The classification of claims and interests in a Chapter 11 bankruptcy case is governed by Section 1122 of the Bankruptcy Code. The ability of a plan proponent to group certain claims in certain categories is a powerful tool in the confirmation process, since it can have a direct effect on the voting and objection process. Continue reading
Adversary proceedings can be used to dispute, remove, or contest liens. The validity of a lien can be disputed by a trustee or a Chapter 11 debtor in possession under several of the various “avoidance” sections of chapter 5 of the Bankruptcy Code. For example:
There are some situations in which the validity of a lien can be contested indirectly. For example, a secured creditor filing a proof of claim may claim a security interest. The trustee or debtor in possession can object to the claim under F.R. Bankr. P. 3007. If the creditor cannot verify its secured status, the claim may be disallowed as a secured claim.
Sometimes valuation of the collateral in question is an important issue. This issue can come up in adversary proceedings that attempt to strip away the second or third mortgage that is claimed to be wholly unsecured. In Re Mansaray-Ruffin, 530 F.3d 230 (3d Cir. 2008).
Here, the real issue is to what “extent” the secured creditor is secured. If there is no equity in the property to which a lien can attach, then the lien is said to be unsecured.
For example, suppose a house has a fair market value of $150,000. The first mortgage secured against the property is in the amount of $165,000. There is no equity left in the property for any second mortgage to attach to, since the mortgage is larger than the fair market value. Under Section 506(a) of the Code, secured claims are to be valued and allowed as secured to the extent of the value of the collateral, and unsecured for the excess over such value.
This provision is implemented by F.R. Bankr. 3012. Under Rule 3012, the court can determine the value of a claim secured by a lien on property on motion of any party in interest. If a debtor attempts to “strip off” or “strip down” a lien based on valuation, the majority view is that no adversary proceeding is required. Harmon v. U.S., 101 F.3d 574 (8th Cir. 1996); In Re King, 290 B.R. 641, 647 (Bankr. C.D. Ill. 2003); In Re Marsh, 475 B.R. 892, 896 (N.D. Ill. 2012). Local rules and procedures here will provide the best guidance on whether a lien can be removed by motion or by adversary proceeding.
Despite the case law supporting the idea that unsecured mortgages can be removed by motion, in practice most courts prefer that this by done by adversary proceeding, due to the nature of the rights of the creditor that are being affected.In the 8th Circuit, there is case law holding that a debtor can strip off a junior lien of a wholly unsecured claim on a debtor’s principal residence by confirmation of a Chapter 13 plan. In Re Fisette, 455 B.R. 177 (8th Cir. BAP 2011).
If a trustee is in doubt as to the priority of a lien in estate property, an adversary may be appropriate. For example, if the trustee is authorized to sell estate property under Section 363(b) of the Code “free and clear” of other interests, then an adversary might need to be used.A trustee could use Rule 7022 to do this, which permits him to interplead any competing claimants and obtain a determination of the rights of all the various claimants. An adversary proceeding can also be used under Rule 7001 to determine “other interests in property.”
Adversary proceedings have a wide range of uses. They can be used by a Chapter 11 debtor in possession, a debtor in a Chapter 7 or Chapter 13 case, by a trustee, or by a creditor. Besides providing a way to object to the discharge of certain debts, they are commonly used to determine property rights, valuations of secured collateral, extent of security interests, and determinations of ownership priority in collateral.
Read More: Bankruptcy Adversary Proceedings Under Section 523: Seeking To Prevent Discharge of Certain Debts
Transparency and due process are fundamental and primary objectives of a functioning legal system. U.S. courts have historically recognized a presumption of public access to court records. Nixon v. Warner Commc’ns Inc., 435 U.S. 589, 597-98 (1978). This preference for public access is rooted in the public’s first amendment right to know about the administration of justice.
This public access helps to protect the integrity, quality, and respect in our judicial system. In re Analytical Sys., 83 B.R. 833 (Bankr. N.D. Ga. 1987). The policy interest in favor of public access is at its best where issues concerning the integrity and transparency of bankruptcy proceedings are involved.
Under certain situations, a bankruptcy trustee may try to recover transfers made by a debtor to creditors before the filing of his case. These types of conveyances are termed “fraudulent conveyances.” But does an innocent transferee, who had no knowledge of a debtor’s coming bankruptcy, have any way to prevent a trustee from recovering this kind of a transfer? Under Section 548( c) of the Bankruptcy Code, a transferee can have an affirmative defense in such a situation.
When in doubt, file a claim. This is the take-away lesson from a recent bankruptcy court case coming from Nebraska. Proofs of claim in a Chapter 11 case are handled somewhat differently than those in Chapter 7 or Chapter 13 cases. Under Fed. R. Bankr. P. 3003(b)(1) and Section 1111(a) of the Bankruptcy Code, a creditor is permitted to have an allowed claim without actually filing a proof of claim with the bankruptcy court (provided, of course, that the claim is not otherwise disputed, contingent, or unliquidated).
A recent court case from the District of Nebraska, however, interestingly ruled that a creditor who failed to file a timely proof of claim was unable to vote on the debtor’s Chapter 11 plan. This was so even though the plan sought to modify the creditor’s claim.
The case in question is In Re Woodward (D. Nebraska, case number 11-40936, from April 2014). The debtor here argued that the plan was eligible for confirmation under Section 1129(a)(10) because an impaired creditor had voted in favor of the plan. An objecting creditor argued, however, that no “class” of impaired claims had accepted the plan as required by Section 1129(a)(10).
The bankruptcy court was particularly irked by the fact that the objecting creditor had not filed a proof of claim. Under Section 1126(a) of the Bankruptcy Code, a creditor is entitled to share in plan distributions as a result of being listed on the debtor’s schedules (even if the creditor had not filed a claim). But this was not good enough, the court believed. Under Section 1126(a), the only parties entitled to vote on a Chapter 11 plan are holders of claims or interests which are allowed under Section 502.
Unfortunately for the objecting creditor, a look at Section 502(a) specifically calls for claims or interests to be “filed under Section 501…” Using this reference bank to Section 502 and 501, the court interpreted Section 1126(a) as restricting voting to creditors who have actually filed a proof of claim. In other words, when it comes to voting, there is a big difference between scheduled claims and filed claims.
A harsh ruling? Perhaps. It is odd that the court did not consider Section 1111(a) of the Code, which states that a proof of claim is “deemed filed” under Section 501 if it appears on the debtor’s schedules (unless that claim is contingent, disputed, or unliquidated). Looking at Section 1111(a) give one the impression that the ruling here may have been unduly harsh.
In addition, it appears that the court could have used its (limited) equitable powers to find an imputed or constructive proof of claim from any of the creditor’s previous filings. This, however, did not happen. F.R. Bankr. P 3003, after all, specifically states that a Chapter 11 creditor does not have to file a claim.
The rule in Woodward is not the majority view, it should be noted. It seems that the court looked more towards the circumstances of the plan as a whole, and the need for a plan to be confirmed that had little opposition. Taken as a whole, it seems to be bad precedent. The weight of authority recognizes that Chapter 11 creditors are not required to file claims in order to assert their voting rights under a proposed plan.
But this case illustrates an important point that we would do well to bear in mind: if you are a creditor in a Chapter 11 case, it is to your advantage to participate in the case by keeping informed of developments in the case, and filing a claim. When in doubt, file a claim, even if you are not required to do so. Sleeping on your rights benefits no one except the opposing party.
Read More: Buying And Selling Bankruptcy Proofs Of Claim: Knowing The Risks
Adversary proceedings contesting the dischargeability of debt in a bankruptcy case are rare, but they do happen. There are various types of nondischargeability actions that a bankruptcy debtor can face under 11 U.S.C. 523. One of these is an adversary proceeding under Sect. 523(a)(4) for “fraud” or “defalcation” while “acting in a fiduciary capacity.” This type of action is often brought as an additional count in an adversary petition along with other Section 523 claims, such as claims under 523(a)(2). They seem to be appearing more often than in the past, as creditors increasingly seek to have commercial debts classfied as “trusts” or “trust fund proceeds.”
The vast majority of bankruptcy filings are “voluntary”, in the sense that the process is initiated by the debtor with the filing of a petition, accompanying schedules and forms, and if applicable, a Chapter 11, 12, or 13 plan or reorganization. There are, however, a small minority of “involuntary” bankruptcy filings, in which the process is initiated by a creditor or creditors of a debtor. The major requirements can be found in 11 U.S.C. Section 303, or Section 303 of the Bankruptcy Code. In an involuntary filing, a petition is filed in court, in which the court is basically asked if the individual or corporation can be put into bankruptcy.
First, there are some rules regarding the number of creditors. The Bankruptcy Code (Section 303) specifies the minimum number of creditors and amount of their claims. If a company has 12 or more creditors, an involuntary bankruptcy petition requires (a) three or more creditors whose claims are not contingent as to liability or subject to a bona fide dispute as to either liability or amount to file the petition, and (b) those qualifying claims must total, in the aggregate, at least $10,000 if unsecured or $10,000 more than the value of any liens securing those claims if any are secured. If the company has fewer than 12 creditors, it only takes one qualifying creditor to file an involuntary petition.
Additional creditors can join the petition later, If only one creditor files and it turns out that the company has more than 12 creditors, the bankruptcy court will give other creditors an opportunity to join. If the company timely objects to the involuntary filing, for the company to be placed in bankruptcy, the company or person also must: (1) generally not be paying its debts as they become due unless those debts are subject to a bona fide dispute as to liability or amount, or (2) have had a custodian appointed within the past 120 days to take possession or control of substantially all of its assets.
In the involuntary petition, the petitioning creditors must state on the petition which chapter (Chapter 7 or Chapter 11) they wish to force the person or company to into. These two chapters are the only ones available for involuntary cases. In other words, you can’t have an involuntary Chapter 13 or Chapter 12 case.
There are some big differences between involuntary and voluntary cases. In an involuntary case, the automatic stay does begin when the petition is filed, just as in a voluntary case. But there are some major differences between the two types of scenarios after that. In an involuntary case:
1. After an involuntary petition is filed (Chapter 7 or 11), a company can still continue to operate its business until the court has actually ruled that the company should be in bankruptcy. The petition is served together with a summons. The involuntary petition is more like a request to a court asking that the company or person be declared to be bankrupt. So, due process here is an issue.
2. In an involuntary case, a trustee is not automatically appointed. It can be sought by motion, but the court may not grant this request.
3. The debtor has the power to respond to the involuntary petition and propose counter-remedies. For example, in an involuntary Chapter 7 filing, the debtor could respond with its own Chapter 11 filing and resume control over the company or personal affairs as a debtor in possession.
4. A debtor has the power to contest an involuntary petition, usually by means of an answer or motion to dismiss (or both) and must do so within required time limits (21 days after service of the summons, under the Federal Rules of Bankruptcy Procedure).
5. In an involuntary case, there is normally a significant amount of litigation right in the beginning to determine whether the proper requirements of an involuntary case have been met. Companies and persons do not usually like to be “forced” into bankruptcy court by the filing of an involuntary petition. If the bankruptcy court finds in favor of the petitioning creditors, an order of relief is entered and the debtor is “placed” into bankruptcy. And at that point, the provisions of the Bankruptcy Code governing debtors and creditors will come into play.
Involuntary petitions are also rare because there can be unpleasant consequences to creditors who frivolously attempt to put an entity or person into bankruptcy case without a very good reason. A debtor who has been hit with an involuntary petition without good reason is not going to take kindly to this type of extreme collection activity. Consider the following:
1. An involuntary petition cannot be dismissed once filed without a notice and opportunity for hearing, even if all parties agree.
2. If an involuntary petition is dismissed, the creditors who brought the action can be liable for the debtor’s fees and costs.
3. If the bankruptcy court determines that the petition against the debtor was filed frivolously or in bad faith, the creditors who initiated the action can be liable for damages, and in some situations, even punitive damages.
It is clear from the foregoing that involuntary cases are very different from the standard bankruptcy process. The possibility that creditors can be found liable for damages and costs for vindictive filings means that few creditors are willing to take the plunge into this “nuclear option” in the debt collection world. In addition, it may be that the prospect of financial recovery for creditors is outweighed by the difficulties of litigation or the likelihood of finding assets. But involuntary cases do happen. Sometimes, an unusual circumstance or event can make it worthwhile for a creditor or creditors to go forward with it.
They seem to most often happen in situations where some sort of fraud, malfeasance, or significant hiding of assets may have taken place, or situations where some sort of Ponzi scheme has been discovered by creditors. We have also seen it in situations where large amounts of equity exist in commercial or residential real estate that cannot be tapped into by aggressive judgment creditors. In most situations, aggressive collection activity by creditors individually or in concert will be enough to force a debtor to simply file a case on his own. If you have questions with this area of the law, you need an experienced bankruptcy attorney.
Read More: Debts From Ponzi Schemes: Dischargeable In Bankruptcy?
It is an all-too-common issue in bankruptcy. The bankruptcy attorney will be preparing the case for filing, and will discover that the debtor or debtors have not filed federal or state tax returns for some year or years. If there is one piece of advice I would want to give regarding bankruptcy and taxes, it is this: always file your tax returns in a timely way. Can’t pay the tax? File the return anyway. Don’t want to deal with it? File the return anyway. Stressed out or depressed? File the return anyway. Don’t want to put the effort in to get the returns done? File the return anyway.
This article will discuss briefly the attorney-client privilege for corporations in Chapter 7 and Chapter 11 cases. Notice that I put the words “for corporations” in bold face here. We will here only be talking about the attorney-client privilege for corporations, not for individuals. The two scenarios are different and separate. There can be major differences between how individuals and business entities are treated, and it is critical to keep this in mind.
There are times in a Chapter 11 case when the debtor wishes to assign a contract or lease to a third party. The debtor, for example, may not be able to continue performing on the contract but may want to continue to see the contract or lease honored. The first step in this process is for the debtor to assume the contract in accordance with Chapter 11 procedure.
Once this has been done, the debtor would need to provide some assurance of future performance of the contract by the person to whom the contract has been assigned. This may be done by providing financial information about the assignee that demonstrates the ability to perform the contract, or, in the case of a default, the ability to compensate the other party to the contract in some meaningful way.
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