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In re CWS Enterprises, Inc.

United States Court of Appeals, Ninth Circuit

September 14, 2017

In re CWS Enterprises, Inc., Debtor,
Charles W. Siller, Defendant-Appellant, Spiller McProud, Plaintiff-Appellee, and David D. Flemmer, Chapter 11 Trustee; CWS Enterprises, Inc., Defendants. IN RE CWS ENTERPRISES, INC., Debtor, SPILLER MCPROUD, Plaintiff-Appellee,
CWS ENTERPRISES, INC.; CHARLES W. SILLER, Defendants, and DAVID D. FLEMMER, Chapter 11 Trustee, Defendant-Appellant.

          Argued and Submitted October 21, 2016 San Francisco, California

         Appeal from the United States District Court for the Eastern District D.C. Nos. 2:10-cv-00779-KJM 2:10-cv-00780-KJM 2:12-cv-00142-KJM of California Kimberly J. Mueller, District Judge, Presiding

          Bradley A. Benbrook (argued) and Stephen M. Duvernay, Benbrook Law Group PC, Sacramento, California; David A. Cheit, DLA Piper LLP (US), Sacramento, California; for Defendant-Appellant David D. Flemmer.

          Randy Michelson (argued), Michelson Law Group, San Francisco, California, for Defendant-Appellant Charles W. Siller.

          Steven T. Spiller (argued), Spiller McProud, Nevada City, California; Walter R. Dahl, Dahl Law, Sacramento, California, for Plaintiff-Appellee Spiller McProud.

          Before: Andrew J. Kleinfeld and Milan D. Smith, Jr., Circuit Judges, and Edward R. Korman, [*] District Judge.

         SUMMARY [**]


         The panel affirmed the district court's reversal of the bankruptcy court's decision reducing a claim for pre-petition attorneys' fees pursuant to 11 U.S.C. § 502(b)(4), which limits claims for services rendered by the debtor's attorney to the extent that such claims exceed the reasonable value of such services.

         Agreeing with the Tenth Circuit, the panel held that section 502(b)(4) acts as a federal cap on a fee already determined pursuant to state law. The proper mode of analysis is: (1) an acknowledgment or determination that the fee contract was breached; (2) an assessment of the damages for the breach under state law; (3) a determination under section 502(b)(4) of reasonableness of the damages claim afforded by state law; and (4) a reduction of the claim by whatever extent, if any, it is deemed excessive. The panel held that it is error for a bankruptcy court to bypass this analysis and determine for itself in the first instance a reasonable contingent fee using the lodestar method.

         Agreeing with the Third Circuit, which analyzed section 502(b)(7), the panel held that the bankruptcy code's reasonableness cap limits a pre-petition obligation for a debtor's attorneys' fees, even if such fees were allowable under state law, and even if such fees had been reduced to a state court judgment.

         The panel held that the bankruptcy court was required to give full faith and credit to a state court's judgment, confirming an arbitration award and entitling the attorneys to their fees, to the same extent that California res judicata law would give that judgment preclusive effect. The panel affirmed the district court's conclusion that issue preclusion applied because the arbitration proceeding establishing the reasonableness of the fees was fully contested and later confirmed by the judgment of a California court. The panel held that, although there might in some cases be room for a reduction, under section 502(b)(4)'s reasonableness cap, of a state court judgment confirming an arbitration award for a contingent fee, there was no room in this case because the relationship between the contracted-for amount the service the attorneys provided was not such as to make enforcement of the contract or payment of the fee unreasonable.


          KLEINFELD, Senior Circuit Judge.

         We address the bankruptcy code's provision on claims for pre-petition attorneys' fees, 11 U.S.C. § 502(b)(4).


         Charles Siller has been litigating with his brothers over his interest in the family business since 1982. The family business, Siller Brothers, Inc., held among its assets some 500 pieces of real estate, and Siller owned 40% of the stock. By 2001, Siller Brothers, Inc. had obtained a $10 million judgment against Siller, and it was threatening to execute on his shares. To fight this litigation, Siller retained several law firms at various times.

         In 2001, Charles Siller hired the law firm Cotchett, Pitre & Simon[1] to represent him both in his lawsuit with his brothers and a legal malpractice dispute with some of his former lawyers. The Cotchett firm agreed to a contingent fee of 28% of the net settlement or trial award after subtraction of a $10 million judgment against Siller in favor of his brothers. The engagement agreement said that Siller was "without funds to pay hourly fees." The arbitration provision, initialed by Siller when he signed it, stated that "any dispute" relating to the fee agreement or the Cotchett firm's performance of services would be submitted to arbitration.

         Two and a half years later, Siller retained the Spiller • McProud law firm. Siller hired the Spiller firm "not as additional trial attorneys, but to assist, advise and discuss these legal matters personally" with Siller, and to act as "an interface" for Siller "with the attorneys at the Cotchett law firm." The Spiller firm was to work to ensure that Siller could "fully understand and [be] in agreement with the Cotchett law firm's trial strategy, trial preparation (including selection of experts), and conduct of the trial itself." The Spiller firm was to serve as Siller's "general counsel" and "to communicate to the Cotchett law firm [Siller's] ideas, suggestions, and requests."

         Siller wanted Spiller • McProud to convince the Cotchett firm to pursue a theory that Siller's brother's death entitled Siller to purchase his brother's shares for a small fraction of what they were worth, under a separate contract Siller had with his deceased brother. The Spiller firm agreed, but Siller and the Spiller firm expressly agreed that the contingent fee would not depend on the success of this theory. The Spiller firm was to get 8% of the same net amount from which the Cotchett firm's 28% contingent fee was to be calculated. Siller and the Spiller firm also incorporated the other terms of Siller's agreement with the Cotchett firm, including the arbitration provision.

         The Cotchett firm, consulting with the Spiller firm, won Siller's case against Siller Brothers, Inc. After a failed mediation and a stay of execution on Siller Brothers, Inc.'s $10 million judgment against Siller, the case went to trial in California Superior Court. The judge issued a proposed judgment valuing Siller's shares at over $56 million. Pending appeal and cross appeal, the parties settled for $10 million cash to Siller and $20.5 million worth of real estate in exchange for Siller's shares. Consistent with Siller's fee agreements with the firms, the contingent fees were to be based upon the $30.5 million value of the settlement. Documentation was delayed while Siller's counsel, working with tax experts, created for Siller a new corporate spinoff, CWS Enterprises, Inc., so that Siller could mitigate the tax impact of his lawyers' victory.

         The firms also tried other cases that Siller insisted on. While the dissolution case was ongoing, the Cotchett and Spiller firms filed a separate action against Siller Brothers, Inc. and pursued Siller's preferred theory (that Siller had acquired a right to buy his deceased brothers' shares cheaply under a separate contract). They lost that case. The two firms also lost a malpractice case Siller brought against one of his previous lawyers, and they negotiated a $41, 000 settlement in another case where Siller had refused to pay a different set of previous lawyers. (Siller then refused to pay even the $41, 000 settlement, so those disputes remained pending after he moved on from the Cotchett and Spiller firms.)

         Nor would Siller pay the 28% and 8% fees he had agreed to pay the Cotchett and Spiller firms, respectively. Siller's failure to pay the Spiller firm its 8% contingent fee is the subject of the appeal before us. Siller and the two firms arbitrated the fee dispute before a retired state judge acting as arbitrator, presenting two days of testimony and extensive argument.

         Every aspect of the arbitration, including whether it should take place, was hotly contested. Despite his agreement to arbitrate "any dispute, " Siller refused to do so until the Superior Court denied his ex parte application to prevent such arbitration. Siller then continued his attempt to evade arbitration by way of unsuccessful motions in limine before the arbitrator.

         During the arbitration, Siller's counsel led off his cross examination of the attorneys' lead witness, Mr. Pitre of Cotchett, Pitre, by asking what his and his associates' hourly rates were. Siller's lawyer then asked why they had contracted for a contingent fee. Pitre replied, "Because Mr. Siller didn't have any money, " so the attorneys would have to be paid "[o]ut of a recovery, hopefully." The lawyers advanced about $400, 000 in expenses, as well as their time and effort. Pitre was initially reluctant to pursue the case against Siller's deceased brother under the buy-sell agreement (the theory under which Siller would buy his brother's shares for a valuation price that was a small fraction of what the shares were worth) because he doubted that agreement's enforceability. But, as Spiller had agreed to do in his retainer agreement, he consulted with Pitre and came up with a theory that the two firms could advance with a straight face. (They lost that portion of the case, as they did the malpractice case Siller had started against one of his previous lawyers.)

         As Siller's attorney presented his case during the arbitration, (1) the real estate accounting for two thirds of the settlement had declined in value since the settlement, so if a contingent fee applied at all, it should be against much less than the $30.5 million; (2) the value of the legal services was far less than the contingent fee would yield; (3) much of the work, including the failed lawsuits against the deceased brother's estate and the failed lawsuit against one of Siller's previous attorneys, produced no value, so the attorneys should not be compensated for it; (4) Spiller had participated actively in the successful trial, but had only been retained as "general counsel" to consult, so he ought not to be compensated for any of that time; and (5) the money went to the spinoff created for Siller to avoid taxes, not to Siller, and the spinoff had not signed the fee agreement, so no fees were due.

         Siller's case focused largely on the reasonable value of the Cotchett and Spiller firms' respective services, both as an alternative to the contingent fee agreement and as justification for not holding him to his contingent fee agreement. Siller's attorney urged the arbitrator to limit compensation to "the reasonable value of the services rendered" because the Cotchett and Spiller firms had "failed to fulfill" their contracts. He argued that "[i]f you have a breach of contract then the answer's in quantum meruit." "And even if it's a contract, the law says you must prove reasonable value of the services, and that goes to the performance." Siller's attorney argued that the hours were also relevant to "the issue of conscionability." "[T]he conscionability of this fee will be determined also based upon . . . [the] hours they devoted to matters that they failed to bring to conclusion through their own errors, " referring to the unsuccessful malpractice case against one of Siller's prior lawyers.

         The Cotchett and Spiller firms objected to all this evidence, which was the bulk of Siller's case, on the theory that evidence as to quantum meruit was not necessary in a breach of contract action. But they conceded that Siller could "inquire about the amount of time put into the matters . . . the time for their quantum meruit, " because it was an issue the arbitrator could reach if he deemed the contract void.

         Siller's attorney pointed out that the arbitrator had not yet ruled on whether the contingent fee agreement was binding, so "quantum meruit is still an issue." He argued that if the contract was not deemed to be binding, then quantum meruit would determine the proper amount of the fee, and even if the contract were binding, counsel would still have to show a reasonable effort to justify the amount of the fee under state bar rules. So "[u]ltimately this comes down to hours, " Siller's attorney argued, which apparently is why Siller's presentation was largely a challenge to how many hours ought not to be compensated because they were either not contracted-for or led to no success.

         The arbitrator overruled the Cotchett and Spiller firms' objections and let in all of Siller's evidence going to the value of the attorneys' services, including evidence concerning the reasonableness of the attorneys' contingent fees, the hours the attorneys worked, and the reasonableness of the time they spent relative to the results (except for some details regarding valuation of the parcels of real estate they won for Siller), evidently because that evidence might bear on quantum meruit or unconscionability if the arbitrator decided the case on either basis.

         Spiller testified that he put in 1, 760 hours and that his usual rate was $250 per hour. He and Pitre had told Siller that the actions to enforce the buy-sell agreement and for legal malpractice were likely to be unsuccessful (and they were), but Siller insisted on pursuing them anyway.

         After hearing all of this testimony and argument, the arbitrator chose to view the case as a claim on a contract, the written fee agreements. He concluded that the fee agreements were not unconscionable, that they were "reasonable, " and that the two firms were entitled to every penny of the fees they and Siller had agreed to, as well as the expenses the firms had advanced on Siller's behalf. The Cotchett firm and Siller have since settled, so we need discuss only the Spiller firm's claim.

         The arbitrator found that Siller provided extensive advice almost daily for the three years of the litigation, working "full bore" for "over 1, 760 hours on Siller's behalf." (The dispute had been litigated through multiple trials and proceedings in multiple courts on multiple theories, including Siller's disputes with several of his former attorneys.) The arbitrator also concluded that, as Siller himself admitted in his testimony, he had hired Spiller to assist trial counsel, not just to advise.

         The arbitrator wrote a detailed, 26-page, single-spaced opinion explaining his decision. After rejecting Siller's theories for why the arbitration should not proceed, and why it should not bind CWS (the corporate spinoff created so that Siller could avoid taxes on his $30.5 million settlement), the arbitrator made findings of fact regarding the fee agreements. He found that Spiller "worked . . . alongside [the Cotchett lawyers] on all litigation." As for Siller's contention that Spiller was not supposed to do that, just act as his "general counsel" to advise and inform him and the Cotchett firm, the arbitrator found otherwise. "Siller testified that he hired Spiller to 'help Frank [Pitre] and not just to advise . . . although Spiller did provide Siller with extensive advice about the progress of the litigation on an almost daily basis throughout three years of representation." The arbitrator further found that Spiller spent less than 5% of his time on the unsuccessful malpractice litigation against one of Siller's previous lawyers and sought no fees for that work.

         As for not completing the contract, the arbitrator credited Spiller's contention that Siller fired his lawyers "hoping to avoid paying his now former counsel" by "actions clearly designed to avoid payment of his legal obligations attendant to the extraordinary result obtained, " a $30.5 million settlement on a $45.7 judgment obtained after years of representation in complex litigation.

         The critical question for this appeal, as argued on Siller's behalf, is whether the arbitrator resolved only the issue of whether the contingent fee was unconscionable as applied to the $30.5 million result, or whether the arbitrator also determined the reasonable value of the legal services performed. The transcripts show, and the arbitrator found, that Siller's attorney "devoted most of his cross examination to a detailed attack on how Mr. Pitre and Mr. Spiller spent their time on the case, on the theory that the Arbitrator might find the contract to be unconscionable (it is not) and that quantum meruit would be relevant." The arbitrator concluded, though, that quantum meruit was not relevant because the contingent fee agreement was a valid contract. He expressly found that the contracted-for percentages were "reasonable" based on the work put into the case, the risks, and the need for counsel to finance the litigation.

         Siller did not pay what the arbitrator concluded he owed, so the Cotchett and Spiller firms sought and obtained confirmation of the award in California Superior Court. The Superior Court entered a money judgment in their favor for the amount of the award. But Siller did not pay the judgment, either; instead, he prevented its execution by filing for chapter 11 bankruptcy.

         The bankruptcy court took a fresh look at the "reasonable value" of Spiller's services under section 502(b)(4) and applied a lodestar approach, multiplying Spiller's hourly rate by those hours that the bankruptcy court adjudged to be productive on the portions of the litigation on which Spiller was successful. Using this approach, the bankruptcy court concluded that Spiller's fee was unreasonably high and should have been $440, 250 (rather than the arbitrator's figure of just under $2.5 million).

         The bankruptcy court's view was that there were "two tiers of reasonableness scrutiny, " first under state law, which if not satisfied required disallowance of the claim as "unenforceable, " and then under bankruptcy law, independently of state standards. The bankruptcy court did not articulate what the federal standard of reasonableness was, just that it was not necessarily satisfied by reasonableness under state standards. As the bankruptcy court saw it, the arbitrator had not determined reasonableness because he merely conducted a contract analysis under the contingent fee agreement. Responding to the attorneys argument that full faith and credit should be given to the Superior Court judgment, the bankruptcy court held that "as a matter of the Supremacy Clause, and regardless of the state preclusion law, the state-court judgment based on state law cannot trump the specific provision in Bankruptcy Code 502(b)(4)." As for claim and issue preclusion, the bankruptcy court's view was that since section 502(b)(4) of the bankruptcy code could not have been raised in the arbitration (because Siller had not yet filed for bankruptcy), the claim arbitrated did not involve the same "primary right." The bankruptcy court thus could determine reasonableness on a clean slate without taking account of the arbitration award and the California Superior Court judgment.

         The district court, on the Spiller firm's appeal, reversed. The controlling determination in the district court decision was that "the similarity between the standard for determining the unconscionability of a contingent fee agreement, which was before the arbitrator, and the bankruptcy court's standard for determining the reasonable value of the fees suggests that the issue of an appropriate fee for appellant's work was necessarily determined and actually litigated in the formal arbitration that took place here." The district court noted that the bankruptcy court "did not consider the transcript of the arbitration proceedings in determining what was before the arbitrator." The district court did consider the transcript to see whether reasonableness was at issue. It noted that Siller's position in the arbitration, fully litigated, was that, despite a contingent fee agreement, the attorneys still had to prove "reasonable effort . . . to justify the fee." The arbitrator heard evidence about the time spent and the complexities and risks of the litigation, not just the contract itself, and evaluated all of these factors for reasonableness. The district court concluded that "[b]y considering both the reasonable nature of the contingent fee contracts and rejecting the claim that the contracts were unconscionable, and applying California's tests for both determinations, the arbitrator necessarily decided that the fees were reasonable within the contemplation of § 502(b)(4)."

         After a trial in the bankruptcy court, Siller and the trustee argued in a second appeal to the district court that the issues adjudicated by the arbitrator were not "identical, " as required by California res judicata law, to the reasonableness determination under the bankruptcy code, so the judgment confirming the arbitration award should have no preclusive effect. But the district court, based on the arbitration transcript and arbitrator's decision, found that "the arbitrator determined that Spiller's fees were not unconscionable applying a test equivalent to the federal reasonableness test, " so the California Superior Court judgment was entitled to preclusive effect. Because the case required no further proceedings in bankruptcy court once the amount of Spiller's claim was liquidated, and because that condition had occurred, the district court held that Spiller was entitled to the full amount of his claim as adjudicated.

         Siller and his new spinoff corporation appeal.


         Two statutes are at issue in this case, the bankruptcy code's provision on claims for pre-petition attorneys' fees, 11 U.S.C. § 502(b)(4), and the Full Faith and Credit Act, 28 U.S.C. § 1738. The first limits ...

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