In re McKenna

• Decision Date: 26 October 2006
• Docket Number: No. 05-75754.,05-75754.
• Citation: 362 B.R. 852
• Parties: In re Gordon McKENNA/Joy Carson, Debtor.
• Court: U.S. Bankruptcy Court — Northern District of Ohio

362 B.R. 852

In re Gordon McKENNA/Joy Carson, Debtor.

No. 05-75754.

United States Bankruptcy Court, N.D. Ohio.

October 26, 2006.

Raymond L. Beebe, Raymond L. Beebe Co LPA, Toledo, OH, Joy L. Carson, Perrysburg, OH, for Debtors.

Anthony B. Disalle, Toledo, OH, for trustee.

DECISION AND ORDER

RICHARD L. SPEER, Bankruptcy Judge.

This cause came before the Court after an Evidentiary Hearing on the Debtors' Objection to Claim Number 20 filed by Huntington National Bank. In the time leading up to the Hearing, the Parties submitted multiple briefs in support of their respective positions. The Court has now had the opportunity to fully review these briefs in light of the arguments made by Parties' counsel at the Hearing held in this matter. Based upon this review, the Court, for the reasons that will now be explained, finds that the Debtors' Objection should be Sustained in Part.

The substance of the Debtors' Objection to the Claim of Huntington National Bank (hereinafter referred to as the "Creditor") is limited to one issue: the amount of fees and costs, both prepetition and postpetition, the Creditor is entitled to include on its claim against the Debtors' bankruptcy estate. The underlying facts giving rise to this issue are not materially in dispute.

FACTS

On October 15, 2005, the Debtors, Gordon D. McKenna and Joy L. Carson (hereinafter "Debtors"), filed a petition in this Court for relief under Chapter 13 of the United States Bankruptcy Code. Prior to the time they petitioned this Court for relief, the Debtors had entered into a commercial-loan agreement with the Creditor, Huntington National Bank. The principal amount of the loan was $350,000.00; in addition to being secured against the commercial property constituting the subject of the loan, the loan was secured as a second mortgage against the Debtors' residence.

Because of a later default, the Creditor initiated legal proceedings to foreclose on the Debtors' residence; but with the commencement of the Debtors' bankruptcy case, the foreclosure action was stayed. After the commencement of their case, the Creditor filed a proof of claim in the amount of $345,704.24. Later, the Creditor amended its claim so as to reflect a reduction in principal stemming from the sale of the commercial property.

The Creditor's amended claim, number 20, set forth a balance owing of $33,413.58. Later, as the result of a partial settlement between the Parties, this amount was reduced to $16,450.00, representing solely the legal fees and costs associated with the Creditor protecting its mortgage interest in the Debtors' property. (Doc. No. 132, at pg. 2). Of this amount, $8,140.20 represented prepetition fees and costs; $8,309.80 constituted postpetition fees and costs. (Doc. No. 133, at pg. 2): These fees were imposed under the terms of the loan agreement entered into between the Parties.

DISCUSSION

Before this Court is the Debtors' objection to the proof of claim filed by the Creditor. Determinations concerning the allowance or disallowance of claims against the estate are core proceedings over which this Court has been conferred with the jurisdictional authority to enter final orders. 28 U.S.C. § 157(b)(2)(B).

Bankruptcy Code § 502(a) provides that the Creditor's claim, as represented by its amended proof of claim, is deemed allowed unless an objection is filed. If, as here, an objection is filed, § 502(b) then directs this Court to undertake a two-step analysis: (1) "determine the amount of such claim" and then (2) "allow such claim in such amount, except to the extent that" any of the conditions subsequently set forth in the provision are present. But this only forms a part of the equation.

The fact that a claim may be allowed under § 502(b) goes only so far as its allowance as an unsecured claim. In this matter, however, the Creditor seeks to have its legal fees and costs, both prepetition and postpetition, included as a part of its secured claim. As authority for this position, the Creditor relies solely on § 506(b), which provides relevant part:¹

To the extent that an allowed secured claim is secured by property the value of which ... is greater than the amount of such 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 under which such claim arose.

The function of this provision is straightforward; it affords an oversecured creditor the right to recover its reasonable legal fees and costs out of the surplus value of the property securing its claim.

In this matter, the Parties do not dispute the Creditor's status as an oversecured creditor. But insofar as it concerns the Creditor's prepetition fees and costs, its reliance on § 506(b) would appear to be misplaced. Although there exists authority to the contrary, courts have generally held that § 506(b) is limited in its applicability to postpetition fees and charges. (For a complete discussion see In re Leatherland Corp., 302 B.R. 250 (Bankr. N.D.Ohio 2003) (J. Whipple)). This would appear to be the better view; section 506(b), by referring to reasonable fees, costs, or' charges which may be added to an "allowed secured claim," is structured so as to be forward looking in time. In re 900 Corp., 327 B.R. 585, 593 (Bankr. N.D.Tex.2005).

But this also means that the converse is true; any fees, costs and charges arising prepetition are simply part of the secured creditor's claim in the first instance, being governed by § 502(b), not § 506(b). In re Vanderveer Estates Holdings, Inc., 283 B.R. 122, 131 (Bankr.E.D.N.Y.2002). As explained in a commonly used treatise on bankruptcy:

The amount of a creditor's `claim' is typically determined as of the petition date, and includes the principal amount of the obligation plus all matured pre petition interest, fees, costs and charges owing as of the petition date. The allowability of these prepetition amounts as part of the secured creditor's `claim' is not determined by section 506, but is governed by section 502 in conjunction with other provisions of the Code.

4 Collier on Bankruptcy, ¶ 506.04[1] at 506-101, 506-102 (15th ed. rev.2002). Resultantly, the prepetition fees sought by the Creditor will be discussed in the context of § 502 while its request for postpetition fees will be discussed in the context of § 506(b).

Among the reasons a claim may be disallowed under § 502(b) is that "such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law ...." 11 U.S.C. § 502(b)(1). The Debtors' position with regards to the allowability of the Creditor's prepetition fees focuses entirely on this ground, and the unenforceability, of the Creditor's claim by virtue of applicable law, that is Ohio law. As taken from their brief to the Court: "The Debtors in the instant case concedes [sic] that the mortgage allows for the fees but ... believe that the provision allowing for fees is void under Ohio law." (Doc. No. 133, at pg. 2).

Ohio has adopted what is known as the "American Rule," whereby in litigation each party is responsible for their own attorney fees and costs. Sorin v. Bd. of Edn., 46 Ohio St.2d 177, 179, 347 N.E.2d 527 (1976). An exception is made when, as here, the Parties' agreement provides otherwise. Nottingdale Homeowners' Assn., Inc. v. Darby, 33 Ohio St.3d 32, 514 N.E.2d 702 (1987). Notwithstanding, since the year 1911, it has been the law in Ohio that agreements set forth in promissory notes for the payment of legal fees and costs upon default are contrary to public policy and hence void. Miller v. Kyle, 85 Ohio St. 186, 97 N.E. 372 at syllabus (1911). The reasoning: unequal bargaining power. Over time, however, there has been some weakening of this Rule, especially when its purposes would not be served. First Capital Corp. v. G & J Industries, Inc., 131 Ohio App.3d 106, 111; 721 N.E.2d 1084 (1999).

Relevant here, the Rule in Miller v. Kyle was partially abrogated by statute through O.R.C. § 1301.21, wherein it is provided:

(B) If a contract of indebtedness includes a commitment to pay attorneys' fees, and if the contract is enforced through judicial proceedings or otherwise after maturity of the debt, a person that has the right to recover attorneys' fees under the commitment, at the option of that person, may recover attorneys' fees in accordance with the commitment, to the, extent that the commitment is enforceable under divisions (C) and (D) of this section.

As it concerns the Creditor's right to assess prepetition fees and costs against the Debtors, there is no reason to conclude that this provision is not applicable to the Parties' transaction. First, for purposes of § 1301.21, the introductory term "contract of indebtedness" is defined to encompass any "mortgage" so long as the indebtedness was not "incurred for purposes that are primarily personal, family, or household." In this matter, the mortgage given by the Debtors was for a business endeavor; the fact that the mortgage was also secured against the Debtors' residence does not change its underlying character. Additionally, the indebtedness involved, $350,000.00, is well over the $100,000.00 threshold set forth in paragraph (C) of this provision.

Yet, even though O.R.C. § 1301.21 permits the Creditor to assess legal fees and costs, the statute contains a quantitative limitation in paragraph (D): the fees assessed must be reasonable. And with respect to those prepetition legal fees sought by the Creditor, a fair reading of the Debtors' arguments shows that their primary point of contention centers on this limitation. Specifically, the Debtors contest the reasonableness of the $2,458.00 charge the Creditor assessed in obtaining its cognovit judgment, a position which is anything but specious: a primary function of a cognovit note is to reduce a creditor's expense in the event of default. Fogg v. Friesner, 55 Ohio App.3d 139, 140, 562...