In re: Michael Allen Zito and Elizabeth Zito

FILED
AUG 21 2019
ORDERED PUBLISHED
SUSAN M. SPRAUL, CLERK
U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT

UNITED STATES BANKRUPTCY APPELLATE PANEL
OF THE NINTH CIRCUIT

In re: BAP No. AZ-18-1289-BFL

MICHAEL ALLEN ZITO and Bk. No. 3:09-bk-25681-GBN
ELIZABETH ZITO,

Debtors.

MICHAEL ALLEN ZITO; ELIZABETH
ZITO,

Appellants,

v. OPINION

DOUGLASS ENTERPRISES, LLC,

Appellee.

Argued and Submitted on July 18, 2019
at Phoenix, Arizona

Filed – August 21, 2019

Appeal from the United States Bankruptcy Court
for the District of Arizona

Honorable George B. Nielsen, Jr., Bankruptcy Judge, Presiding
Appearances: Appellant Michael Allen Zito argued pro se; Philip J.
Giles of Allen Barnes & Jones, PLC argued for Appellee
Douglass Enterprises, LLC.

Before: BRAND, FARIS and LAFFERTY, Bankruptcy Judges.

BRAND, Bankruptcy Judge:

INTRODUCTION

Douglass Enterprises, LLC sued debtors Michael and Elizabeth Zito

in Arizona state court to recover on a personal guarantee. The Zitos

returned to the bankruptcy court and sought an order that the debt was

discharged in their previous chapter 111 bankruptcy case despite

§ 523(a)(3)(A). After the bankruptcy court determined that the Zitos' debt

to Douglass Enterprises was not discharged, Douglass Enterprises, as the

prevailing party, sought and obtained a judgment from the bankruptcy

court awarding attorney's fees and costs for defending the discharge action.

The Zitos now appeal the post-judgment award of attorney's fees and costs

to Douglass Enterprises. Although we agree that Douglass Enterprises, as

the prevailing party in this action, would be entitled to reasonable

attorney's fees and costs in the event that it ultimately prevails in its

1
Unless specified otherwise, all chapter and section references are to the
Bankruptcy Code, 11 U.S.C. §§ 101-1532.

2
personal guarantee action, the bankruptcy court erred by awarding fees

and costs prematurely. Accordingly, we REVERSE.

I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

The Zitos owned and managed BySynergy, LLC, a Delaware limited

liability company in the business of real estate development. Prior to 2008,

BySynergy was developing a 106 single-family home project in Arizona. To

help fund the venture, BySynergy obtained a $200,000 loan from Douglass

Enterprises, which was evidenced by a note and a second-position deed of

trust against the project property in favor of Douglass Enterprises. To

further secure repayment, the Zitos executed a Personal Guarantee for the

amounts owed to Douglass Enterprises under the note. The Personal

Guarantee was governed by Arizona law and contained an attorney's fees

clause providing for reasonable attorney's fees to the prevailing party in

any suit "to enforce any of its terms."

In 2008, BySynergy filed a chapter 11 bankruptcy case, which was

later converted to chapter 7. Ultimately, Douglass Enterprises's second-

position lien was wiped out by a senior lienholder and it received nothing

on its unsecured claim.

The Zitos then filed their individual chapter 11 bankruptcy case on

October 13, 2009. They did not list Douglass Enterprises or the Personal

Guarantee debt on their bankruptcy schedules. They received a discharge

on October 9, 2012.

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 In April 2013, Douglass Enterprises filed suit against the Zitos in the

Arizona state court for breach of the Personal Guarantee. The Zitos

reopened their individual chapter 11 case and sought a determination from

the bankruptcy court that the Personal Guarantee debt had been

discharged. After trial, the bankruptcy court found that the Zitos had failed

to establish that Douglass Enterprises had notice or actual knowledge of

the case in time to file a timely proof of claim. Accordingly, the debt was

not discharged under § 523(a)(3)(A). A judgment was entered to that effect

on September 7, 2018, which the Zitos appealed.2

Douglass Enterprises then moved for $207,210.85 of attorney's fees

and costs incurred in the § 523 action ("Fee Application"). Douglass

Enterprises maintained that it was entitled to such an award because the

Personal Guarantee provided for the recovery of attorney's fees and costs

to the prevailing party. The Zitos opposed the Fee Application. They

argued that, because the § 523 action involved only a question of

bankruptcy law — i.e., whether the debt owed to Douglass Enterprises was

discharged under § 523(a)(3)(A) — and did not address the enforceability

of the contract under state law, attorney's fees were not recoverable under

the Personal Guarantee or Arizona law. Because the underlying contractual

matter was yet to be litigated in the state court, the Zitos argued that the

2
We are concurrently issuing an affirmance in that appeal. See BAP No. AZ-18-
1236-BFL.

4
issue of attorney's fees could be addressed there, should Douglass

Enterprises prevail in that litigation.

After a hearing, the bankruptcy court announced its oral ruling

granting the Fee Application. The court reasoned that, even though the

§ 523 action involved the determination of whether the debt was

discharged under bankruptcy law, it "really turned into a factual case, not

an issue of abstract bankruptcy law, . . . but what the facts were and the

facts were such that I concluded the claim was not discharged." The court

opined that the Zitos' § 523 action "was an attempt to short-circuit Arizona

Superior Court litigation that was pending against them as well."

The bankruptcy court entered a judgment in favor of Douglass

Enterprises and against the Zitos for attorney's fees and costs in the

requested amount of $207,210.85 plus interest ("Fee Judgment"). The Zitos

timely appealed. While this appeal was pending, Douglass Enterprises

filed a Notice of Partial Satisfaction, after the Zitos alerted Douglass

Enterprises that the Fee Judgment inadvertently contained fees awarded in

prior sanctions orders and paid by the Zitos. Accordingly, the amount

owed on the Fee Judgment is now $184,210.35.

II. JURISDICTION

The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and

157(b)(2)(I). We have jurisdiction under 28 U.S.C. § 158.

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 III. ISSUE

Did the bankruptcy court err by awarding Douglass Enterprises its

attorney's fees and costs for defending the § 523(a)(3)(A) action?

IV. STANDARDS OF REVIEW

We review a bankruptcy court's determination on attorney's fees for

abuse of discretion. Bertola v. N. Wisc. Produce Co. (In re Bertola), 317 B.R. 95,

99 (9th Cir. BAP 2004). A bankruptcy court abuses its discretion if it applies

the wrong legal standard, or misapplies the correct legal standard, or if its

factual findings are clearly erroneous. United States v. Hinkson, 585 F.3d

1247, 1262 (9th Cir. 2009) (en banc). The bankruptcy court's decision to

award attorney's fees under § 523 and under Arizona law is an issue of law

that we review de novo. In re Bertola, 317 B.R. at 99.

V. DISCUSSION

A. The bankruptcy court did not err in determining that Douglass
Enterprises would be entitled to its attorney's fees and costs for
defending the § 523(a)(3)(A) action, but it did err by awarding them
prematurely.

The Zitos argue that the bankruptcy court erred by awarding

attorney's fees to Douglass Enterprises based on the Personal Guarantee.

They contend that such fees were not recoverable because the only issue

before the court was whether the Personal Guarantee debt had been

discharged under § 523(a)(3)(A); that action did not address the

enforceability of the contract.

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 Under the "American Rule," prevailing parties in federal court are not

ordinarily entitled to attorney's fees unless authorized by contract or

statute. Alyeska Pipeline Serv. Co. v. Wilderness Soc'y, 421 U.S. 240, 257 (1975).

The Code does not provide a general right to recover attorney's fees.

Heritage Ford v. Baroff (In re Baroff), 105 F.3d 439, 441 (9th Cir. 1997). The Fee

Judgment is silent as to what authority the bankruptcy court relied upon

for its ruling. Its oral ruling is also not clear. We cannot tell whether the

court awarded fees and costs based on the contract or an Arizona statute.

For their argument, the Zitos rely on In re Baroff, Fobian v. West Farm

Credit Bank (In re Fobian), 951 F.2d 1149 (9th Cir. 1991), Johnson v. Righetti

(In re Johnson), 756 F.2d 738 (9th Cir. 1985), and Collingwood Grain, Inc. v.

Coast Trading Co. (In re Coast Trading Co.), 744 F.2d 686 (9th Cir. 1984). The

Fobian line of cases has been abrogated by the Supreme Court in Travelers

Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. 443 (2007).

However, Travelers does not govern here either. As we noted in Fry v.

Dinan (In re Dinan), 448 B.R. 775, 785 (9th Cir. BAP 2011), "while Travelers

supports the proposition that an unsecured creditor may assert a

postpetition claim against the estate for attorney's fees if governing

contracts and state law permit such fees, such cases apply to claims against

the estate, not to nondischargeable claims against the debtor. In

nondischargeability actions, Cohen [v. de la Cruz, 523 U.S. 213 (1998)]

applies." We further recognized in AT&T Universal Card Services Corp. v.

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Pham (In re Pham), 250 B.R. 93, 99 (9th Cir. BAP 2000), that the general rule

in Baroff and American Express Travel Related Services Co. v. Hashemi (In re

Hashemi), 104 F.3d 1122 (9th Cir. 1997), no longer retained any vitality in

nondischargeability actions in light of Cohen. Baroff and Hashemi held that

whether fees may be awarded in bankruptcy proceedings generally

depends on whether the case involves state or federal claims and whether

the applicable law allows such fees. In re Baroff, 105 F.3d at 441; In re

Hashemi, 104 F.3d at 1126-27. See also In re Bertola, 317 B.R. at 99-100

(upholding award of attorney's fees under § 523(a)(6) based on Cohen).

In Cohen, the Supreme Court held that the discharge exception under

§ 523(a)(2)(A) applies to all liability arising on account of a debtor's

fraudulent conduct, including attorney's fees and costs. 523 U.S. at 223

(because creditors were entitled to treble damages and attorney's fees and

costs under a state statute for debtor's fraudulent conduct, the entire debt

was nondischargeable, including the attorney's fees and costs). Cohen is not

limited to cases under § 523(a)(2)(A). The Supreme Court indicated that its

holding would apply to nondischargeability cases under other paragraphs

in § 523 as well, such as (a)(1), (a)(4), (a)(6), and (a)(9). Id. at 219-20. See also

Correia–Sasser v. Rogone (In re Correia-Sasser), BAP No. AZ-13-1461-KiTaPa,

2014 WL 4090837, at *13 (9th Cir. BAP Aug. 19, 2014) (applying Cohen to

§ 523(a)(4)); In re Bertola, 317 B.R. at 100 (applying Cohen to § 523(a)(6)). We

have also applied Cohen to § 523(a)(14). See In re Dinan, 448 B.R. at 786.

8
Although we could not locate a case where a court has applied or refused

to apply Cohen to § 523(a)(3), we see no logical reason why its holding

would not extend to § 523(a)(3). See Brown v. Link (In re Link), 538 B.R. 783,

792 (Bankr. E.D. Mo. 2015) (reasoning that Cohen applies to any exception of

a debt from discharge under § 523(a)). Cohen is also not limited to

attorney's fees awarded under state or federal statutes; it applies equally to

cases in which fees are provided for by contract. In re Dinan, 448 B.R. at 786

(citing Redwood Theaters, Inc. v. Davison (In re Davison), 289 B.R. 716, 725 (9th

Cir. BAP 2003)).

“[U]nder Cohen, the determinative question for awarding attorney's

fees is whether the creditor would be able to recover the fee outside of

bankruptcy under state or federal law.” Id. at 785 (citing Levitt v. Cook (In re

Levitt), BAP No. AZ–07–1166, 2008 WL 8448069, at *6 (9th Cir. BAP July 22,

2008); In re Bertola, 317 B.R. at 99–100; Kilborn v. Haun (In re Haun), 396 B.R.

522, 528 (Bankr. D. Idaho 2008)). The entire basis for the debt the Zitos

sought to have discharged under § 523(a)(3)(A) was the Personal

Guarantee, a contract governed by Arizona law.3 It contains an attorney's

fee clause which states:

3
Under Arizona law, "[a] contractual provision for attorneys' fees will be
enforced according to its terms. Unlike fees awarded under A.R.S. § 12–341.01(A), the
court lacks discretion to refuse to award fees under the contractual provision." Chase
Bank of Ariz. v. Acosta, 880 P.2d 1109, 1121 (Ariz. Ct. App. 1994) (internal citations
omitted). Thus, if a contractual provision states fees will be awarded to the prevailing
party, the court must award fees.

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 In the event suit is brought by any party under this Personal
Guarantee to enforce any of its terms, it is agreed . . . that the
prevailing party shall be entitled to reasonable attorneys' fees in
said suit, or in any appeal therefrom, to be fixed by the Court.

Douglass Enterprises was seeking to enforce the terms of the Personal

Guarantee against the Zitos with its breach of contract action in the state

court. For reasons not entirely clear, that matter was stayed so the Zitos

could seek a determination from the bankruptcy court on whether the

Personal Guarantee debt had been discharged in the Zito's chapter 11

bankruptcy case. However, the state court had concurrent jurisdiction to

decide that issue and was not required to apply a stay. See Rein v. Providian

Fin. Corp., 270 F.3d 895, 904 n.15 (9th Cir. 2001) (bankruptcy courts and

state courts have concurrent jurisdiction over all nondischargeability

actions except those brought under § 523(a)(2), (4), (6) and (15)).

Litigation relating to the enforcement of the Personal Guarantee falls

under the attorney's fees clause, and the prevailing party in such litigation

is entitled to reasonable fees. The Zitos' § 523(a)(3)(A) action was

essentially litigating an affirmative defense to the enforceability of the

Personal Guarantee. The bankruptcy court determined that the Personal

Guarantee debt was not discharged, and we have affirmed that ruling. But

the § 523(a)(3)(A) action was only part of the litigation between the parties.

The Arizona state court has yet to determine whether the Personal

Guarantee is enforceable against the Zitos under state law. Because that

10
litigation is still pending, there is no "prevailing party" as of yet.

While we agree that Douglass Enterprises was the prevailing party in

the § 523(a)(3)(A) action and entitled to an award of fees and costs per the

contract and Cohen, the award was premature. It would be an inequitable

result for the Zitos to have to pay those fees and costs if Douglass

Enterprises ultimately loses at the state court.4 Therefore, we believe the

bankruptcy court erred by prematurely awarding Douglass Enterprises its

attorney's fees and costs. However, should Douglass Enterprises prevail in

the state court litigation, that court should include in its award the amount

of the Fee Judgment, which is now $184,210.35.

VI. CONCLUSION

For the reasons stated above, we REVERSE.

4
While the Zitos appear to contest on appeal the reasonableness of the fees, we
decline to consider this argument since it was never raised before the bankruptcy court.
See Smith v. Marsh, 194 F.3d 1045, 1052 (9th Cir. 1999) (generally, appellate courts will
not consider arguments raised for first time on appeal).

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