FOR THE NORTHERN DISTRICT OF CALIFORNIA
COMMERCIAL ASSOCIATES I, No. 587-06639-WCM
Memorandum of Decision
Debtor Commercial Associates I is the former tenant of landlords Witt and Kennedy under
a 65-year ground lease of commercial property. After a long legal battle with Witt and Kennedy,
the debtor's Chapter 11 plan was confirmed a few months ago. The plan provided for the
assumption and assignment of the lease to a new tenant.
Pursuant to the plan, a sum of money was held in escrow and the parties reserved the issue
of whether Witt and Kennedy are entitled to reimbursement of their attorneys' fees as a condition
of assumption. However, this simple issue has multiplied in the months since confirmation into
a myriad of related issues, claims and counterclaims involving the debtor, Witt and Kennedy, and
Mercury Savings & Loan, the construction lender. Since a provision of the plan left the door
open for the raising of such issues, the doctrine of res judicata
does not bar their
postconfirmation litigation. The court accordingly will plunge into the sea of issues, in no
1. Past Due Rents
Lessor Witt, not joined by lessors Kennedy, claims that more rents are due because rents for
1986 through 1988 were improperly calculated. Specifically, he argues that payments made by
the debtor to Mercury were not proper deductions in determining the adjusted gross revenue of
Despite a voluminous lease, it is clear that a circumstance occurred that was not specifically
contemplated. Although Mercury loaned over $2 million, it did not insist on subordination of the
lessors' interest and was accordingly not a "First Mortgagee" under the lease. The lease
specifically allows as deductions only payments to the First Mortgagee. Witt argues that since
Mercury was not a First Mortgagee, payments to it may not be deducted in computing the
adjusted gross revenue upon which the rents are calculated.
The problem with Witt's argument is that the lease does not exclude payments to an entity
which is not a First Mortgagee. The lease says that all
cash expenditures for the benefit of or
with respect to the property are proper deductions; the payments to Mercury clearly fall within
this definition. The only expenditure excluded from the calculation of adjusted gross revenue
is a rent payment to the landlords themselves. Thus, just because the payments to Mercury were
not payments to a First Mortgagee, which are by the lease specifically included as proper
deductions, does not mean that they were excluded from being proper deductions. The
payments fall within the general definition of what is deductible, and the lease does not exclude
from deductibility payments made to a secured creditor who is not a First Mortgagee.
As a fallback position, Witt argues that some of the funds borrowed from Mercury were used
to reimburse the debtor for rents paid to the landlords. While the court agrees in principal that
repayment of such funds is not deductible, a quick mental calculation shows that even if the
unproved allegation were true the amount involved would be de minimus
. The payments to
Mercury were interest only, and the rents under the lease were only two percent of the adjusted
gross income. Thus, any underpayment is only two percent of the interest on that small portion
of the Mercury loan which was used to reimburse the debtor for rents. This comes out to
roughly $400 per year, a sum too small to fuss with.
For the above reasons, Witt's application for an award of rents still owing will be denied.
2. Award of Attorneys' Fees to the Debtor
The debtor alleges that because it obtained confirmation of its plan over the landlords'
objection, it is entitled, as a "prevailing party," to recover its attorneys' fees from the landlords,
and surcharge them for Mercury's fees as well. The court sees no merit in this claim for both
factual and legal reasons.
Factually, the only reason that the plan was confirmed was that it was substantially modified
during the confirmation hearing. To say that the debtor was the "prevailing party" because a plan
was ultimately confirmed, and ignore months of trying to sell an unconfirmable version of the
plan, is not something the court is prepared to do.
As a matter of law, a debtor is not entitled to attorneys' fees based on state law for obtaining
confirmation of a plan over a party's objection. The plan confirmation process is unique to federal
bankruptcy law, with no state law equivalent. Under such circumstances, attorneys' fees are
recoverable only if federal law so provides. In re Johnson
, 756 F.2d 738 (9th Cir.1985).
3. Fees of Witt and Kennedy
Pursuant to resolution of state court litigation, lessors Witt and Kennedy recovered $50,000
in attorneys' fees from the debtor. The issue now before the court is whether they are entitled
to additional reimbursement for attorneys' fees incurred in contesting the debtor's plan. Witt
seeks and additional $80,000 in such fees and costs, and the Kennedys seek $28,000.
The court's first inquiry is whether section 506(b) of the Bankruptcy Code is applicable. That
section allows an oversecured creditor to recover reasonable attorney's fees if there is a
contractual provision which so provides. While in form Witt and Kennedy are lessors, the form
of the financing vehicle should not alter the fact that they are in substance secured creditors.
Such an approach is the "easy way" for the court to resolve the issue, as under section 506(b)
a creditor may be awarded fees for any reasonable service, even if unsuccessful. In re Mills
B.R. 413, 418 (Bkrtcy.S.D.N.Y.1987); In re Brunel
, 54 B.R. 462, 465 (Bkrtcy.D.Colo.1985).
Unfortunately, the ground lease itself is not sufficient to afford the court an easy way of
dealing with the problem. Deeds of trust usually contain a clause allowing the beneficiary to add
to the amount of the obligation any attorney's fees incurred in protecting the beneficiary's
interest, and such a clause clearly allows fees under section 506(b). However, the ground lease
here contains no such provision. Witt points to Article 3.2, which does not mention attorneys
fees and excludes from reimbursement expenses "incurred by or at the instance of Landlord."
At the very least, it is far too vague to support an award of attorneys' fees. Witt also points to
Article 23, which provides for attorney's fees to the prevailing party in litigation. In this regard
Witt is no more a prevailing party than the debtor, in that he continued to fight the plan even
after its amendment, and lost on the key issue as to whether the subordination provision in the
lease was enforceable upon assumption.
Being prevented by the lease itself from looking to section 506(b), the court must base any
award of attorneys' fees to the lessors on section 365(b)(1)(B) of the Code, which requires the
bankruptcy estate to compensate the lessors for "actual pecuniary loss to such party resulting
from such default." Such pecuniary losses include attorneys' fees. In re Bullock
, 17 B.R. 438,
439 (9th Cir.BAP 1982). This is a more difficult application than 506(b) because under 506(b)
the court could find reasonable any services, even if they were unsuccessful. Under section
365(b)(1)(B), only such fees which were incurred as the result of a default are recoverable.
Therefore, fees for time spent litigating over an alleged default are not recoverable if the court
ultimately found that there was no default.
Reviewing the fee applications with the above principles in mind, the court sees that the vast
majority of the fees were directed toward defaults which the court found existed. However,
some of the fees were associated with the landlord's argument that the lease could not be
assumed because of the subordination provision. Since the lessors lost on this issue, the fees
associated with its litigation cannot be said to be related to a default and section 365(b)(1)(B)
does not require their reimbursement as a condition of assumption.
After a full review of the applications, the court finds that the sum of $25,000.00 is
reasonable additional compensation to the Kennedys and $50,000.00 is reasonable additional
compensation to Witt for attorney's fees related to defaults. The court has cut back Witt more
than Kennedy because some of the fees sought by Witt's counsel were associated with the state
court litigation for which he has already received full compensation. Also, some of Witt's
application seems to be unnecessarily duplicative.
4. Fees of Mercury
When the escrow for the assigment of the lease to the new buyer was ready to close, Mercury
gave a demand for payoff to the escrow holder which included some $73,000.00 in attorneys'
fees. The debtor now asks the court to review these fees for reasonableness, and Mercury has
filed an application seeking another $30,000.00.
First, the court will have nothing to do with awarding more fees to Mercury. Its demand was
satisfied, and the debtor's note paid. To the extent the court has some equitable power to award
Mercury more fees it declines to do so. While the court may find the fees already taken by
Mercury to be reasonable, they are only barely so. Adding anything further would be
As previously noted, Mercury is entitled to its reasonable attorneys' fees pursuant to section
506(b). Mercury was very actively involved in the confirmation process, at one point even
taking the laboring oar in trying to sell the debtor's plan to the court. It would be very naive to
think that Mercury would not seek reimbursement for its attorney's fees, and equally naive to
think that the amount of the fees would be a bargain. The only way a trustor under a deed of
trust can avoid having what many would see as exorbitant attorneys' fees added to its obligation
is to keep the beneficiary from incurring any legal fees at all. Once it becomes necessary for the
beneficiary to hire a lawyer, the trustor is not likely to be happy with the beneficiary's bottom
The fees paid to Mercury out of escrow are about thirty percent higher than the figure the
court would have guessed, given the role it saw Mercury play in the confirmation process.
However, they represent bills actually paid by Mercury and they are not out of line with the
obligation owed to Mercury, which was well over $2 million. The court therefore reluctantly
finds those fees reasonable, but not one penny more. Mercury and the debtor shall each bear
their own attorneys' fees incurred in litigating this dispute over fees.
The funds held aside pursuant to the plan to compensate the lessors pursuant to section
365(b)(1)(B) are not property of the debtor's estate until after the landlord's claims have been
satisfied. Accordingly, they are not to be prorated between the lessors and debtor's counsel. The
latter may be compensated only from property of the estate, not property of the lessors.
No additional attorneys' fees will be awarded to any party as a result of litigating any of the
issues addressed in this memorandum.
Counsel for the debtor shall submit an appropriate form of order which counsel for Witt,
Kennedy, and Mercury have approved as conforming to the above decisions.
Dated: July 7, 1990 _______________________