Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_04-cv-05100/USCOURTS-cand-3_04-cv-05100-0/pdf.json

Nature of Suit Code: 422
Nature of Suit: Bankruptcy Appeals Rule 28 USC 158
Cause of Action: 28:0158 Notice of Appeal re Bankruptcy Matter (BAP)

---

U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

U

nite

d

States District C

o

u

rt

For the Northern District of California

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

In re: AUREAL, INC., 

Debtor.

______________________________________/

NEXT FACTORS, INC.,

Appellant,

 v.

 AUREAL, INC.,

Appellee.

 /

No. C 04-05100 SI

ORDER PARTIALLY AFFIRMING

BANKRUPTCY COURT’S AWARD OF

ATTORNEYS’ FEES TO AUREAL’S

ESTATE REPRESENTATIVES

Having carefully considered the submitted papers, the Court hereby AFFIRMS the bankruptcy

court’s grant of attorneys’ fees in all respects, with the following exception: the Court REVERSES the

bankruptcy court’s grant of attorneys’ fees related to the administrative claim and REMANDS for

consideration of whether such fees are inextricably intertwined with fees related to the pre-petition

claim.

BACKGROUND

Prior to the commencement of this bankruptcy case, Aureal and Momentum Data Systems

entered into a written Software Development Agreement (“SDA”) for development of computer

software. The SDA contained a clause allowing the prevailing party in any dispute arising over the

interpretation or enforcement of the SDA to recover attorneys’ fees and costs. Appellant’s Excerpt of

Record (“ER”) Ex. 8 at 18. 

On April 5, 2000, Aureal filed a voluntary petition for Chapter 11 bankruptcy. Shortly thereafter,

Aureal sold substantially all of its assets to Creative Technologies, Ltd. (“Creative”). Upon learning of

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 1 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

1

 A pre-petition claim is a claim submitted during bankruptcy proceedings by a party owed some

payment or performance by the party petitioning for bankruptcy. The claim is designated a pre-petition

claim because the debt was incurred and outstanding before the bankruptcy petition was filed. In this

case, Momentum filed a claim asserting that Aureal owed $104,000 on an executory contract and

Momentum held no security on that debt. See 1-1COLLIER ON BANKRUPTCY § 1.03(4)(B)(15th ed., rev.

2005).

2

 An administrative claim is a claim submitted by a creditor when an executory contract between

the debtor and the claimant is assumed by the debtor’s bankruptcy estate, but subsequently is breached

by the estate. The claimant then has an administrative claim for damages arising from that breach. See

1-1 COLLIER ON BANKRUPTCY § 1.03(4)(B) (15th ed., rev. 2005).

2

Aureal’s bankruptcy petition, Momentum filed a proof of claim, asserting a general, unsecured claim,

or pre-petition claim,1 for $104,000. Aureal objected to all but four thousand dollars of the claim. On

October 16, 2000, Next Factors, Inc. (“Next”) purchased Momentum’s interest in the claim submitted

to Aureal’s bankruptcy estate.

In July 2001, Next filed an amended pre-petition claim on Momentum’s behalf in the amount

of $254,000 plus uncalculated pre-petition interest and royalties. Aureal objected to the claim. The

bankruptcy court issued a Memorandum of Decision in October 2001, disallowing certain portions of

Next’s pre-petition claim. See ER Ex. 7 at 11. It deferred ruling on other portions of the claim to allow

Next further opportunity for discovery. Id.

Next also filed an administrative claim2 for $25 million in royalties in September 2001. Next

later amended the administrative claim, changing the claim from $25 million to a claim for damages of

an unknown amount.

Two years after the bankruptcy court allowed Next to pursue further discovery, Aureal filed a

motion for summary judgment on Next’s remaining pre-petition claim and the administrative claim. In

December 2003, the bankruptcy court issued a Memorandum of Decision granting Aureal’s motion for

summary judgment. See ER Ex. 12 at 25.

On February 19, 2004, the estate representatives filed a request for recovery of attorneys’ fees

and costs associated with litigating Next’s claims. The request was for $174,781.50 in fees and

$1,887.64 in costs incurred through December 31, 2003, but the estate representatives reserved the right

to supplement their request to account for fees and costs incurred thereafter. The bankruptcy court

granted Aureal a substantial portion of its requested fees. See ER Ex. 17 at 15.

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 2 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

3

LEGAL STANDARD

In reviewing a bankruptcy court’s decision, the reviewing court examines findings of fact for

clear error and conclusions of law de novo. See In re Strand, 375 F.3d 854, 857 (9th Cir. 2004). A

bankruptcy court’s determination of attorneys’ fees will not be disturbed “unless the bankruptcy court

abused its discretion or erroneously applied the law.” Id.

DISCUSSION

Next brings five challenges to the bankruptcy court’s decision to grant the Aureal estate

representatives prevailing party attorneys’ fees. The Court will discuss each in turn.

1. The Bankruptcy Court did not err when it applied California law instead of federal

bankruptcy law

Cal. Civ. Code § 1717 provides:

In any action on a contract, where the contract specifically provides that attorney's fees

and costs, which are incurred to enforce the provisions of that contract, shall be awarded

either to one of the parties or to the prevailing party, then the party who is determined to

be the prevailing party, whether he or she is the party specified in the contract or not,

shall be entitled to reasonable attorney's fees in addition to costs and necessary

disbursements.

Cal. Civ. Code § 1717(a) (2005) (emphasis added). Next contends that the bankruptcy court’s award

of attorneys’ fees pursuant to California Civil Code § 1717 constituted clear error because the action

litigated was not one “on a contract,” as required by the language of Section 1717. Next further argues

that federal bankruptcy law is applicable, not state law. In contrast to California law, federal bankruptcy

law does not provide for a general right to recover attorneys’ fees. In re Larry’s Apt., L.L.C., 249 F.3d

832, 836 (9th Cir. 2001).

Next bases its argument on several cases in which the Ninth Circuit held that state laws

permitting recovery of attorneys' fees were inapplicable to the matter before the court. In In re Johnson,

756 F.2d 738 (9th Cir. 1985), the Ninth Circuit held that an action seeking relief pursuant to 11 U.S.C.

§ 362(d) that did not involve application of California law to any substantive issues could not support

a fee award pursuant to § 1717. See id. at 741. Next also cites In re Fobian, 951 F.2d 1149 (9th Cir.

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 3 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

4

1991), in which the Ninth Circuit held attorneys’ fees should not be awarded absent bad faith or

harassment in cases where the litigated issues are peculiar to federal bankruptcy law and are not issues

of basic contract enforcement. See Fobian, 951 F.2d at 1153.

In contrast to both Fobian and Johnson, however, Next’s pre-petition and administrative claims

did not involve issues peculiar to federal bankruptcy law. Next’s pre-petition claim was directly

dependent on the SDA, the interpretation of which is a matter of California law. See ER Ex. 7 at 4. The

bankruptcy court considered Next’s pre-petition claim for $104,000 pursuant to the fixed fee provision

in the SDA. Id. at 4-6. The court also considered whether the conditions of the SDA were sufficiently

proved by Next to support its claim for fixed fees. Id. With regard to Next’s pre-petition claim for

royalties, the court looked at the SDA to determine whether Aureal had, by its actions, amassed an

outstanding debt for payment of royalties. Id.

In December 2003, after continued litigation on Next’s remaining claim for royalties and Next’s

new amended administrative claim, the bankruptcy court expended a significant amount of effort

interpreting the SDA when considering Aureal’s motion for summary judgment. See ER Ex. 12. Next’s

royalties claim depended on the court’s interpretation of the SDA’s “release for sale” language. Id. at

22. At no time did the bankruptcy court indicate that it was applying federal bankruptcy laws to the

matter before it. The court’s memoranda indicate that the primary issue before it was whether Next's

claims were sufficiently based upon the terms and conditions of the SDA. 

The action from which Aureal’s motion for attorneys’ fees arises stemmed from Next’s claims

seeking enforcement of the SDA, thus requiring the court to interpret the SDA. The Ninth Circuit

recognizes that California Civil Code § 1717 authorizes the award of attorneys’ fees in any action on a

contract where the contract provides attorneys’ fees shall be awarded. See In re Baroff, 105 F.3d 439,

442-43 (9th Cir. 1997). California courts liberally construe the “any action on a contract” language. Id.

at 442. The bankruptcy court did not err when it applied California Civil Code § 1717 to award

attorneys’ fees to the prevailing party.

2. The Bankruptcy Court did not err in finding the SDA and its attorneys' fees clause

enforceable

Next appeals the bankruptcy court’s determination that the SDA’s attorneys’ fee provision is

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 4 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

3

 The SDA was rejected by Aureal’s estate representative pursuant to the third amended plan of

reorganization which provided that upon confirmation of the Plan on August 27, 2001, Aureal

effectively rejected any executory or unexpired lease to which it was a party that was not assumed or

assigned. See Becker Decl. in Supp. of Opp’n to Mot. for Attorneys’ Fees ¶ 5-7.

4

 In chapter 11 bankruptcy, after a petition for bankruptcy is filed and accepted, the petitioner

automatically becomes the debtor-in-possession. Once a reorganization plan for the debtor-inpossession is confirmed, a liquidating trustee is appointed to conclude the proceedings. If there are still

executory contracts outstanding, the trustee may assume or reject the agreement, subject to court

approval. If the trustee rejects the executory contract it is deemed breach and the non-debtor contracting

party has a pre-petition unsecured claim for breach of contract. If the contract is assumed by the trustee,

the trustee must perform according to the terms of the contract, otherwise the contract is breached, giving

rise to an administrative claim. An executory contract cannot be assumed without court approval. See

5

enforceable. At the bankruptcy court, Next argued that fairness prohibited the court from allowing

Aureal recovery of attorneys' fees pursuant to California Civil Code § 1717 when Next would have been

unable to recover pursuant to the SDA if it had prevailed on its claims. Before this Court, Next also

argues that Aureal’s rejection of the SDA resulted in the termination of the contract.3 Next maintains

that because the SDA was terminated, no provisions of the contract survive and the attorneys’ fee clause

is unenforceable. 

A. Fairness of allowing recovery under SDA

The bankruptcy court awarded Aureal prevailing party attorneys’fees pursuanttoCaliforniaCivil

Code § 1717. Section 1717 creates a reciprocal right to recovery of attorneys’ fees in a contract dispute

over a contract containing an attorneys’ fee clause, regardless of whether the attorneys’ fee clause

provision in the contract would have allowed for reciprocal recovery. See Slurry Seal v. Laborers Int’l

Union, 241 F.3d 1142, 1145 (9th Cir. 2001). The purpose of the statute is to broaden already existing

attorneys' fee clauses so as to even the playing field in cases where the provision is unilateral. Id. 

Next argues that it would have been unable to recover under the SDA because the bankruptcy

court found the SDA unenforceable in its October 2001 Memorandum of Decision regarding Next’s

claim for royalties. However, as the bankruptcy court discussed, Next misunderstood the court’s

explanation of Next’s inability to recover royalties based on the SDA. The bankruptcy court explained

that if the agreement had been assumed by the debtor-in-possession and then assigned to Creative and

if Creative subsequently sold boards containing software made by Momentum that was covered by the

SDA, then Next would have had a claim for royalties.4 Next produced no evidence that the SDA had

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 5 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28 1-1 COLLIER ON BANKRUPTCY § 1.03(4)(a) & (b) (15th ed., rev. 2005).

6

been assumed by the Aureal’s estate or assigned to Creative, nor did Next produce any significant

evidence that Creative sold any of the SDA software. 

After the bankruptcy court dismissed Next’s pre-petition claim for royalties, Next filed an

administrative claim for tort damages against Aureal based on wrongful disclosure. The bankruptcy

court denied that claim because Next failed to present sufficient evidence to establish a prima facie case

supporting the claim. There is no evidence that the court intended to eliminate all possible avenues of

recovery pursuant to the SDA.

B. Consequences of terminating the SDA

Next also argues that Aureal’s rejection of the SDA constituted a termination of the contract,

consequently barring Aureal’s recovery of attorneys’ fees based on the SDA. Aureal points out that the

SDA includes a provision providing for the survival of obligations located in the section of the SDA

headed “Terms and Termination.” The provision provides that “the following obligations shall survive

the termination of this agreement: . . . (ii) . . . all dispute resolution provisions.” See ER Ex. 8 at 18-19.

The attorneys’ fee clause of the SDA is clearly a dispute resolution provision, and the survival provision

makes clear that the attorneys’ fee clause is intended to remain enforceable despite termination of the

contract. Therefore, the attorneys’ fees provision is enforceable to allow Aureal’s recovery of attorneys’

fees. 

3. The Bankruptcy Court erred when it allowed recovery of fees related to litigation of Next’s

administrative claims

Next argues that neither California Civil Code § 1717, nor the attorneys’ fee provision in the

SDA is broad enough to include Aureal’s fees and costs expended litigating Next’s administrative claim.

The bankruptcy court agreed with Next that Aureal could not recover pursuant to Section 1717 because

its litigation of the administrative claim was not to “enforce” the SDA as the language of the statute

requires. ER Ex. 17 at 10-11. However, the court concluded that Aureal could recover if the services

in question were covered by section 8.7 of the SDA covering recovery of fees incurred to “interpret” or

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 6 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

7

“enforce” the SDA. The court concluded that this was indeed the case, pointing to its December 2003

decision to disallow the administrative claim as clearly interpreting the SDA. Id. at 10-11 (“Moreover,

the substance of the December 2003 Decision indicates that, in disallowing the administrative claim, the

Court did ‘interpret’ the SDA.”) 

Close examination of the December 2003 memorandum does not reveal where, in its discussion

of Next’s administrative claim, the bankruptcy court ever interpreted the SDA. Next’s administrative

claim sought damages based on Aureal’s alleged wrongful disclosure of software developed by

Momentum when Aureal sold its assets to Creative. See ER Ex. 12 at 24. The court disallowed this

claim based on insufficiency of the evidence proffered by Next to prove that disclosure had been made.

Id. at 24. Next’s sole piece of evidence on the alleged disclosure was a letter from a Next employee to

a Creative employee, the purport of which was not clear to the court. Id. at 24-25. The court also noted

that the asset purchase agreement between Aureal and Creative does not mention the Momentum

software. Id. at 24. It was error to characterize any of this analysis as constituting interpretation of the

SDA.

Aureal contends that even if Next’s administrative claim does not fall within the SDA attorneys’

fees provision, those fees should still be awarded since they are “inextricably intertwined” with fees

related to the pre-petition claim, relying on decisions that award fees incurred for representation on

issues common to causes of action in which fees were proper and in which they were not. However, the

bankruptcy court explicitly refused to rule on this question, and it must now be considered on remand.

4. The Bankruptcy Court did not err when it allowed Aureal to recover attorneys’ fees

owed to the estate representatives’s counsel

Next argues that California Civil Code § 1717 does not permit Aureal recovery of attorneys’ fees

owed to the estate representatives’ attorneys because no attorney-client relationship existed between

Aureal and those attorneys. The bankruptcy court found that Aureal was entitled to recover attorneys’

fees and costs incurred by counsel for the committee and the trustee of the estate, collectively called the

estate representatives. See ER Ex. 17 at 5-6.

Next’s primary argument is based on a 1995 California Supreme Court case, Trope v. Katz, 11

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 7 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

8

Cal. 4th. 274 (1995). Next argues, cites, and even quotes Trope as a case standing for the proposition

that the term “attorneys’ fees” implies the existence of an attorney-client relationship. But a thorough

reading of Trope does not reveal the passage that Next quotes and relies upon to support its argument.

What is instead found in Trope is the conclusion that an attorney who represents herself in propria

persona cannot recover attorneys fees as compensation for the time and effort she expends on her own

behalf. Trope, 11 Cal. 4th at 292. Trope is inapposite to the case at hand. 

Here, as the court below explained, Hennigan (counsel for Aureal), Bingham (counsel for the

committee), and Luce (counsel for the trustee) all represented the bankruptcy estate. See ER Ex. 17 at

6. All of those attorneys incurred fees litigating Next’s claims. The language of California Civil Code

§ 1717 makes clear that the prevailing party awarded attorneys’ fees need not be a stated party to the

contract. See Cal. Civ. Code § 1717. If Next had prevailed, the bankruptcy estate, not Aureal itself,

would have been responsible for paying attorneys’ fees under Section 1717. Conversely, here the

bankruptcy estate has prevailed, and it is entitled to recover from Next.

5. The Bankruptcy Court did not abuse its discretion when it found Aureal’s request for

attorneys’ fees reasonable

Next argues that the bankruptcy court failed to articulate its basis for concluding that Aureal’s

attorneys’ fees were reasonable. Reviewing the substantial proceedings associated with this case, the

Court is not troubled by relying on the bankruptcy court, which oversaw these proceedings from the

beginning. The bankruptcy court made clear that

[b]ased on the evidence and argument provided, the Court concludes that, for the most

part, Next should be required to pay the fees and costs requested by the three law firms.

. . . While narrative descriptions are frequently necessary to permit the Court to

determine whether services are reasonable, in this case, no such narrative is necessary.

The Court was a first hand witness to the conduct of the case. The Court is persuaded

that it was Next’s aggressive and unreasonable litigation strategy, not the Debtor’s, that

caused the costs of the litigation to skyrocket.

ER Ex. 17 at 14. This Court is satisfied that the bankruptcy court considered all relevant evidence and

arguments before finding the fees and costs reasonable to the extent that it did. There was no abuse of

discretion.

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 8 of 9
U

nite

d

States District C

o

u

rt

For the Northern District of California

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

9

CONCLUSION

For the foregoing reasons and for good cause shown, the Court hereby REVERSES the

bankruptcy court’s grant of attorneys’ fees related to the administrative claim, REMANDS for

consideration of whether such fees are inextricably intertwined with fees related to the pre-petition

claim, and AFFIRMS the bankruptcy court’s grant of attorneys’ fees to Aureal in all other respects

(Docket No. 1).

IT IS SO ORDERED.

Dated: July 25, 2006 

SUSAN ILLSTON

United States District Judge

Case 3:04-cv-05100-SI Document 35 Filed 07/25/06 Page 9 of 9