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Bankruptcy Court Denies Attorney’s Fees To Debtor Discharging Debts

Creditor-Side Bankruptcy, Mortgage & Lending Law, and Real Estate Law by Peter N. Brewer, Esq.

Seyed Hosseini was a medical school graduate who incurred substantial student loans.  After graduating he was unable to pass the medical licensing boards and never became a doctor.  Eventually, after being unable to pass the licensing exam, he filed for bankruptcy relief to discharge over $280,000 in student loan debt.  Typically, student loans are not dischargeable unless certain factors are met.

Hosseini filed an adversary proceeding, essentially a trial in the bankruptcy court, to discharge his student loans.  The bankruptcy court agreed with Hosseini’s position and ordered the student loans to be discharged.  After the trial, Hosseini sought to recover approximately $110,000 in attorney’s fees on the theory that the student loan promissory note provided for attorney’s fees incurred in enforcing the terms of the student loan.  However, the bankruptcy court denied the request for attorney’s fees on the basis that an action to discharge debt does not contest the terms of the loan nor the amount due under the loan.

THE DECISION: The United States Bankruptcy Appellate Panel of the Ninth Circuit affirmed the bankruptcy court’s decision and held that a debtor seeking a discharge of a loan is not analogous to an attempt to enforce the terms of a loan.  The Court noted that generally parties cannot recover attorney’s fees for their suit unless there is a specific contractual or statutory provision permitting the recovery of attorney’s fees.  However, in most loans, and as was the case here, the lender includes a provision providing for attorney’s fees if the lender is required to enforce the terms of the loan.  Under California law, the general rule is that if one side is entitled to attorney’s fees by the terms of the contract, the other side is also entitled to attorney’s fees.  In this case, the Court held that because the debtor was solely attempting to discharge the debt, the action did not constitute a dispute over the terms or amount of the debt.

WHY THIS DECISION IS IMPORTANT: This holding greatly limits the attorney’s fee provision in bankruptcy and may prevent lenders from recovering attorney’s fees in future actions.  If a defense to a suit to discharge any obligations to pay a loan is not considered relevant to enforcing the loan terms, it is unclear what would be required to trigger the attorney’s fee provision.  It is likely that the attorney fees provision could be drafted more broadly so as to apply to this situation, should the lender deem it appropriate to do so.

COMMENT:  In this case, a poorly drafted attorney’s fee provision saved the lender more than a hundred thousand dollars.  However, many times, the situations will be reversed.  To insure that a lender will be able to collect its attorney’s fees, a better attorney’s fee provision should be included to specifically address in what situations outside of collection of the loan can fees be recovered.

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