Proofs of Claim: To File, or Not to File ...
The point of this article is simple – a creditor should not file a proof of claim in a bankruptcy case without considering fully the implications of doing so. Although the result of failing to file a proof of claim may be generally known, certain consequences to the creditor – submitting to the jurisdiction of the bankruptcy court, waiving the right to a jury trial and subjecting the proceeds of a letter of credit to a cap on lease rejection damages – are not as well known. The purpose of this article is to highlight potential adverse consequences of filing a proof of claim and to encourage creditors to balance the likely benefits of filing a proof of claim against the risks of doing so.
In every bankruptcy case, all scheduled creditors receive notice of the filing of the case, the scheduling of the first meeting of creditors and certain deadlines established in the case, including the deadline for filing proofs of claim. Under the bankruptcy procedural rules, and except as otherwise provided under those rules, an unsecured creditor must file a proof of claim in order for the unsecured creditor’s claim to be allowed.1 If the unsecured creditor fails to do so, the creditor is not entitled to receive any distribution on its claim in such cases. An exception to this requirement is in a chapter 11 case in which a creditor’s claim is not scheduled as being contingent, unliquidated or disputed. In those circumstances, the creditor is not required to file a proof of claim if the creditor is satisfied with the status of the claim (secured or unsecured) and the amount of the claim as scheduled. Further, any creditor whose claim is not scheduled in a chapter 11 case or whose claim is scheduled in a chapter 11 case as disputed, contingent or unliquidated must file a proof of claim in order for the creditor to vote on the chapter 11 plan and receive any distribution under the plan.2 In a nutshell, filing a proof of claim in bankruptcy is, in many instances, crucial to getting paid. Because of the importance of a proof of claim to getting paid, creditors are susceptible to reacting to the notice of the claims deadline by filing a proof of claim without giving any real thought to whether doing so is actually in their own best interests. This reflex response can have unintended negative consequences.
A creditor that has filed a proof of claim in a bankruptcy case has submitted itself to the jurisdiction of the bankruptcy court.3 Because of the nationwide service of process authorized under the bankruptcy procedural rules,4 there is no need to establish that a domestic creditor has minimum contacts with the state within which the bankruptcy court is located in order for the bankruptcy court to have personal jurisdiction over the creditor. Consequently, in the case of a domestic creditor, a bankruptcy court has personal jurisdiction over that creditor regardless of whether the creditor has filed a proof of claim in the bankruptcy case. In the case of a foreign creditor, however, the due process clause of the Fifth Amendment to the United States Constitution requires that the foreign defendant have “minimum contacts” with the United States in order for the bankruptcy court to have jurisdiction over the foreign creditor.5 Whether the foreign creditor has filed a proof of claim in a bankruptcy case may be a significant factor in the determination of whether the bankruptcy court has personal jurisdiction over the foreign creditor.6
In the case of Lykes Bros. Steamship Co., Inc. v. Hanseatic Marine Serv. (In re Lykes Bros. Steamship Co., Inc.), 207 B.R. 282 (Bankr. M.D. Fla. 1997), the bankruptcy court considered whether foreign creditors could be held accountable for violating the automatic stay as a result of the creditors procuring the arrest of one of the debtor’s vessels in a Belgian court in order to compel payment of pre-petition claims owed by the debtor to the foreign creditors. In considering the question, the bankruptcy court began its analysis with a discussion of whether it could exercise in personam jurisdiction over the foreign creditors.7 With respect to one of the creditors, Andrea Shipping (PTH) Ltd., the court disposed of the question very quickly, stating that the court “[c]learly … has personal jurisdiction over Andrea Shipping because Andrea filed a proof of claim … and has therefore consented to the jurisdiction of the United States Bankruptcy Court.”8
Waiver of Jury Trial Right
The Seventh Amendment to the United States Constitution provides that parties litigating in federal court have the right to a trial by jury in civil cases. This right to a jury trial is subject to being waived and, in the context of a bankruptcy case, may be waived unintentionally as a result of filing a proof of claim.9 In the case of Katchen v. Landry, 382 U.S. 323, 86 S.Ct. 467 (1966), the U.S. Supreme Court held that the bankruptcy court had equitable jurisdiction to order a creditor who had filed a proof of claim against the bankruptcy estate to surrender voidable preferences without affording the creditor a jury trial.10 After Katchen had filed a claim against the bankruptcy estate, the bankruptcy trustee filed an adversary proceeding seeking to avoid the payments as voidable preferences.11 The Court concluded that because the preference action arose “as part of the process of allowance and disallowance of claims, it is triable in equity,” and accordingly, the Seventh Amendment right to a jury trial was not applicable.12
In Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 109 S.Ct. 2782 (1989), the U.S. Supreme Court held that a creditor who had not filed a claim against the bankruptcy estate was entitled to a jury trial on the bankruptcy trustee’s fraudulent transfer claim.13 In that case, the bankruptcy trustee filed a complaint against the creditor to avoid allegedly fraudulent conveyances. The creditor, Granfinanciera, requested a jury trial.14 Because Granfinanciera had not filed a proof of claim in the bankruptcy case, the Court determined that the trustee’s fraudulent conveyance claim did not arise “‘as part of the process of allowance or disallowance of claims,’” nor was it “integral to the restructuring of debtor-creditor relations.”15 Consequently, the Court concluded that a party could not be divested of its right to trial by jury under the Seventh Amendment merely because Congress had designated fraudulent conveyance actions as “core proceedings” under the Bankruptcy Code.16
The Supreme Court’s latest word on the issue was in Langenkamp v. Culp, 498 U.S. 42, 111 S.Ct. 330 (1990), in which case the Supreme Court affirmed the principals established in Katchen and Granfinanciera, restating clearly that “‘a creditor’s right to a jury trial on a bankruptcy trustee’s preference claim depends on whether the creditor has submitted a proof of claim against the estate.’”17 In Langenkamp, the Court concluded that the creditors in that case were not entitled to a jury trial because they had filed claims against the bankruptcy estate, “thereby bringing themselves within the equitable jurisdiction of the Bankruptcy Court.”18 The Court went on to observe, “[i]f a party does not submit a claim against the bankruptcy estate, however, the trustee can recover the alleged preferential transfers only by filing what amounts to a legal action to recover a monetary transfer. In those circumstances, the preference defendant is entitled to a jury trial.”19
More recently, a court has determined that a creditor does not have a jury trial right in connection with an adversary proceeding filed against the creditor.20 In the WorldCom bankruptcy case, a creditor filed a proof of claim against the debtor’s estate. The debtor commenced an adversary proceeding against the creditor, objecting to the proof of claim and asserting breach of contract counterclaims against the creditor.21 In its answer, the creditor included a demand for a jury trial.22 WorldCom filed a motion to strike the creditor’s jury trial demand.23 The WorldCom court determined that if a creditor’s proof of claim is met with an adversary proceeding and the determination of the adversary proceeding affects the claims allowance process, the creditor does not have a right to a jury trial, even if the adversary proceeding involves claims, such as breach of contract claims, that are historically tried in a court of law.24 The WorldCom court determined that the resolution of the debtor’s claim against the creditor bore directly on the claims allowance process for which there is no Seventh Amendment right to jury trial because WorldCom’s claim and its objections to the creditor’s proof of claim were factually and legally intertwined, being based on the same operative facts and contracts.25 The court found that the jury trial right is waived as to any matter that the court would be required to resolve in order to determine the proof of claim’s validity or amount, including offsets against a creditor’s claim due to a debtor’s counterclaim.26
Letter of Credit Proceeds Subject to Section 502(b)(6) Cap
Section 502 of the Bankruptcy Code imposes a cap on the amount of a claim that a lessor can maintain for damages due to the debtor-lessee’s rejection of a nonresidential real property lease.27 An issue which arises in connection with the application of the damages cap is whether the cap limits the amount that the lessor can recover under a letter of credit issued to secure the debtor’s performance under the lease. Whether the lessor has filed a proof of claim in the former tenant’s bankruptcy case can be a material factor in this determination.
In the case of Solow v. PPI Enterprises, Inc. (In re PPI Enterprises, Inc.), 324 F.3d 197 (3rd Cir. 2003), the Third Circuit Court of Appeals considered whether the proceeds of a letter of credit paid to the landlord should be applied against the section 502(b)(6) cap. Prior to filing bankruptcy, the tenant abandoned its office space and ceased paying rent.28 After delivering written notice of the tenant’s default and giving notice of its intent to terminate the lease, the landlord drew down on a letter of credit that had been provided to secure the tenant’s performance under the lease.29 Subsequently, the tenant filed its chapter 11 case and the landlord filed a proof of claim for damages under the lease with the bankruptcy court.30 In a decision affirmed on appeal by the district court, the bankruptcy court determined that the landlord’s damage claim was subject to the damages cap under the Bankruptcy Code and was reduced by application of the letter of credit.31 On appeal, the Third Circuit Court of Appeals accepted the debtor’s argument that if the issuing bank paid out the letter of credit, the issuing bank would seek to recover from the debtor, which would ultimately mean that the debtor would end up paying the amount of the letter of credit twice, once in the form of the original letter of credit and again to the issuing bank.32 In the view of the Third Circuit Court of Appeals, this “double liability” of the debtor would result in a windfall for the landlord at the expense of the debtor and of the other creditors.33 The holding of the appellate court was predicated on the court’s determination that the parties had clearly intended that the letter of credit operate as a security deposit.34
Subsequent to the PPI Enterprises decision, the Fifth Circuit Court of Appeals was presented with essentially the same issue that the Third Circuit Court of Appeals had addressed in PPI Enterprises.35 Unlike the Third Circuit, however, in the case of Stonebridge Technologies, Inc., 430 F.3d 260 (5th Cir. 2005), the Fifth Circuit did not base its decision on whether the parties intended that the letter of credit serve as a security deposit. Instead, the Fifth Circuit focused on the plain language of section 502(b)(6) which provides that a “claim” is disallowed if the “claim” is in an amount greater than the cap set out in that section.36 Consequently, the Fifth Circuit determined that in order for the damages cap to be applicable to a claim, a claim had to be formally filed in the bankruptcy case. Because the landlord in Stonebridge had not filed a proof of claim in the bankruptcy case, the appellate court concluded that the damages cap was not applicable to the landlord’s application of the letter of credit proceeds.37 The Fifth Circuit confirmed its view that if the landlord had filed a proof of claim, section 502(b)(6) would have capped the damages claim at an amount approximately $77,000 less than what the letter of credit had provided.38
The Fifth Circuit determined that the PPI Enterprises decision was distinguishable because the landlord in that case had filed a proof of claim while in the Stonebridge case the landlord had not and concluded that this distinguishing point required a different conclusion than that reached by the Third Circuit. The Fifth Circuit summarized its conclusion: “[Section] 502(b)(6) does not alter the entitlement of [landlord] to the full proceeds of the Letter of Credit in the case where [landlord] has not also filed a claim against the estate for recovery of unpaid lease monies.”39
Rushing to file a proof of claim so as to comply with a claims deadline without considering the possible negative consequences of such a filing is, in many instances, the last thing that a creditor should do. Before filing a proof of claim, a creditor should consider its potential recovery in the bankruptcy case and carefully weigh that benefit against the other possible implications of such a filing. Some questions to consider include the following:
- Is the creditor already subject to the jurisdiction of the bankruptcy court? By filing a proof of claim, the creditor will be submitting itself to the jurisdiction of the bankruptcy court.
- Has the creditor received payments within 90 days prior to the filing of the bankruptcy? By filing a proof of claim, the creditor will be waiving its right to have any preference claim tried by a jury.
- Has the creditor received any transfer from the debtor within two years of the filing of the bankruptcy case which may be challenged as a fraudulent conveyance? By filing a proof of claim, the creditor will not have the right to a jury trial in any fraudulent conveyance action.
- Does the debtor have any counterclaim that it can assert to a claim made by a creditor in the bankruptcy case? By filing a proof of claim, the creditor waives its right to a jury trial in connection with such counterclaim.
- Is the creditor a landlord which has the benefit of a letter of credit securing the tenant’s performance under a lease of nonresidential real property? By filing a proof of claim in the former tenant’s bankruptcy case, the landlord may have committed the predicate act for the application of the section 502(b)(6) damages cap to the letter of credit proceeds.
Hopefully this article has made it clear that a creditor’s right to collect “bankruptcy dollars” as a result of filing a proof of claim may not be worth the “real dollars” that filing a proof of claim could cost the creditor.
1 Fed. R. Bankr. Pro. 3002(a).
2 Fed. R. Bankr. Pro. 3003(c)(2).
3 Langenkamp v. Culp, 498 U.S. 42, 45, 111 S.Ct. 330, 331-32 (1990).
4 See Fed. R. Bankr. Pro. 7004(d).
5 NationsBank, N.A. v. Macoil, Inc. (In re Mid-Atlantic Petroleum Corp.), 233 B.R. 644, 653 (Bankr. S.D. N.Y. 1999).
6 Lykes Bros. Steamship Co., Inc. v. Hanseatic Marine Serv. (In re Lykes Bros. Steamship Co., Inc.), 207 B.R. 282, 286 (Bankr. M.D. Fla. 1997) (“Having voluntarily filed its proof of claim in this reorganization case, Andrea purposefully submitted itself to this Court’s jurisdiction and was obligated to comply with its orders and with its procedures.”)
7 Id. at 285.
8 Id. at 285-86. At least implicitly, the Lykes Bros. court determined that the creditor’s filing of a proof of claim itself constituted sufficient minimum contacts.
9 Although the practical value of a jury trial in a commercial case may be subject to debate, at least one study has concluded that juries can add value to adjudication in complex commercial cases. Eisenberg, Theodore and Miller, Geoffrey P., “Do Juries Add Value?: Evidence from and Empirical Study of Jury Trial Waiver Clauses in Large Corporate Contracts” (November 26, 2006) Cornell Law School Legal Studies Research Paper Available at SSRN: http://ssrn.com/abstract=946465. In any event, the right to a jury trial is a fundamental right which should not be waived without due consideration.
10 Katchen v. Landry, 382 U.S. 323, 325, 86 S.Ct. 467, 470 (1966).
11 Id. at 325, 86 S.Ct. at 470.
12 Id. at 336, 86 S.Ct. at 476.
13 Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 36, 109 S.Ct. 2782, 2787 (1989).
14 Id. at 36-37, 109 S.Ct. at 2787-88.
15 Id. at 58, 109 S.Ct. at 2799, quoting Katchen v. Landry, 382 U.S. at 336, 86 S.Ct. at 476.
16 Id. at 58-59, 109 S.Ct. at 2799.
17 Langenkamp, 498 U.S. at 45, 111 S.Ct. at 331, quoting Granfinanciera, 492 U.S. at 58, 109 S.Ct. at 2799.
19 Id. (emphasis in original).
20 In re WorldCom, Inc., 378 B.R. 745 (Bankr. S.D. N.Y. 2007).
21 Id. at 749.
23 Id. at 750.
24 Id. at 753.
25 Id. at 753-54.
26 Id.; see also In re Skyline Lumber Co., 311 F. Supp. 112, 117 (W.D. Va. 1970) (“[A] creditor who voluntarily files a claim in bankruptcy thereby submits himself to the summary jurisdiction of the court to determine the validity of his claim. Such jurisdiction extends at least to set-offs, counterclaims, and other matters arising out of the same transaction as the claim itself.”)
27 11 U.S.C. § 502(b)(6).
28 Solow v. PPI Enterprises, Inc. (In re PPI Enterprises, Inc.), 324 F.3d 197, 200-201 (3rd Cir. 2003).
30 Id. at 201.
31 Id. at 202.
32 Id. at 209.
34 Id. at 210.
35 In re Stonebridge Technologies, Inc., 430 F.3d 260, 264 (5th Cir. 2005).
36 Id. at 268-69.
37 Id. at 269-70 (“Stated simply, the claim of a lessor against the assets of the estate is an essential precondition to applying the damages claim at all”).
38 Id. at 270 n.9.
39 Id. at 271.