquidated at 15% of the principal and interest owing – an amount totaling approximately $179,000. In actuality, Ozarks only incurred around $102,000 in attorneys’ fees in connection with collection of the debt.
Ozarks’ claim to attorneys’ fees arose under a series of loan documents executed in connection with the financing secured by the condominium complex. The debtor issued a promissory note in favor of Ozarks’ predecessor in interest for approximately $1,333,000. With respect to attorneys’ fees, the note provided as follows: “I also agree to pay attorney’s fees of 15 percent of the principal and interest then owed, plus court costs . . . I also agree to pay the reasonable attorney’s fees and costs [incurred] to collect this debt as awarded by any court exercising jurisdiction under the Bankruptcy Code.”
In July 2011, the debtor defaulted on the note when it failed to make its periodic payments. In December 2011, Ozarks notified the debtor that it was accelerating the amount due on the promissory note and demanded payment of the principal and interest. The debtor failed to pay the demand amount, and Ozarks filed suit in February 2012. In response, the debtor filed a voluntary petition for chapter 11 protection in May that year.
In response to Ozarks’ application for expenses, the debtor contested (1) the applicable accrual method of the contract interest rate; (2) the allowance of attorneys’ fees pursuant to section 13-1-11 of the Georgia Code and section 502(b)(1) of the Bankruptcy Code; and (3) the reasonableness of the attorneys’ fees under section 506(b) of the Bankruptcy Code.
Section 506(b), which applies to oversecured creditors, provides, in relevant part, that for “an allowed secured claim . . . there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.” As such, a secured creditor is entitled to add attorneys’ fees to its secured claim if the following conditions are met: (1) the creditor is oversecured; (2) the fees are reasonable; and (3) the fees are provided for in the agreement or state statute under which the claim arose.
In this case, the parties agreed that Ozarks was oversecured and that the loan documents provided for attorneys’ fees. The debtor, however, disputed the amount of attorneys’ fees included within the scope of the loan documents and the extent to which any allowed fees were entitled to secured status. The debtor argued that the majority of Ozarks’ claim should be disallowed under section 502(b)(1) because the loan documents were ambiguous on the issue of attorneys’ fees. Additionally, the debtor asserted that the contractually liquidated attorneys’ fees were unreasonable under section 506(b) and, therefore, Ozarks’ secured claim for reasonable fees should not exceed the postpetition amount incurred by the debtor’s counsel.
Bound by the Eleventh Circuit’s Welzel decision, the court first determined whether Ozarks’ claim was allowed under section 502(b)(1) of the Bankruptcy Code. Section 502(b)(1) disallows a claim “to the extent that such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law . . . .” Section 13-1-11 of the Georgia Code governs the enforceability of obligations to pay attorneys’ fees upon a note or other evidence of indebtedness. Under Georgia law, when a note specifically provides for liquidated attorneys’ fees calculated at a fixed percentage of the debt, such fees are enforceable up to but not in excess of 15% of the principal and interest owing on the note. Although the loan documents clearly provided for attorneys’ fees, the debtor argued that the documents were inconsistent and ambiguous regarding the method by which the fees were to be calculated. The debtor requested that the court construe the ambiguous terms against Ozarks to invalidate the 15% provisions and limit the claim to “reasonable attorneys’ fees.” According to the debtor, “reasonable attorneys’ fees” should not exceed the attorneys’ fees incurred by the debtor during the same period.
The court, however, rejected the debtor’s arguments, finding that the other loan documents had incorporated the terms of the promissory note by reference. Moreover, the court held that the debtor’s argument mistakenly applied the section 506(b) reasonableness standard to the issue of claims allowance under section 502. Section 506(b) is not a disallowance provision, but rather provides the basis for determining whether a nonbankruptcy law created obligation is allowable as part of a secured or unsecured claim in a bankruptcy case.
After a lengthy discussion of allowance, the court proceeded with the Welzel approach to determine the extent to which Ozarks’ allowed claim for approximately $179,000 was reasonable and, therefore, entitled to secured status. Welzel provides that reasonable fees are secured to the extent the value of the collateral exceeds the amount of the underlying claim, and any unreasonable fees are treated as a general unsecured claim. The Eleventh Circuit applies the “lodestar analysis” to determine the reasonableness of an oversecured creditor’s attorneys’ fees. Relevant factors include: (1) time and labor expended; (2) novelty and difficulty of the legal questions raised; (3) skill required to properly perform the legal services rendered; (4) attorneys’ opportunity cost in pursuing the matter; (5) customary fee for like work; (6) whether the fee is fixed or contingent; (7) time limitations imposed by the client or circumstances; (8) amount in controversy and the results obtained; (9) experience, reputation, and ability of the attorney; (10) undesirability of the case within the legal community in which the case arose; (11) nature and length of the professional relationship between the attorney and client; and (12) attorneys’ fees awarded in similar cases.
The only issue with respect to reasonableness was the amount of time billed by Ozarks’ attorney. From November 2011 to August 2013, Ozarks’ counsel billed 404 hours in connection with the collection of the debt. The court held a reasonableness hearing at which Ozarks’ expert witness testified to the reasonableness of the time expended. The debtor did not present competing testimony, but simply argued that the hours deemed reasonable should not exceed the hours the debtor’s counsel billed during the same period. Again, the court found this argument unpersuasive.
Interestingly, however, the court found that Ozarks’ allowed claim of approximately $179,000 was not entirely reasonable. Implicit in the lodestar analysis is the requirement that reasonable attorneys’ fees be actually incurred. Ozarks actually incurred only $102,485.70 in attorneys’ fees. Its claim for approximately $179,000 was based on the 15% provision contained in the promissory note. Consequently, the court held that only $102,485.70 of Ozarks’ claim constituted reasonable attorneys’ fees that could be added to its secured claim. The approximately $76,000 difference, therefore, was required to be treated as a general unsecured claim.
So, the moral of this story is that, no, Ozarks, you can’t always get what you want, but if you’re reasonable, you just might find you get what you need.