In re Zito

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

          Appeal from the United States Bankruptcy Court for the District of Arizona Honorable George B. Nielsen, Jr., Bankruptcy Judge, Presiding

          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.

          OPINION

          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 11^[1] 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 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.

         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 ...