As a general rule, secured creditors do not have to file a proof of claim in a Chapter 7 case under the Federal Rules of Bankruptcy Procedure ("Fed. R. Bankr. P."). Fed. R. Bankr. P. 3002(a) only requires unsecured creditors and equity security holders to file claims. If secured creditors are scheduled and not listed as disputed, contingent or unliquidated, they do not have to file a proof of claim in a Chapter 11 according to Fed. R. Bank. P. 3003(c)(2). However, the timing of a deadline to file a claim ("Bar Date") may be such that the fixing or determination of the value of underlying collateral will occur subsequent to the deadline to file a claim. For strategy reasons then, a secured creditor may choose to file its claim as fully secured so as not to forfeit rights to greater plan treatment even though no plan is yet on file at the time of the Bar Date. This is a crucial and difficult decision since, if the value of the collateral is later determined to be less than the amount of the debt, such that the creditor is undersecured, then the failure to preserve or protect that remaining deficiency claim by identifying it in some fashion in the previously filed claim, or amending a claim after such a determination, may result in the undersecured creditor being precluded from sharing in a distribution to unsecured creditors. A recent case, In re: J.H. Investment Services, Inc., Debtor, United States of America v. Steven Oscher, Chapter 11 Trustee, a United States Court of Appeals, Eleventh Circuit case, highlights these issues.
In the J.H. Investment Chapter 11 case, the Internal Revenue Service ("IRS") filed a series of secured claims with no reservation of an unsecured claim or preservation of the right to file one. The Debtor then challenged the value of the underlying collateral in the context of its Plan. The IRS challenged the Plan claiming it violated 11 U.S.C. § 1129(a)(9)(C) because it carved-out a fund to pay the Debtor's general unsecured creditors before paying the IRS's priority claim in full. The Debtor countered that the IRS was not part of the unsecured pool having not filed an unsecured claim or preserved the right to do so and thus was not entitled to be paid as part of the unsecured pool on account of either a priority or general unsecured claim.
The bankruptcy court agreed with the Debtor and approved the Plan. On appeal, the district court affirmed the bankruptcy court decision and the Circuit Court affirmed thereafter. The Court concluded that undersecured creditors must provide notice of their intent to pursue a deficiency claim in their filed proof of claim so that a debtor and other parties in interest are on notice if the claimant (here the IRS) was found to not be sufficiently collateralized, they would then seek additional payment on account of the deficiency claim.
The Court found that Section 506(a)(1) of the Bankruptcy Code does not automatically provide for the granting or fixing of a deficiency claim, it merely allows for the possibility of the same. Under the Bankruptcy Code, nonfiling creditors cannot receive a distribution from the debtor's estate. See, e.g., 11 U.S.C. § 524(a). The Court further found that the official Bankruptcy Form 10 ("Form 10") specifically requires a creditor to identify any portion of a claim which is unsecured. Form 10, Box 4. The Court found the concept of notice of the existence of claims and opportunity to object to claims to be of paramount nature and supported by legislative history. H.R. Rep. No. 95-595, at 315, 1978 U.S.C.C.A.N. 5963, 6307 (1978). "[i]n general ... unless a claim is listed in a Chapter 9 or Chapter 11 case and allowed as a result of the list, a proof of claim will be prerequisite to allowance for unsecured claims, including priority claims and the unsecured portions of a claim asserted by the holder of a lien."
Given the timing of how cases play out, it may be such that the valuation of collateral in a case does not get addressed until a later stage than the fixing of the Bar Date. Contrasted with the desire to maximize value and fix rights during the case, identifying an undersecured claim too early is a delicate strategic balance for the filing creditor. In addition, a reservation of rights can be utilized for the equipment lessor as well on two fronts: (1) to cover the reservation of a secured claim in the event the lease is recharacterized as a secured transaction, and (2) to address the J.H. Investment issue if such recharacterization occurs.
Although the facts of each case stand on their own in formulating a strategy for a secured creditor, we often include a reservation regarding a potential unsecured claim such that if valuation establishes a claim to be undersecured, we reserve the right to amend and modify the claim. This statement puts parties on notice that such a claim could be forthcoming. In the event value is determined sooner, amending claims thereafter is strongly recommended.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.