Second Circuit Rules that Bankruptcy Courts May Award Appellate Legal Fees as Sanction for Contempt

Courts disagree whether a bankruptcy court, in exercising its broad equitable powers, has the authority to award appellate legal fees as a sanction for contempt. The U.S. Court of Appeals for the Second Circuit recently weighed in on this issue as an apparent matter of first impression. In Law Offices of Francis J. Reilly, Esq. v. Selene Finance, L.P. (In re DiBattista), 33 F.4th 698 (2d Cir. 2022), the Second Circuit held that a bankruptcy court erroneously concluded that it did not have the power to award attorney fees incurred on appeal by a debtor seeking to enforce a contempt order for violations of a bankruptcy discharge order. 

The American Rule and Fee Shifting in Bankruptcy

The general rule in the United States is that litigants are responsible for their own attorney fees, win or lose. This is referred to as the "American Rule," as distinguished from the "English Rule," whereby the prevailing party ordinarily recovers its own attorney fees from the loser. However, the American Rule is merely the general rule. It can be overridden under certain circumstances, such as by contract or statute—sometimes referred to as a "fee-shifting" statute.

The Bankruptcy Code contains many fee-shifting exceptions to the American Rule, including:

(1) Counsel to a bankruptcy trustee or a chapter 11 debtor-in-possession is compensated by the estate, and if the estate is insolvent, unsecured creditors bear the cost unless secured creditors agree to do so by means of a court-approved collateral "carve out";

(2) The estate is obligated to pay a secured creditor's attorney fees, either pursuant to section 506(b) of the Bankruptcy Code, to the extent the value of the secured creditor's collateral exceeds the face amount of its claim, or in accordance with an order authorizing postpetition financing and providing "adequate protection" to the secured creditor;

(3) Attorneys retained by official committees of unsecured creditors or shareholders are compensated by the estate;

(4) Attorney fees may be imposed as a sanction for violations of the automatic stay under section 362(k);

(5) Court-imposed sanctions under Rule 9011 of the Federal Rules of Bankruptcy Procedure ("Fed. R. Bankr. P.") for misrepresentations to the court may include the imposition of attorney fees;

(6) Creditors and certain other parties who, among other things, file an involuntary petition, make a "substantial contribution" in a chapter 9 or 11 case, recover property transferred or concealed by a debtor, or are involved in the prosecution of a criminal offense relating to the bankruptcy case or the debtor's business or property may be awarded a priority administrative expense claim for their attorney fees under section 503(b)(4);

(7) Expenses incurred by the bankruptcy estate for preserving collateral (including fees of estate professionals) may be surcharged against the collateral pursuant to section 506(c), thereby shifting the fees to the secured creditor; and

(8) A debtor may recover its attorney fees from petitioning creditors in a dismissed involuntary bankruptcy case under section 303(i).

See generally Daniel J. Bussel, Fee-Shifting in Bankruptcy, 95 Am. Bankr. L.J. 613, 629-31 (2021).

Bankruptcy Court's Inherent Power to Award Legal Fees as Contempt Sanction

In addition, it is well recognized that a bankruptcy court may award legal fees as a sanction for violations of its orders or the bankruptcy discharge in exercising its broad equitable powers under section 105(a) of the Bankruptcy Code, which authorizes the court to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code.]" See In re Stewart, 634 B.R. 740, 748 (Bankr. E.D. Mich. 2021); In re Jones, 632 B.R. 138, 148 (Bankr. S.D. Ohio 2021).

Various courts have ruled that a bankruptcy court also has the power under section 105(a) to grant legal fees for the successful appellate defense of a contempt order. See, e.g., Liberis v. Craig, 845 F.2d 326, 1988 WL 37450, **6-8 (6th Cir. 1988); Hoti Enterprises, L.P. v. GECMC 2007 C-1 Burnett Street, LLC (In re Hoti Enterprises, L.P.), 2013 WL 1812197, **9, 20 (S.D.N.Y. 2013), aff'd, 562 Fed. App'x 1 (2d Cir. 2014); In re Markus, 619 B.R. 552, 575 (Bankr. S.D.N.Y. 2020); Sprague v. Williams (In re Van Winkle), 598 B.R. 297, 301-02 (Bankr. D.N.M. 2019); In re Rodriguez, 517 B.R. 724, 738-39 (Bankr. S.D. Tex. 2014).

Other courts have ruled to the contrary. Some have reasoned that the only avenue for awarding legal fees incurred in defending a contempt order on appeal is Rule 38 of the Federal Rules of Appellate Procedure ("Fed. R. App. P.") or Fed. R. Bankr. P. 8020, both of which authorize an appellate court to award damages and costs, including legal fees, if it determines that an appeal was frivolous. See, e.g., In re Del Mission Ltd., 98 F.3d 1147, 1153-54 (9th Cir. 1996); DVI Receivables XIV, LLC v. Rosenberg, 500 B.R. 174, 181-82 (S.D. Fla. 2013).

In DiBattista, the Second Circuit considered whether a bankruptcy court has the authority to award appellate legal fees as a sanction for contempt. 

DiBattista

Chapter 7 debtor Bret DiBattista received a bankruptcy discharge in 2009. Despite the discharge order, the servicer of the debtor's home mortgage (the "servicer") continued its attempts to collect on the delinquent mortgage.

In 2019, the bankruptcy court, upon the debtor's request, reopened the bankruptcy case and granted the debtor's motion for contempt sanctions against the servicer. The court awarded the debtor $17,500 in damages for willful and repeated violations of the discharge order as well as approximately $9,000 in legal fees.

The servicer appealed the ruling to the district court, which vacated the ruling and remanded the case below for clarification of whether the bankruptcy court's award was for "actual" or "punitive" damages. After the bankruptcy court issued a second order clarifying that the $17,500 award was for compensatory damages, the debtor's counsel sought additional fees totaling approximately $28,000 for services provided in connection with the appeal.

The bankruptcy court denied the motion. It reasoned that:

Appeal is a legal avenue for any losing party to pursue, and it's not a violation of the discharge order. And a party is not in contempt for choosing to take an appeal. If [the debtor's attorney] wanted fees, [it] needed to ask [the district court] for fees for that proceeding.

The district court affirmed on appeal, writing that a "bankruptcy judge has simply not been empowered by Congress to award legal fees incurred in connection with an appeal to the district court."

The debtor's attorney appealed to the Second Circuit.

The Second Circuit's Ruling

A three-judge panel of the Second Circuit vacated the district court's ruling and remanded the case below. Writing for the panel, U.S. Circuit Court Judge Richard J. Sullivan explained that it is well settled that a bankruptcy court, exercising its broad equitable powers under section 105(a), "may compensate a debtor for a creditor's violation of [a] discharge order" entered under section 524(a). These provisions, Judge Sullivan wrote, which "'bring with them the old soil that has long governed how courts enforce injunctions,'" authorize a court to impose civil contempt sanctions to coerce compliance with an injunction or to compensate a complainant for losses arising from noncompliance. DiBattista, 33 F.4th at 702 (quoting Taggart v. Lorenzen, 139 S. Ct. 1795 (2019)).

Judge Sullivan was guided by Weitzman v. Stein, 98 F.3d 717 (2d Cir. 1996)—a non-bankruptcy case—where the Second Circuit reversed a district court's denial of legal fees incurred in defending a contempt ruling on appeal, reasoning that the appellate costs were caused by the contemnor's misconduct because "'none of this [litigation] would have been necessary' if the contemnor had simply obeyed the district court's order." DiBattista, 33 F.4th at 703 (quoting Weitzman, 98 F.3d at 720). As in Weitzman, Judge Sullivan concluded, the debtor's appellate fees were "caused by" the servicer's contempt. He also wrote that, given the "old soil that has long governed how courts enforce injunctions … it is immaterial that this case involves a bankruptcy court's, rather than a district court's, contempt order." Id. Thus, Judge Sullivan found, the bankruptcy court's rationale that an appeal is not a violation of the discharge order was erroneous.

The Second Circuit also faulted the bankruptcy court's determination that only the district court could award appellate litigation costs. "[I]n line with long-established practice," Judge Sullivan explained, a bankruptcy court's contempt power includes the authority to compensate a party for damages arising from noncompliance with an injunction, "even if those losses take the form of appellate litigation fees." Id. 

According to Judge Sullivan, the district court was never asked to award appellate legal fees to the debtor, and the bankruptcy court was "in no way prohibited" from doing so. Moreover, he wrote, the "frivolous appeal" sanctioning rules—Fed. R. Bankr. P. 8020(a) and Fed. R. App. Proc. 38—do not "prevent a lower court from assessing fees against a willful contemnor who has flouted the lower court's injunction order, even where the contemnor's appeal is non-frivolous." Id. at 704.

Finally, the Second Circuit rejected the servicer's argument that the American Rule precludes an award of appellate fees "absent explicit statutory authority." According to Judge Sullivan, an exception to the American Rule has long been recognized that permits a court to award legal fees for willful disobedience of an order entered as part of a fine levied on a contemnor.