Southside, LLC v SunTrust Bank (In re Southside, LLC), 520 B.R. 914 (Bankr. N.D. Ga. 2014) –

A debtor objected to attorney fees included in the proof of claim filed by a mortgagee, and the mortgagee moved for relief from the automatic stay to exercise its rights under a security deed securing the debtor’s guaranty based in part on the debtor’s lack of equity in the property.

The lender’s proof of claim initially included attorney fees of $275,000 (15% of the outstanding principal and interest as of the petition date).  It was later amended to claim ~$184,000 in attorney fees (based on a statutory formula of 15% of the first $500 of outstanding principal and interest and 10% of the excess).  The lender acknowledged that actual fees were ~$149,000.

The debtor objected, arguing that the lender was limited to reasonable actual fees.  In particular, the debtor had guaranteed a note, and an addendum to the note stated: “Notwithstanding anything to the contrary contained within the Note or other Loan Documents … any reference to attorney fees accrued to the account of the Borrower or any Guarantor shall be limited to reasonable attorneys’ fees actually incurred.”

However, the preprinted security deed signed by the debtor stated that it secured all costs of collections “including attorneys’ fees in the amount of fifteen percent (15%) of the indebtedness and obligations secured thereby, if collected by law or through an attorney-at-law or in bankruptcy or other judicial proceedings.”  The guaranty contained a similar provision.

To complicate matters, the parties also entered into a forbearance agreement and an amended forbearance agreement.  Both provided that the lender was entitled to its “reasonable attorneys’ fees and costs incurred at all trial, appellate, and bankruptcy cases or proceedings,” but also noted that the rights under the forbearance agreements were in addition to, and not in lieu of, rights under the other loan documents.

The court noted that the debtor had not executed the note or the addendum limiting attorneys’ fees, but before deciding whether the lender’s claim was properly for actual attorney fees or based on a percentage formula, the court turned to the debtor’s argument that the lender was not entitled to collect any attorney fees because it failed to comply with state law requirements for collection.

Under the applicable state statute, a lender is authorized to provide for attorney fees equal to a specific percentage of the outstanding principal and interest of up to 15%.  Alternatively, if the evidence of indebtedness provides for “reasonable attorneys’ fees” without including a specific percentage, it will be construed to mean 15% of the first $500, and 10% of the excess outstanding balance.

Procedurally, in order to collect fees the lender or its attorney must provide written notice after maturity of the obligation of the intent to enforce payment of attorneys’ fees.  To comply with the statute, the notice must “(1) be in writing; (2) to the party sought to be held on the obligation; (3) after maturity …; (4) [stating] that the contractual attorneys’ fees provisions will be enforced; and (5) [stating] that the party has 10 days from the receipt of such notice to pay the principal and interest without the attorney fees.”  If the debt is paid in full within the 10 days, the obligation to pay attorney fees will be void.

The lender contended that it sent two notices that satisfied the statute.  However, the first notice was sent to an attorney who did not represent the debtor.  Although the attorney served as a contact person for another non-debtor party, he did not represent that party nor the debtor in connection with the loan transactions.  Notice to an attorney can be construed as notice to a client if the attorney in fact represents the client and the notice comes within the subject matter of employment.  So, under the circumstances, the first notice could not be imputed to the debtor and thus did not satisfy the statutory requirements.  The second notice was sent after the debtor filed bankruptcy.  Consequently, the automatic stay prevented any action to recover a pre-petition claim so that the second notice was void.

Since the lender failed to provide the notice required by statute, the claim for fees was unenforceable under state law, and therefore the claim with respect to pre-petition attorney fees was disallowed under Section 502(b)(1) of the Bankruptcy Code.  However, with respect to post-petition fees, Section 506(b) allows an oversecured creditor to claim “reasonable fees, costs, or other charges provided for under the agreement.”  Since the agreement provided for attorney fees incurred in bankruptcy proceedings, the court determined that the claim for post-petition fees would be allowed under Section 506(b).

With respect to the lender’s request for relief from the automatic stay, the lender had asserted that the property value was $2.1 million.  Based on its original claim of $2,113,987, the debtor did not have any equity in the property.  However, once the pre-petition attorney fees were disallowed, its claim was only ~$1.85 million.  In other words, the consequence of losing on its claim for pre-petition attorney fees was that debtor had equity in the property, which justified denying the lender’s request for relief from the automatic stay.

There are a surprising number of local law quirks in documenting and enforcing mortgage loans.  This case illustrates that failing to comply with those quirks can have a cascading effect.  And lawyers giving “general” advice to a client in a multi-jurisdiction context need to be wary of these potential traps.