HOW CLAIMS ARE ADMINISTERED DURING CHAPTER 11 BANKRUPCTY ?
Claims constitute the foundation of the creditor side of a Chapter 11 case. A corporation may have hundreds or thousands of creditors, including lenders, trade creditors, employees, taxing authorities, landlords, customers and other persons asserting rights against the debtor. Before the debtor can formulate a workable Chapter 11 plan, it is necessary to identify these claims, determine their amount and legal character, resolve disputes concerning their validity, and establish the claims that will ultimately participate in distributions under the plan. The process through which these matters are identified and resolved is generally referred to as claims administration.
The Bankruptcy Code establishes a statutory framework for determining what constitutes a claim, how a claim may be asserted, when it is deemed allowed, and the circumstances in which it may be disallowed or reduced. The principal provisions governing claims are contained in Sections 101(5), 501 and 502 of the Bankruptcy Code, supplemented by provisions dealing with administrative expenses, secured claims and priority claims, including Sections 503, 506 and 507. The procedural framework is principally contained in Federal Rules of Bankruptcy Procedure 3001, 3003, 3006 and 3007. Claims administration is particularly important in a Chapter 11 case because the amount and validity of claims can directly affect the debtor’s liabilities, the feasibility of the proposed plan, the voting rights of creditors and the distributions contemplated under the plan.
MEANING OF A CLAIM
The starting point of claims administration is the statutory definition of a “claim.” Section 101(5) of the Bankruptcy Code defines a claim broadly as a “right to payment,” whether or not such right has been reduced to judgment, is liquidated or unliquidated, fixed or contingent, matured or unmatured, disputed or undisputed, legal or equitable, or secured or unsecured. The definition also includes certain rights to an equitable remedy for breach of performance where the breach gives rise to a right to payment.
The broad definition contained in Section 101(5) is of considerable importance in Chapter 11 proceedings. A creditor does not necessarily have to possess a final judgment or a presently payable debt in order to hold a bankruptcy claim. A contingent, unmatured, disputed or unliquidated obligation may nevertheless constitute a claim for purposes of the Bankruptcy Code. Consequently, the claims administration process may require the bankruptcy court to determine whether a legally enforceable right to payment exists, even though the amount of the obligation has not yet been finally determined.
A claim should also be distinguished from an equity interest. A creditor asserts a claim against the debtor or the bankruptcy estate, whereas a shareholder generally holds an ownership interest in the debtor. Claims and equity interests are treated differently under the Bankruptcy Code. The question of how allowed claims and equity interests are subsequently grouped into classes for purposes of a Chapter 11 plan is addressed separately in the chapter dealing with classification.
CLAIMS EXISTING AT THE COMMENCEMENT OF THE CASE
A significant part of claims administration concerns the identification of obligations existing at the commencement of the Chapter 11 case. Prepetition claims generally arise from obligations incurred before the filing of the bankruptcy petition. These may include bank loans, trade debts, unpaid contractual obligations, lease liabilities, litigation claims, tax liabilities and obligations arising from guarantees or other contractual arrangements.
The commencement of the bankruptcy case therefore provides an important reference point for determining the nature of liabilities. Claims arising from prepetition transactions or obligations are generally dealt with as prepetition claims, subject to the specific provisions of the Bankruptcy Code applicable to the particular claim. Postpetition obligations may, however, have a different legal character. Certain expenses and obligations incurred after the commencement of the case may qualify as administrative expenses under Section 503(b), and allowed administrative expenses receive priority under Section 507(a)(2).
The distinction between pre-petition claims and post-petition administrative expenses is consequently important in determining both the allowance and eventual payment of an obligation. Claims administration must therefore consider not only the amount asserted by a creditor but also when and how the underlying obligation arose.
FILING AND ASSERTION OF CLAIMS
Section 501 of the Bankruptcy Code provides the statutory basis for filing proofs of claim. A creditor may file a proof of claim in accordance with the Bankruptcy Code and the Bankruptcy Rules. A proof of claim is the principal procedural mechanism through which a creditor asserts its entitlement against the bankruptcy estate.
Federal Rule of Bankruptcy Procedure 3001 prescribes the requirements relating to proofs of claim. A proof of claim is a written statement setting forth the creditor’s claim and generally must conform substantially to the applicable Official Form. Where the claim is based upon a writing, the rule generally requires the relevant writing or appropriate supporting information to accompany the proof of claim, subject to the requirements and exceptions contained in the rule.
The filing of a proof of claim has important evidentiary significance. Under Rule 3001, a proof of claim executed and filed in accordance with the applicable requirements constitutes prima facie evidence of the validity and amount of the claim. Accordingly, the filing of a proof of claim is not merely an administrative formality. It establishes the creditor’s asserted amount and basis of entitlement and provides the debtor and other parties in interest with the information necessary to examine and, where appropriate, challenge the claim.
CLAIMS IN CHAPTER 11 AND DEBTOR’S SCHEDULES
Claims administration in a Chapter 11 case also involves the debtor’s schedules of assets and liabilities. Federal Rule of Bankruptcy Procedure 3003 specifically governs the filing of proofs of claim or interests in Chapter 11 cases. Under Rule 3003, the debtor’s schedules may constitute prima facie evidence of the validity and amount of scheduled claims, subject to the qualifications contained in the rule. Where a claim is scheduled as disputed, contingent or unliquidated, the creditor generally must file a proof of claim in order to assert the claim for purposes of the case.
A creditor should therefore carefully examine the debtor’s schedules after commencement of the Chapter 11 case. If the creditor’s claim has not been scheduled, has been scheduled in an incorrect amount, or has been scheduled as disputed, contingent or unliquidated, the creditor may be required to file a proof of claim within the prescribed period. The claims process therefore involves both the debtor’s schedules and proofs of claim filed by creditors.
BAR DATE OF FILING CLAIMS
A Chapter 11 court generally establishes a deadline by which proofs of claim must be filed. This deadline is commonly referred to as the “bar date.” The purpose of the bar date is to bring certainty to the claims process by establishing a date after which claims may not ordinarily be filed without appropriate authorization or relief.
Rule 3003(c) provides that the court fixes the time within which proofs of claim or interests may be filed in a Chapter 11 case. The applicable bar date is generally established by a court order, and creditors are required to comply with the requirements contained in that order. A creditor whose claim is required to be filed but is not timely filed may face significant consequences concerning its ability to participate in the plan process or receive distributions.
The bar date is therefore an important event in the administration of a Chapter 11 case. Before and after the bar date, the debtor and its claims agent may undertake extensive efforts to identify, record, reconcile and resolve claims. Special rules may apply to governmental units and certain other categories of claims, and therefore the applicable provisions of the Bankruptcy Code, Bankruptcy Rules and court orders must be examined in each individual case.
CLAIMS RECONCILIATION
After proofs of claim have been filed, the debtor ordinarily undertakes a process of claims reconciliation. The purpose of reconciliation is to compare the claims filed against the debtor’s books and records, contracts, payment records, loan documents, invoices, litigation records and other relevant information. This process enables the debtor to determine whether the claims asserted by creditors correspond with the debtor’s own records and whether the amounts claimed are legally and factually supportable.
The reconciliation process may identify claims that are fully consistent with the debtor’s records as well as claims that are overstated, duplicated, already paid, filed against the wrong debtor or unsupported by sufficient documentation. It may also identify claims involving incorrect calculations of interest, fees or other charges, claims subject to setoff or recoupment, and claims whose legal validity is disputed. Claims reconciliation therefore involves both accounting and legal analysis. The objective is to determine the amount for which the bankruptcy estate should recognize legal liability rather than merely recording the amount asserted by the creditor.
EXAMINATION OF THE VALIDITY AND AMOUNT OF CLAIMS
Section 502 of the Bankruptcy Code contains the principal statutory framework for determining whether a claim is allowable. Section 502(a) provides that a claim or interest, proof of which is filed under Section 501, is deemed allowed unless a party in interest objects. Where an objection is made, Section 502(b) requires the court, after notice and a hearing, to determine the amount of the claim and allow the claim in the amount determined under the applicable provisions of the Bankruptcy Code, except to the extent one of the statutory grounds for disallowance applies.
The objection process is therefore fundamental to claims administration. The mere filing of a proof of claim does not make the amount asserted by the creditor immune from challenge. The debtor, trustee, creditors’ committee or another party in interest may object to a claim where there is a legitimate factual or legal basis for doing so. The resulting process may involve examination of contracts, invoices, payment records, security documents, correspondence, litigation records and applicable non-bankruptcy law.
The ultimate purpose of the process is to determine the amount of the allowed claim. Accordingly, a claim may be allowed in the amount originally asserted, allowed in a reduced amount, or disallowed in whole or in part.
GROUNDS FOR DISALLOWANCE OF REDUCTION OF CLAIMS
Section 502(b) sets out various circumstances in which a claim may be disallowed or its amount determined differently from the amount asserted by the creditor. Among other matters, a claim may be disallowed to the extent that the underlying obligation is unenforceable against the debtor under applicable law or agreement. The provision also contains specific rules dealing with matters such as unmatured interest, certain tax claims, excessive compensation, certain lease and employment termination claims and other specified categories of obligations.
The claims objection process may therefore involve both factual and legal questions. For example, a debtor may dispute whether goods were delivered, whether services were actually performed, whether an invoice was paid, whether interest was properly calculated or whether an agreement creates an enforceable obligation. In other cases, the dispute may involve the application of a particular provision of the Bankruptcy Code or applicable non-bankruptcy law.
The result of the objection process may be complete disallowance of the claim, partial disallowance, or allowance in an amount different from that originally asserted. The determination is ultimately governed by the Bankruptcy Code and, where necessary, by an order of the bankruptcy court.
In Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., 549 U.S. 443 (2007), the Supreme Court reaffirmed the general principle that a claim that is enforceable under applicable non-bankruptcy law is not rendered non-compensable merely because it arises in bankruptcy, unless the Bankruptcy Code itself disallows the claim. The decision is important to claims administration because allowance of a claim generally requires examination of the underlying substantive law as well as the specific limitations contained in the Bankruptcy Code.
OBJECTION TO CLAIMS
The procedure for objecting to proofs of claim is principally governed by Federal Rule of Bankruptcy Procedure 3007. The rule establishes requirements concerning the filing, service and notice of an objection and provides a procedural framework through which the claimant may respond to the objection.
In large Chapter 11 cases, the number of claims may be substantial. Claims objections may therefore be handled through organized procedures approved by the bankruptcy court. Subject to the applicable rules and court orders, multiple claims raising similar issues may in appropriate circumstances be addressed through omnibus objection procedures.
A claims objection may seek complete disallowance of a claim or may seek only a reduction in the amount asserted. The objection may also challenge the legal basis of the claim or seek determination of the amount of the obligation. The claimant is ordinarily given an opportunity to respond, and unresolved disputes may ultimately be determined by the bankruptcy court.
CONTINGENT, UNLIQUIDATED AND DISPUTED CLAIMS
Chapter 11 cases frequently involve claims that cannot immediately be reduced to a definite amount. A contingent claim depends upon the occurrence of a future event. An unliquidated claim is one whose amount has not yet been determined with sufficient certainty. A disputed claim is one whose validity or amount is contested.
Such claims can complicate the administration of a Chapter 11 case because the ultimate amount of the claim may affect the debtor’s liabilities and, at a later stage, the creditor’s participation in the plan process. The Bankruptcy Code therefore provides a mechanism for dealing with claims that cannot otherwise be resolved without delaying the administration of the case.
Section 502(c) provides for estimation of certain contingent or unliquidated claims when fixing or liquidation of the claim would unduly delay the administration of the case. Estimation does not necessarily constitute a final determination of the underlying claim for every purpose; rather, it provides a mechanism through which the court can assign an amount where necessary to permit the case to proceed efficiently.
Estimation can be particularly important where the debtor faces substantial litigation claims, guarantee obligations, environmental liabilities, tax disputes or other contingent liabilities that may take considerable time to resolve through ordinary litigation.
SECURED CLAIMS
Claims administration must also address whether and to what extent a claim is secured. Section 506(a) generally determines the extent to which a claim is secured by a lien on property of the estate by reference to the value of the creditor’s interest in the debtor’s interest in that property. Where the amount of the debt exceeds the value of the collateral securing it, the creditor may have an unsecured deficiency claim, subject to the applicable provisions of the Bankruptcy Code.
Determining the amount of a secured claim may therefore require consideration of the underlying loan documents, the validity and priority of the lien, the amount of the outstanding debt and the value of the collateral. Valuation disputes may arise where the parties disagree about the appropriate value of the property securing the debt.
Section 506 and related provisions, including Section 1111, may have significant consequences for the rights of secured creditors in a Chapter 11 case. However, the detailed treatment and classification of secured claims under a Chapter 11 plan is more appropriately considered separately in the chapters dealing with classification and plan treatment.
PRIORITY AND ADMINISTRATIVE CLAIMS
Claims administration must also take account of the statutory priorities established by the Bankruptcy Code. Certain claims receive priority over general unsecured claims because Congress has determined that they should receive preferential treatment in the distribution of the bankruptcy estate.
Section 503(b) provides for the allowance of certain administrative expenses, including specified expenses incurred in preserving the estate and administering the bankruptcy case. Administrative expenses allowed under Section 503(b) receive priority under Section 507(a)(2). Section 507 also establishes priority for other specified categories of claims, including certain employee wage and benefit claims and certain tax claims.
The determination of whether a claim is entitled to priority may itself be disputed. The creditor may have to establish that the claim satisfies the statutory requirements applicable to the particular priority category. Thus, claims administration involves not only determining whether an obligation exists and the amount owed, but also determining whether the claim is entitled to a statutory priority.
AMENDMENT AND WITHDRAWAL OF CLAIMS
A creditor may in appropriate circumstances seek to amend a proof of claim. An amendment may become necessary where the creditor discovers an error, obtains additional information or determines that the original proof of claim incorrectly stated the amount or basis of the obligation. The treatment of an amended claim may depend upon the circumstances of the case, applicable court orders and the relevant procedural rules.
Federal Rule of Bankruptcy Procedure 3006 governs the withdrawal of proofs of claim. The rule permits withdrawal in specified circumstances but imposes restrictions where, among other things, an objection has been filed or other proceedings involving the claim have occurred. The rule also addresses circumstances in which withdrawal may affect acceptance or rejection of a plan.
Amendment and withdrawal of claims are therefore matters that may have consequences beyond the immediate claims register. In particular, once a creditor has participated in the Chapter 11 process, the withdrawal or modification of its claim may require consideration of the effect on voting and other rights.
CLAIMS AGENTS AND ADMINISTRATION OF CLAIMS
Large Chapter 11 cases may involve a very substantial number of claims. The debtor may therefore seek authority from the bankruptcy court to retain a claims and noticing agent to assist in the administrative aspects of the claims process.
A claims agent may receive and record proofs of claim, maintain the claims register, process amendments and withdrawals, provide notices, maintain electronic records, assist in reconciling claims and prepare reports concerning the status of claims. The claims agent generally performs an administrative function and does not independently determine the legal validity of a claim. Substantive disputes concerning claims remain subject to the Bankruptcy Code, the Bankruptcy Rules, the orders of the bankruptcy court and the rights of the parties.
The appointment of a claims agent can be particularly useful in large Chapter 11 cases because it provides an organized system for managing the large volume of claims and related documentation generated during the case.
DETERMINATION OF ALLOWED CLAIMS
The culmination of the claims administration process is the determination of the claims that are allowed for purposes of the Chapter 11 case. Under Section 502(a), a properly filed claim is generally deemed allowed unless a party in interest objects. Where an objection is filed, the bankruptcy court may determine the validity and amount of the claim in accordance with Section 502(b).
A claim may therefore become an allowed claim because it is properly filed and not objected to, because an objection is resolved in favour of the claimant, or because the parties reach a settlement or other consensual resolution that determines the amount of the claim. Conversely, a claim may be reduced or disallowed where the requirements for disallowance are established.
Claims may also be resolved through estimation under Section 502(c), amendment, settlement or other procedures authorized by the Bankruptcy Code and the bankruptcy court. The important point is that the claims administration process seeks to establish a reliable and legally supportable amount of liabilities that can be used in administering the Chapter 11 estate.
CLAIMS ADMINISTRATION AND THE CHAPTER 11 PLAN
Claims administration provides an essential foundation for the formulation of the Chapter 11 plan. The debtor must have a reasonably accurate understanding of the amount and nature of its liabilities before it can determine how those liabilities can be restructured. The claims process therefore assists in determining the total liabilities of the debtor, the amount of secured and unsecured obligations, the amount of priority claims and the potential distributions that may be required under the proposed plan.
The claims process may also affect the debtor’s financial projections, liquidation analysis and feasibility analysis. If substantial claims are subsequently allowed in amounts materially different from those assumed during plan formulation, the economic assumptions underlying the plan may be affected.
Claims administration is consequently closely connected with the plan process, but it remains conceptually distinct from classification. Claims administration determines whether a claim exists and, if so, the amount and applicable legal status of the claim. Classification, which is dealt with in the following chapter, addresses how claims and interests are grouped for purposes of the Chapter 11 plan.
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Mukesh Suman is a lawyer based at Delhi, India. He also provides bankruptcy paralegal services to clients based in USA. He may be contacted at mukesh_suman@outlook.com or +91 9717864570.
