This blog first appeared as part of an article in Trial Talk, Oct/Nov 2017 – “What Every Trial Lawyer Should Know About Bankruptcy,”
It is the rare trial lawyer who has not been forced to adjust her litigation or post-trial strategy to deal with the profound impact of a bankruptcy filing. Defendants can thwart trial settings with propitiously-timed bankruptcy petitions; the automatic stay in bankruptcy can prevent post-judgment collection; and sizeable claims may be whisked away through bankruptcy court-approved discharges.
When one of these events, or something along these lines, happens, what should a creditor or attorney do? Or, perhaps more critically, what should they not do?
Bankruptcy Basics
What is commonly known today as the “Bankruptcy Code” is found in Title 11, United States Code. Federal Rules of Bankruptcy Procedure, along with local rules of U.S. Bankruptcy Courts, provide for the administration of bankruptcy cases and related proceedings litigated in the federal courts.
Chapters of the Bankruptcy Code
The first three (chapters 1, 3, and 5) generally pertain to administration of all bankruptcy cases. The remaining chapters deal with particular kinds of bankruptcy cases (liquidations or reorganizations) for particular debtors. Chapter 7 governs the liquidation of an individual’s or entity’s assets to satisfy creditor claims. Chapters 11, 12 and 13 are reorganization chapters for the restructuring of debts, although chapter 11 cases frequently involve liquidations conducted pursuant to a plan of reorganization. Both entities and individuals may file under chapter 11, but chapter 13 is available only to an individual with regular income whose debts fall below statutory caps. Less well-known and used chapters are for family farmers or family fishermen (chapter 12); municipalities (chapter 9); and proceedings related to a foreign insolvency case (chapter 15).[1]
In all chapter 7, 12 and 13 cases, a trustee is appointed to administer the bankruptcy estate in accordance with the provisions of the governing chapter. In cases in which a trustee administers the bankruptcy estate (including causes of action belonging to the debtor upon the bankruptcy filing), the trustee is the “owner” of the estate’s claims and the person with authority to negotiate any resolution of the claim. In most chapter 11 cases, the debtor (whether an individual or entity) remains in charge as the “debtor-in-possession.” A trustee may be appointed in chapter 11 cases, however, upon court order.
In reorganization cases, a debtor may obtain a discharge of debts through a confirmed plan of reorganization that permits payment (usually partial payment) to creditors on court-approved terms.
In chapter 7 liquidations, an individual debtor can obtain a discharge of his pre-bankruptcy debts in exchange for surrendering his non-exempt assets to the bankruptcy trustee for sale and distribution to creditors.
Commencement of Bankruptcy Proceedings
Bankruptcy cases are commenced by either (i) the debtor’s voluntary filing of a bankruptcy petition, or (ii) creditors’ filing of an involuntary petition. The filing of a bankruptcy petition creates the “bankruptcy estate,” which includes all legal or equitable interests of the debtor in property “as of the commencement of the case.”[2] Whether property is “property of the estate” can be critical to a determination of whether a cause of action belongs to the bankruptcy trustee or the debtor, whether the automatic stay applies, and whether a creditor’s rights in such property can be modified through the bankruptcy process.
Litigation in bankruptcy cases is resolved either as (i) a contested matter, which involves motion practice governed by Bankruptcy Rule 9014, or (ii) an adversary proceeding, which is a separate action commenced by the filing of a complaint. Bankruptcy Rule 7001 identifies the causes of action that must be presented through an adversary proceeding. They include, generally: (i) a proceeding to obtain an injunction, or other equitable relief, (ii) a proceeding to determine the dischargeability of a debt, and (iii) “avoidance actions” to recover preferential transfers and fraudulent conveyances from third parties.
Non-Dischargeable Claims
Bankruptcy Code section 523 lists multiple “exceptions to discharge” applicable to chapters 7, 11, 12, and 13 and ranging from taxes owed to the United States to student loans to domestic support obligations.[3] Bankruptcy Code section 523(c)(1) places the burden on the creditor to timely file a complaint challenging the dischargeability of a debt based on (i) false pretenses, false representations, or actual fraud, (ii) fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny, and (iii) willful and malicious injury by the debtor. The other exceptions do not expressly require that the creditor file a non-dischargeability complaint, but circumstances may make doing so the safer course of action – particularly if there could be a dispute about whether the basis for the creditor’s claim qualifies as an exception to discharge.[4]
Deadlines for filing complaints objecting to dischargeability are typically contained in the Notice of Bankruptcy sent to creditors by the clerk of the bankruptcy court based upon the mailing list supplied by the debtor. If the debtor fails to list a known creditor on the required mailing list or schedules in time to permit the creditor to protect its rights by filing a timely proof of claim or dischargeability complaint, the creditor’s claim may not be discharged unless the creditor had notice or actual knowledge of the bankruptcy case.[5] Whether unscheduled claims are not discharged, and under what circumstances, is a fact-intensive analysis based on the nature of the claim, the chapter under which the debtor filed, whether the bankruptcy estate has assets, and other factors about which not all bankruptcy courts agree.
Jurisdiction and Venue
Jurisdiction of bankruptcy matters is vested in the U.S. District Courts, which have exclusive jurisdiction over bankruptcy cases and original but non-exclusive jurisdiction over civil proceedings “arising in, arising under, or related to a bankruptcy case.”[6] Under standing orders of reference issued by the U.S. District Courts, bankruptcy cases are automatically referred to the bankruptcy courts.[7] The bankruptcy courts can enter final judgments in most “core proceedings,”[8] but cannot, without necessary consent, enter final judgments in non-core matters. Instead, the bankruptcy court issues proposed findings of fact and conclusions of law that are reviewed by the U.S. District Court before entry of final judgment. Appeals of bankruptcy court judgments are typically to the U.S. District Court or, in those circuits like the Tenth Circuit that have Bankruptcy Appellate Panels, to the BAP. Appeals may also be direct to the Circuit Court of Appeal in certain circumstances.
District Courts have discretion to “withdraw the reference” of bankruptcy cases and bankruptcy proceedings for “cause,” meaning that the case or proceeding is thereafter adjudicated in the District Court.[9] Withdrawal of the reference can be efficient when the matter tried in the bankruptcy court is a non-core proceeding in which the bankruptcy court can only make proposed fact findings and conclusions of law and that would require the District Court’s review of a substantial record before entering final judgment. Although usually discretionary, withdrawal of the reference is mandatory if the proceeding involves a determination of both bankruptcy law and laws regulating organizations or activities affecting interstate commerce.[10]
Venue of most bankruptcy litigation is in the bankruptcy court in which the bankruptcy case is pending. With some exceptions, pending state court cases can be removed to the U.S. District Court upon the filing of the bankruptcy case if jurisdiction in the District Court exists under 28 U.S.C. § 1334 – that is, the state court action is related to the bankruptcy case. Removal is to the U.S. District Court for the district in which the state court action is pending, and the court can remand the case to state court on “any equitable ground.”[11] Upon removal to a U.S. District Court other than the one with jurisdiction over the main bankruptcy case, a party may move to transfer venue to the debtor’s “home” district court, which will then likely refer the matter to the bankruptcy court.
The Automatic Stay
“The automatic stay is one of the fundamental debtor protections provided by the bankruptcy laws. It gives the debtor a breathing spell from his creditors. It stops all collection efforts, all harassment, and all foreclosure actions. It permits the debtor to attempt a repayment or reorganization plan, or simply to be relieved of the financial pressures that drove him into bankruptcy.”[12]
At some point in their careers, most litigators have encountered the automatic stay in bankruptcy either directly or indirectly. Some have experienced its effects when a defendant filed bankruptcy before or during a trial. Some unfortunate others may have violated the automatic stay and learned the hard way how problematic that can be.
No matter how you have learned what you know about the automatic stay, it can be helpful to brush up on what you know and to learn more about how it can affect your practice if a bankruptcy filing occurs during the course of your lawsuit.
What makes the stay “automatic?” The bankruptcy filing. Immediately, by operation of law, and without any requirement of court order, the bankruptcy filing creates an automatic stay against a broad scope of actions against the debtor and its estate. Bankruptcy Code section 362 is the statutory basis for the stay and its limited exceptions. For more on this topic, see related blog post “The Automatic Stay in Bankruptcy”
Bankruptcy’s Effect on Statutes of Limitations
Like state laws that affect statutes of limitations (SOL) when a party is barred from filing a lawsuit or taking other action, Bankruptcy Code section 108 provides a basis for extending the SOL because of the bankruptcy filing. Sections 108(a) and (b) apply to bankruptcy trustees and debtors-in-possession, and section 108(c) applies to creditors.
Because the Bankruptcy Code provides multiple deadlines for actions involving claims against the estate or belonging to the estate, one should be careful to assess section 108’s application to a particular claim in the context of the bankruptcy case. For instance, the deadline to file a proof of claim, or for a debtor to cure a default under a lease, are deadlines set by other Bankruptcy Code sections and not affected by section 108.
Claims against the Debtor – Bankruptcy Code section 108(c)
As detailed in Bankruptcy Code Section 362(a)(1), the automatic stay prevents, among other things, the commencement of a “judicial, administrative, or other action against the debtor” that could have been commenced before the filing of the bankruptcy case. So what now? The client’s action against the would-be defendant is stayed, and the statute of limitations keeps running . . . . Or does it?
The answer to whether the statute of limitations keeps running is “yes, it does.”
“Bankruptcy does not affect the consequences under nonbankruptcy law of the passage of time except as provided in section 108 of the Bankruptcy Code, ‘Extension of Time.’”[13] Thus, it is important to note that a bankruptcy filing does not stop the running of the statute of limitations. But, by virtue of Bankruptcy Code section 108(c), the bankruptcy filing can extend the limitations period if such extended date would exceed the SOL otherwise in effect. Section 108(c) describes it this way: if applicable nonbankruptcy law, an order or an agreement fixes a period for commencing or continuing a civil action against the debtor in a court other than the bankruptcy court, and such period has not expired before the bankruptcy case filing, the period shall not expire until the later of (i) the actual limitations period or (ii) 30 days after notice of the termination or expiration of the stay with respect to such claim.
Two examples help illustrate how section 108(c) works. Suppose that an injured party has a tort claim against a company, and the cause of action has a three-year SOL. Two years into the limitations period, the company files a chapter 11 case, thereby creating an automatic stay that prevents the injured party from filing suit. Aware that the company has insurance to cover the claim, the party promptly seeks relief from the automatic stay and obtains a court order terminating the stay and permitting the injured party to commence an action against the debtor company on the condition that the only recovery permitted will be from the insurer. Say there are nine months remaining before the end of the limitations period when the bankruptcy court enters the order for relief from stay. What is the injured party’s deadline for commencing the action? The same deadline that existed before the bankruptcy filing, because it is the longer of (i) the actual limitations period and (ii) 30 days after notice of the termination of the stay.
If, however, the company filed bankruptcy with only 20 days remaining before the SOL expired, section 108(c) would extend the limitations period to 30 days from the date that the party received notice of the order terminating the stay with regard to the tort claim. Or, if the automatic stay terminated by operation of law because of the dismissal of the bankruptcy case,[14] then the SOL would be extended to 30 days following notice of the termination.
Critical Words of Caution
First, be mindful that a primary purpose of a bankruptcy filing is to eliminate or restructure debts through the bankruptcy process. Therefore, when the SOL runs may not be your primary concern. A chapter 7 debtor with no assets who seeks to discharge your client’s unliquidated claim can accomplish that quickly so that, even if there’s time to file a lawsuit when the stay lifts, the debtor’s discharge may prevent it.[15] Second, the automatic stay can terminate by operation of law in addition to through a court order granting a motion to lift the stay.[16] For instance, under section 362(c)(1), the stay of an action against specific property continues until that property is no longer property of the bankruptcy estate. The trustee’s abandonment of that property to the debtor could therefore lift the stay, thereby starting the 30-day clock on the SOL. Also, as noted above, the stay may lift by operation of law in other ways, so careful monitoring of the bankruptcy case is imperative.
In summary, if you are considering commencing litigation against a party who files bankruptcy, keep your eye on the statute of limitations, but also focus on whether – and how – the debtor attempts to eliminate or modify any debt owed through the bankruptcy process. Further, be mindful of the right to assert the claim by filing a proof of claim in the bankruptcy case (discussed below) and whether that process makes sense in your case.
Commencing Causes of Action that are Property of the Estate – Section 108(a)
What happens when a debtor files bankruptcy and its assets include un-filed causes of action? Does the Bankruptcy Code affect the statute of limitations for those actions?
It can. Congress enacted Bankruptcy Code section 108(a) to give bankruptcy trustees and debtors-in-possession an extension of time to file lawsuits that the debtor could commence. Section 108(a) provides that if applicable nonbankruptcy law, an order entered in a non bankruptcy proceeding, or an agreement fixes a period of time within which the debtor may commence an action, and that period has not expired before the bankruptcy filing, then “the trustee[17] may commence such action only before the later of – (1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or (2) two years after the order for relief.” Stated differently, the limitations period for filing any unexpired cause of action held by the debtor upon the commencement of the bankruptcy case is the longer of the end of the otherwise applicable SOL or two years after the order for relief in the bankruptcy case.[18] The extended period (if needed) provides the trustee or debtor-in-possession additional time to discover and evaluate the claims, which is frequently not practicable during the early stages of a bankruptcy case.
Section 108(b) – Extension for Time to Take Acts Covered by Section 108(a)
Section 108(b) addresses actions already in progress when the bankruptcy case is filed. It applies to the time by which the trustee or debtor-in-possession must take other acts not covered by section 108(a). The statute provides that “If applicable nonbankruptcy law, an order entered in a non bankruptcy proceeding, or an agreement fixes a period within which the debtor . . . may file any pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act, and such period has not expired before the filing of the petition,” the deadline is the longer of (i) that established by the nonbankruptcy law, agreement, or court order or (ii) 60 days after the entry of the order for relief.[19]
Proofs of Claim
First things first: never file a proof of claim without first carefully considering the possible ramifications. But before addressing that rule, let’s review some basics.
Some POC Basics
What is a proof of claim (POC)? It is a written statement that a creditor files in the bankruptcy case to notify the court, the debtor, and other parties in interest of its assertion of a claim and right to receive a distribution from the bankruptcy estate.
The clerk of the bankruptcy court typically sets a deadline (the “bar date”) by which POCs must be filed. If not set by the clerk, the bankruptcy court may schedule a bar date, usually at the request of a chapter 11 debtor. The clerk sends notice of the deadline for filing POCs to all creditors and parties in interest identified by the debtor on its mailing lists submitted to the bankruptcy court.
With the exception of certain creditors in chapter 11 cases, unsecured creditors and equity security holders who wish to share in the distribution of assets from the bankruptcy estate must file a POC that asserts the amount owed and the basis for the claim. The creditor must support the claim by attaching sufficient documentation to satisfy Bankruptcy Rule 3001. If a chapter 11 debtor schedules a creditor’s claim in an amount that the creditor agrees is correct, and without any qualifying language on the schedule (e.g., “disputed,” “contingent,” “unliquidated”), the debt is deemed “admitted” and the creditor need not file a POC. If the chapter 11 case is converted to chapter 7, however, the creditor must file a POC to be entitled to distribution.
The POC is most typically filed on Official Bankruptcy Form B410 (although in limited circumstances the court may recognize an “informal proof of claim”[20]). Official Form B410 also comes with detailed instructions for how to complete the POC. The Federal Rules of Bankruptcy Procedure 3001 through 3008 describe additional requirements for proper POC filing and treatment, along with Bankruptcy Code sections 501 and 502.
Bankruptcy Rule 3001(b) requires that a POC shall be executed by the creditor or the creditor’s authorized agent. Unless it is unavoidable, the better practice is to have the creditor (and not the lawyer) sign the POC. Official Form B410 requires that the signer declare under penalty of perjury that the information contained within the POC is true and correct. And not once, but twice, Form B410 states that the person who files a fraudulent claim could be fined up to $500,000, imprisoned for up to 5 years, or both. If you choose to sign the POC, it is advisable to obtain the client’s express approval of the filing.
A properly filed proof of claim constitutes prima facie evidence of the validity and amount of the claim.[21] The claim is deemed “allowed” unless a party in interest objects.[22]
Things to Consider Before Filing the POC
Filing a POC should not be a knee-jerk reaction to the notice of bar date. Nor should it be viewed as an administrative task to be delegated to staff members. Proofs of claim can have significant ramifications beyond whether your client receives a check from the debtor or bankruptcy trustee.
Consent to Bankruptcy Court Jurisdiction and, Possibly, Final Adjudication
Filing a proof of claim implicates the claim’s allowance and disallowance process and the bankruptcy court’s core jurisdiction to resolve that process. Thus, by filing a proof of claim, the creditor submits itself to the jurisdiction of the bankruptcy court and consents to the court’s resolution of the claim and related counterclaims.[23] Whether the bankruptcy court may enter a final judgment or must submit proposed findings and conclusions to the U.S. District Court for entry of final judgment is fact-dependent and the subject of some dispute among courts and scholars, particularly in light of recent Supreme Court decisions about bankruptcy court jurisdiction.[24] Recently, however, the Court clarified that parties can “knowingly and voluntarily consent” to a bankruptcy court’s entry of final judgment in certain non-core matters.[25] Although bankruptcy courts have the power to abstain from adjudicating certain issues, or to lift the automatic stay to permit other courts to resolve any unliquidated claims, they also have the right to conduct summary proceedings or estimate claims to expedite the bankruptcy administration.[26] A creditor filing a proof of claim should, therefore, be cognizant of the various mechanisms available to the bankruptcy court to resolve disputed POCs. Creditors should also consider whether taking an assertive approach to claim resolution (such as asking for relief from stay to proceed with a pending state court action) would increase the chances of having the claim resolved in another forum if that is the creditor’s preference.
Waiver of the Right to a Jury Trial
A party sued in bankruptcy court on a fraudulent conveyance claim has a Seventh Amendment right to a jury trial.[27] The same is true for a defendant sued to recover preferential transfers.[28] The defendant’s filing of a proof of claim may, however, constitute the creditor/defendant’s consent to the bankruptcy court’s equitable jurisdiction and thereby waive its right to a jury trial of the dispute.[29] Creditors concerned about the possibility of being sued for recovery of preferences or fraudulent conveyances – and interested in preserving the right to a jury trial in such event – should think twice before filing a proof of claim. Although Bankruptcy Rule 3006 permits a creditor to withdraw a POC as a matter of right by filing a notice of withdrawal, that right is lost once an objection to the POC or an adversary proceeding against the creditor is filed, or the creditor votes on the debtor’s plan or otherwise participates significantly in the bankruptcy case. Thereafter, withdrawal is only accomplished via motion and court order. Trying to regain the right to a jury trial by withdrawal of a POC may not work.[30]
In Conclusion
Bankruptcy law is specialized and complicated by sometimes-obscure Code sections and disagreement among the federal courts about what those sections mean. You may decide that, in the end, consulting a bankruptcy lawyer is advisable. But knowledge of the basics can help a trial lawyer make good choices about next steps when a bankruptcy filing adds yet another issue to your client’s case.
[1] 11 U.S.C. § 109 identifies who may be a debtor.
[2] 11 U.S.C. § 541(a).
[3] Bankruptcy Code section 1328(b) contains additional discharge provisions applicable to chapter 13 debtors.
[4] For instance, it may be necessary to obtain the bankruptcy court’s adjudication of whether an obligation qualifies as a specific non-dischargeable debt, such as whether the claim is actually a “domestic support obligation” subject to section 523(a)(5) or a non-support obligation excepted from discharge under section 523(a)(15). See, e.g., Reeves v. Arnold (In re Arnold), No. 15-20011, 2016 WL 5390114 (Bankr. D. Colo. June 9, 2016).
[5] 11 U.S.C. §§ 523(a)(3)(A) and (B).
[6] 28 U.S.C. §§ 1334 (a) and (b).
[7] 28 U.S.C. § 157(a).
[8] “Core proceedings” are identified in 28 U.S.C. § 157(b)(2).
[9] 28 U.S.C. § 157(d).
[10] Id.
[11] 28 U.S.C. §§1452(a) and (b).
[12] H.R. Senate Report No. 95-989.
[13] Durwick, LLC v. Doe (In re Durwick), No. 11-1723, 2012 WL 2046877, *3 n.4 (June 1, 2012), citing In re Cucumber Creek Dev., Inc., 33 B.R. 820 (D. Colo. 1983).
[14] 11 U.S.C. § 362(c)(2).
[15] See 11 U.S.C. § 727.
[16] Note that Bankruptcy Code section 362(c) references sections 362(d), 362(e), 362(f), and 362(h) as other ways that the stay may be lifted.
[17] Section 108(a) also applies to debtors-in-possession. 11 U.S.C. § 103(a).
[18] The “order for relief” occurs upon the commencement of a voluntary bankruptcy case. 11 U.S.C. §§ 301, 302. In an involuntary bankruptcy case, the bankruptcy court enters an order for relief after finding that the involuntary debtor should be in bankruptcy. 11 U.S.C. § 303.
[19] Sen. Rep. No. 95-989.
[20] Clark v. Valley Fed. Sav. & Loan Ass’n (In re Reliance Equities, Inc.), 966 F.2d 1338, 1345 (10th Cir. 1992).
[21] F.R.B.P. 3001(f).
[22] 11 U.S.C. § 502(a).
[23] Langenkamp v. Culp, 498 U.S. 42, 45 (1990).
[24] See, e.g., Stern v. Marshall, 564 U.S. 462 (2011); Executive Benefits Ins. Agency v. Arkison (In re Bellingham Ins. Agency, Inc.), 573 U.S. ___, 134 S. Ct. 2165, 2172-2173 (2014).
[25] Wellness Internat’l Network, Ltd. v. Sharif, 575 U.S. __, 135 S. Ct. 1932, 1944-45 (2015).
[26] 11 U.S.C. § 502(d).
[27] Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 36 (1989).
[28] Langenkamp, 498 U.S. at 45.
[29] Id. at 44-45.
[30] See, e.g., EXDS, Inc. v. RK Electric, Inc. (In re EXDS, Inc.), 301 B.R. 437, 443 (Bankr. D. Del. 2003).
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