California Creditor's Rights & Business Bankruptcy Lawyer & Attorney : Robert Eisenbach : Business Bankruptcy Blog

The Spring 2008 edition of the Absolute Priority newsletter, published by the Cooley Godward Kronish LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter give updates on current developments in bankruptcies and workouts with the goal of keeping you "ahead of the curve" on these issues. Follow the links in this sentence to access a copy of the newsletter or to register to receive future editions.

The latest edition covers a range of cutting edge topics, including:

• The ability of unsecured creditors to recover post-petition attorney's fees;
• Key issues when selling claims in bankruptcy;
• Jury trials and proofs of claim;
• Assignments for the benefit of creditors; and
• The impact of post-petition performance on executory contracts.

We have also included information on some of our recent representations of official committees of unsecured creditors in Chapter 11 bankruptcy cases, and unofficial committees in out-of-court workouts, involving major retailers. These include Sharper Image, Lillian Vernon, CompUSA, Wickes Furniture, and The Bombay Company, among others. In addition, a note from my partner Adam Rogoff, the editor of Absolute Priority, discusses the increasing number of bankruptcy filings nationwide and our representation of Bayonne Medical Center in its Chapter 11 reorganization.

I hope you find this latest edition of Absolute Priority to be a helpful resource.

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An article my partner Adam Rogoff, associate Seth Van Aalten, and I wrote was recently published in the January 2008 issue of Pratt's Journal of Bankruptcy Law. The article discusses the significant amendments to the Federal Rules of Bankruptcy Procedure that took effect on December 1, 2007. Those amendments covered a range of procedures from omnibus claims objections to motions to assume executory contracts and real property leases to "first day" motions in Chapter 11 cases. 

If you don't have a copy of the Journal, you can read the article, entitled "Important Changes To Bankruptcy Rules Take Effect," by clicking on its title in this sentence. For more details on the rule changes, use the links that follow for a copy of the full, "clean" set of rule amendments as well as the redline set showing changes made by the amendments to the existing rules, together with the Advisory Committee's comments.

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Happy New Year to everyone. I'm back from a holiday blogging break with a report on the first appellate decision to address the question left open in last year's U.S. Supreme Court decision in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. -- whether post-petition attorney's fees can be added to unsecured claims. Although unrelated, this new decision also tackles the interesting question of whether a guarantor of a debt can become liable if the payment of the debt by the primary obligor later is returned in a preference settlement.

The Travelers Case. As a brief refresher, the U.S. Supreme Court overruled the Ninth Circuit's so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision (available here) in March 2007. However, it did not decide whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorney's fees incurred during the course of the bankruptcy case. For more on the Travelers decision, you may find this earlier post of interest.

A Developing Split. Since the Travelers decision, two bankruptcy courts issued decisions on the open issue, coming to different conclusions. 

• In May 2007, in the In re Qmect, Inc. decision (available here), the U.S. Bankruptcy Court for the Northern District of California held that unsecured creditors could recover post-petition attorney's fees. For more on that decision, see this earlier post on the case and its analysis. 
• In July 2007, in the In re Electric Machinery Enterprises, Inc. case (available here), the U.S. Bankruptcy Court for the Middle District of Florida came to the opposite conclusion, following a majority of courts that had addressed this issue unrestrained by the Ninth Circuit's Fobian decision. See this previous post for more on the Florida decision.
• Commentators, including with the recent article written by the American Bankruptcy Institute's Scholar in Residence Professor Mark Scarberry, have joined the fray as well.

The SNTL Corp. Ruling. On December 19, 2007, the Ninth Circuit Bankruptcy Appellate Panel ("BAP") issued its decision in the In re SNTL Corp. case (available here). After carefully reviewing both the Qmect and Electric Machinery decisions, as well as pre-Travelers case law, the BAP chose to follow Qmect, holding that "claims for postpetition attorneys' fees cannot be disallowed simply because the claim of the creditor is unsecured." Judge Dennis Montali, writing for the unanimous BAP panel, first explained its analysis of the interplay between Sections 502 and 506(b):

We are not persuaded by the approach of the Electric Machinery court and, like Qmect, we reject the argument that section 506(b) preempts postpetition attorneys’ fees for all except oversecured creditors. While we cannot predict how the Ninth Circuit will decide this issue in Travelers, we do find a clue in Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678 (9th Cir. 1986), where the Ninth Circuit observed that section 506(b) defines secured claims and does not limit unsecured claims:

When read literally, subsection (b) arguably limits the fees available to the oversecured creditor. When read in conjunction with § 506(a), however, it may be understood to define the portion of the fees which shall be afforded secured status. We adopt the latter reading.

268 Ltd., 789 F.2d at 678.

Next, the BAP discussed Section 502(b)(1)'s requirement that the court determine the amount of an unsecured claim as of the petition date: 

The Electric Machinery court, like the bankruptcy court here and many of the pre-Travelers majority courts, disallowed the postpetition fees of an unsecured creditor because section 502(b)(1) provides that a bankruptcy court  “shall determine the amount of such claim . . . as of the date of the filing of the petition” and the postpetition fees did not exist as of that date. Elec. Mach., 371 B.R. at 551; Pride Cos., 285 B.R. at 373. Because the amount of fees incurred postpetition cannot be determined or calculated as of the petition date, section 502(b) purportedly precludes their allowance. Id. We disagree with this approach, as it is inconsistent with the Bankruptcy Code’s broad definition of “claim,” which -- as discussed previously -- includes any right to payment, whether or not that right is contingent and unliquidated. See 11 U.S.C. § 101(5)(A); Qmect, 368 B.R. at 884.

The BAP then held that the Supreme Court's 1988 Timbers decision did not apply:

We believe that Electric Machinery’s reliance on Timbers is misplaced. Timbers provided that an undersecured creditor could not receive postpetition interest on the unsecured portion of its debt. Timbers, 484 U.S. at 380. This holding is consistent with section 502(b)(2), which specifically disallows claims for unmatured interest. Inasmuch  as section 502(b) does not contain a similar prohibition against attorneys’ fees, the comparison between the current issue and that presented in Timbers is not persuasive.

Finally, the BAP held that it was unnecessary to reconcile the competing public policy considerations advanced by the Electric Machinery and Qmect decisions:

Because we find that the Bankruptcy Code itself provides the answer to this issue (by not specifically disallowing postpetition fees), we do not attempt to reconcile these policy concerns. In the end, it is the province of Congress to correct statutory dysfunctions and to resolve difficult policy questions embedded in the statute.

A Ninth Circuit Decision To Come? In the first quote above, you may have picked up the BAP's reference to the Ninth Circuit having this issue before it in the Travelers case. That case, on remand from the Supreme Court, appears to have been fully briefed. Any decision from the Ninth Circuit itself on the issue would, of course, supersede this BAP decision and be controlling authority in the circuit, but it may be months before such a ruling comes down.

A Bonus Issue: Guarantor's Liability Revived After A Preference Settlement. The facts of the SNTL Corp. case are complex, but the key facts are fairly straightforward. In short, one of the debtor's insurance company subsidiaries owed money to the creditor and the debtor guaranteed the debt. Although the subsidiary paid the creditor, the subsidiary was later placed into state insolvency proceedings. The state insurance commissioner sued the creditor for return of the payment on preference grounds. The creditor settled the preference case and returned most of the payment ($110 million of a $163.4 million original payment). The creditor thereafter amended its proof of claim in the debtor's Chapter 11 case, seeking recovery under the guaranty of the returned preference.

• After first determining that the guaranty's language permitted the creditor to assert a claim to the extent provided by law, the BAP next held, "[w]hile we located no Ninth Circuit or California case precisely on point, we agree that the return of a preferential payment by a creditor generally revives the liability of a guarantor."
• The BAP cited to various case and restatement authority for the proposition that although a guarantor is discharged on payment of a debt, a preferential payment is deemed to be no payment at all.
• The BAP also held that repayment of a preference in a settlement, following a preference lawsuit, is not a voluntary payment that would avoid the guarantor's liability.
• Given the risk of a preference recovery, the creditor's revival claim under the guaranty was a contingent claim as of the petition date and became allowable once the contingency occurred following the petition. As a result, the creditor's claim for the full $110 million of the preference settlement was an allowed claim.

An Important Decision. BAP decisions are not binding precedent in the Ninth Circuit, but this first appellate decision on the open, post-Travelers question may encourage unsecured creditors to include post-petition attorney's fees as part of their allowed unsecured claims when their contracts or a statute provides for them outside of bankruptcy.  We may see creditors begin to include such amounts in unsecured claims at an increasing pace, while we wait for the Ninth Circuit's decision on this issue in the remanded Travelers case. The added bonus of the SNTL Corp. court's guaranty analysis and holding makes this decision an even more interesting, and important, read.

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As described in a post earlier this week, one of the major changes made by the new amendments to the Federal Rules of Bankruptcy Procedure that took effect on December 1, 2007 was the inclusion of limits on the use of omnibus claim objections. Newly revised Rule 3007 restricts omnibus objections to certain situations and imposes formatting standards on the motions that can be filed. 

• Click the following link for the full set of redlined rule changes, including Advisory Committee comments.
• This second link will take you to the official bankruptcy forms, many of which have been amended effective December 1, 2007.

When describing the amended rule, I commented that the Delaware Bankruptcy Court, through Local Rule 3007-1, has had its own omnibus objection procedures for some time and that they seemed to be in conflict with the new national rule. Well, taking advantage of the "unless otherwise ordered by the court" language in amended Rule 3007(c), Chief Judge Mary F. Walrath of the Delaware Bankruptcy Court issued this General Order noting the conflict but directing that the amended Rule 3007(c) "shall not be applicable to omnibus objections that are filed in accordance with Local Rule 3007-1." As a result, barring an individual judge choosing to apply the national Rule 3007 procedure in a particular situation, omnibus objections in Delaware cases will continue to be governed by Delaware's own local procedures.

Special thanks to Chuck Kunz of MorrisJames, publishers of the Delaware Business Bankruptcy Report, for alerting me to Delaware's new General Order.

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On December 1st of almost every year, amendments to the Federal Rules of Bankruptcy Procedure -- the ones that govern how bankruptcy cases are managed -- take effect to address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. Often the changes are relatively minor and of interest only to bankruptcy practitioners, but this year's set has made some significant changes that will directly impact debtors, creditors and other stakeholders.

A Look At The Amendments. You may find it interesting to see the entire group of amendments together, so I have included two links. The first is to the full "clean" set of the amended rules. The second is to a redline showing the changes made by these amendments to the existing rules, together with the Advisory Committee's comments.

The Omnibus Objection Problem. One of the most significant amendments will make changes to the popular practice of filing omnibus objections. In large cases the debtor or other estate representative has so many claims to address that they have combined objections to dozens -- sometimes hundreds -- of different claims in one single motion. The objection may have a name such as “Debtors' Fourteenth Omnibus Objections To Claims (Substantive)” or some similarly titled document. Click here for one example. In a post last year called "Objections To Claims: Ignore Them At Your Peril," I discussed how it can be hard to tell which claims an omnibus objection is targeting.

• The format has often meant that the only reference to an individual creditor is buried within the objection’s many pages of text and exhibits, typically in an attached list or chart.
• If the creditor doesn't respond to the objection timely, its claim will likely be disallowed and it will recover absolutely nothing from the bankruptcy estate.

The Amended Rule 3007: An "Anti-Gotcha" Solution. The new rules restrict the use of omnibus objections to certain limited circumstances and impose formatting standards. Otherwise, each claim will require its own separate claim objection unless the combined objection covers claims filed by the same person or entity. What grounds for objection can be made by an omnibus objection under the newly revised Rule 3007?

• Duplicate claims;
• Claims filed in the wrong case;
• Original claims that were amended by later claims;
• Claims that were not timely filed;
• Claims that have already been paid or released;
• Claims filed in a form that does not comply with applicable rules;
• Claims that are really asserting an equity interest in the debtor; and
• Priority claims that assert an amount in excess of the maximum amount in the Bankruptcy Code.

In short, if the claim is being challenged on substantive grounds, rather than more technical or procedural ones, then the objection will have to be filed one claimant at a time.

When an omnibus objection does make the permitted objections, it will now have to list claimants in alphabetical order, cross-reference claim numbers, give the ground for the objection and cross-reference that to the text of the objection, describe the objector and the reason for the objection in the document's title, and combine no more than 100 claims in a single objection. This is all designed to make it easier for the creditor to figure out whether its claim is included and the basis for the objection.

• This rule change has gotten some coverage in the business press. CFO.com had an article entitled "Bankruptcy Short List to Help Creditors," and CNN Money.com had an article entitled "New Ch 11 Court Rule Helps Creditors." (Dean Kirby, quoted in the CFO.com article, had a post on the topic on his Bankruptcy Beach blog as well.)
• Those who have experience with bankruptcy cases in Delaware will probably notice that new national Rule 3007 is similar to the Delaware Bankruptcy Court's Local Rule 3007-1, which has put limits on "non-substantive" and "substantive" claim objections for some time. New Rule 3007 generally appears to be more restrictive than the Delaware local rule so the local rule will likely need amendment.

Amended Rule 4001: The Clearer Disclosure Rules. Changes have been made to the rule that governs motions and stipulations for use of cash collateral and obtaining debtor in possession (DIP) financing. The amended rules now require that more details about the key provisions of cash collateral and DIP financing terms and conditions be stated in the motion, that proposed forms of order be filed with the motion, and that cross-references be made in the motion to where in the cash collateral or DIP financing agreements and proposed orders the key provisions are reflected. Since some financing agreements can run hundreds of pages long, with complex formulas and provisions, this rule change is designed to make it easier for the court and the parties to understand their material features without wading through the entire document.

New Rule 6003: Putting The Breaks On Some "First Day" Orders. Another major change is the addition of Rule 6003. This new rule provides that "except and to the extent that relief is necessary to avoid immediate and irreparable harm, the court shall not, within 20 days after the filing of the petition, grant relief" regarding three key areas:

• The employment of professionals;
• A motion to pay any prepetition claims (read: critical vendors) or to use, sell, lease (Section 363 sales), or incur an obligation for property of the estate, other than cash collateral or DIP financing motions; or
• Assumption or assignment of any executory contract or unexpired lease (including commercial real estate leases).

As drafted, unless there is an emergency, and then only to the extent it's really necessary, the bankruptcy court should defer these decisions until after the 20th day following the filing of the Chapter 11 bankruptcy petition (although technically these apply under the other chapters of bankruptcy). One reason for the rule is to give time for a creditors committee to be appointed and retain counsel before important decisions are made. That said, the exceptions for cash collateral and DIP financing, as well as for rejection of leases and other executory contracts, means a lot can still be done during the early part of a case. When Section 363 sale or critical vendor motions come up on an emergency basis, it'll be interesting to see how often courts, in applying this new rule, find the existence of irreparable harm.

Amended Rule 6006: Assumption, Assignment, And Rejection Of Executory Contracts. Similar to Rule 3007, Rule 6006 has been changed to put limits on when omnibus motions can be used to deal with executory contracts and leases. Under new Rule 6006(e), absent special court authorization, omnibus motions may be used for multiple executory contracts or leases only when all of the executory contracts to be assumed or assigned are (1) between the same parties, or (2) being assigned to the same assignee. This latter provision likely covers most Section 363 asset sales, so non-debtor contracting parties should continue to carefully review those motions, as discussed in this earlier post. An omnibus motion may also be used when a debtor or trustee seeks to assume, but not assign to more than one assignee, real property leases. In addition, omnibus motions may be used to request rejection of multiple executory contracts or leases.

New Rule 6006(f) provides that, when allowed, these omnibus motions can list no more than 100 executory contracts or leases in any one motion (unlike the chart on this fairly typical pre-amendment motion), and multiple motions will need to be numbered consecutively. The new rule also requires that permitted omnibus motions provide a variety of new information, including:

• An alphabetical listing by party name;
• The terms of the assumption or assignment, including for curing defaults; and
• The identity of the assignee and the adequate assurance of future performance to be provided.

A Few Other Changes. The other amendments this year (1) permit a court to consider a change of venue, (2) clarify when corporate ownership disclosure needs to be made, (3) address constitutional challenges to statutes, and (4) specify procedures for protecting social security numbers and other private information in court filings. Check the clean or redline sets linked above to read these additional rule amendments.

Conclusion. This year's amendments to the Federal Rules of Bankruptcy Procedure have more than their share of real changes and they will have an impact on business bankruptcy cases. The omnibus motion changes should help creditors from missing when their claim is the target of an objection and contract parties from failing to see that their executory contract or lease is part of a motion to assume and assign. Although cash collateral and DIP financing motions are not affected, the new irreparable harm standard for certain relief in the first 20 days of a case may prove interesting when emergency Section 363 sales are attempted. Stay tuned.

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Here's a scenario frequently seen in Chapter 11 cases. A tenant files bankruptcy and rejects a commercial real estate lease. The landlord files an unsecured lease rejection claim seeking to recover the lost future rent under the rejected lease. The claim amount is capped by Bankruptcy Code Section 502(b)(6) but may still be one of the larger unsecured claims in the case. Now let's add a small, but relatively common, twist. Sometime later, but before distributions are made on the claim, the landlord sells the real estate that the debtor had occupied under the rejected lease.

The FLYi Chapter 11 Case. That, complete with the twist, was the situation in the In re FLYi, Inc. Chapter 11 case pending in the Delaware Bankruptcy Court. After the landlord sold the property, the liquidation trust established under the debtor's Chapter 11 plan of reorganization objected to the landlord's claim, arguing that after the sale of the property the debtor had no further obligations under the lease. Virginia law applied because the property was located in Dulles, Virginia. As described by the Bankruptcy Court, the landlord had three options under Virginia law:

[D]o nothing and sue for the rent remaining under the Lease; reenter the Premises for the sole purpose of re-letting it without terminating the Lease; or re-enter the Premises and exercise full dominion over the premises thereby terminating the Lease and eliminating FLYi’s obligation to pay any future rent.

The landlord argued that this interpretation of the law was wrong but asserted that provisions in the lease protected the landlord's claim anyway. The Bankruptcy Court rejected those arguments and held that the landlord's sale of the property terminated both the lease and the landlord's right to future rent after the date of the sale. A copy of the Bankruptcy Court's decision is available here.

Be sure to read the Delaware Business Bankruptcy Report's interesting discussion for more details on the decision, including the arguments advanced and the Bankruptcy Court's treatment of them.

What Does This Mean For Landlords? A landlord contemplating a sale of the real property will have to consider what impact that sale might have on its lease rejection claim.

• In states like Virginia where, according to the Bankruptcy Court in the FLYi case, termination of a lease cuts off a landlord's claim for future rent, landlords will have to be prepared to lose all or a portion of a lease rejection claim if they sell the real property. 
• The outcome may be different in other states. Section 1951.2 of the California Civil Code, for example, expressly permits a landlord, upon termination of a lease, to recover the present value of the difference between the unpaid future rent under the lease and the amount of rent that could reasonably be avoided through mitigation efforts. This may permit a landlord to sell the property and still retain a lease rejection claim.
• When state law allows it, landlords may seek to include provisions in a lease to preserve contractually the right to a post-sale lease damages claim.

What Does This Mean For Bankruptcy Estates? Debtors, liquidation trusts, and other estate representatives may have an incentive to determine whether the landlord still owns the property. In states where a post-rejection sale of the property operates to cut off the landlord's future rent claim, this fact could provide a new ground for an objection to the landlord's Section 502(b)(6) claim.

Conclusion. Time will tell how frequently this scenario will play out in future cases, but landlords should expect to see the "did you sell the property" question asked more often going forward.

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When the U.S. Supreme Court overruled the Ninth Circuit's so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision (available here) in March 2007, it left for another day the question of whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorney's fees incurred during the course of the bankruptcy case.

Early Decisions Take Different Views. Since the Travelers decision, two bankruptcy courts have issued decisions but have come to different conclusions on that question. 

• In May 2007, in the In re Qmect, Inc. decision (available here), the U.S. Bankruptcy Court for the Northern District of California held that unsecured creditors could recover post-petition attorney's fees. For more on that decision, see this earlier post on the case and its analysis. 
• In July 2007, in the In re Electric Machinery Enterprises, Inc. case (available here), the U.S. Bankruptcy Court for the Middle District of Florida came to the opposite conclusion, following a majority of courts that had addressed this issue unrestrained by the Ninth Circuit's Fobian decision. See this previous post for more on the Florida decision.

New Article Sides With Majority View. A new article to be published in the Winter 2007 issue of the American Bankruptcy Institute Law Review, gives context for these differing views and argues that the majority position is the correct one. The article, entitled "Interpreting Bankruptcy Code Sections 502 and 506: Post-Petition Attorneys' Fees in a Post-Travelers World," was written by Professor Mark S. Scarberry, Professor of Law at the Pepperdine University School of Law. Professor Scarberry is the current Robert M. Zinman Scholar in Residence at the American Bankruptcy Institute. A copy of the article is available for download from the Social Science Research Network website by following this link.

A Textual Argument. The centerpiece of the article is Professor Scarberry's interesting analysis of the interplay between Sections 502(b) and 506 of the Bankruptcy Code and the textual argument he advances to support the majority view.

• A key building block of this argument is his conclusion that the language in Section 502(b), which provides that a claim is to be allowed in an amount "as of the date of the filing of the petition," precludes inclusion of post-petition amounts as part of the Section 502(b) claim allowance. 
• He then argues that Section 506(b)'s function is to add post-petition interest and "reasonable fees, costs, and charges" to this Section 502(b) allowed amount but only for secured claims (determined under Section 506(a)) and only when the value of a secured creditor's collateral exceeds the allowed amount of the claim, determined under Section 506(a).
• He contends that Section 506(b)'s use of the phrase "there shall be allowed" demonstrates that its purpose is to allow amounts not otherwise allowable under Section 502(b).

The Debate Continues. Professor Scarberry's article is an excellent resource for those seeking to understand the history and background of this issue. It also provides debtors, creditors committees, and their attorneys with arguments to oppose an unsecured creditor's attempt to recover post-petition attorney's fees. The issue, however, remains far from settled in the courts. 

• The majority view, now bolstered by the arguments in Professor Scarberry's article, will probably prevail in many cases.
• Still, the In re Qmect decision shows that at least some courts may allow these fees.

Until this issue is resolved by the Supreme Court, or at least by more Courts of Appeals, unsecured creditors with a contractual or nonbankruptcy statutory right to attorney's fees may try their luck and seek allowance of post-petition attorney's fees in bankruptcy cases as part of their unsecured claims.

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A commercial real estate lease often represents the largest single liability of many debtors. For retailers, which typically have scores or even hundreds of store leases, the liability involved is orders of magnitude larger. It's fair to say that the management of lease obligations can be of enormous consequence to debtors, landlords, and other creditors in Chapter 11 bankruptcy cases.

Rejected Leases And The Capped Claim. As explained in an earlier post on how commercial real estate leases are treated in bankruptcy, one of a debtor's options in a Chapter 11 case is to reject uneconomic or otherwise burdensome leases, terminating the debtor's obligation to pay rent and turning the landlord's claim for termination of the lease into a prepetition claim. Section 502(b)(6) of the Bankruptcy Code goes further and caps the landlord's prepetition rejection claim at an amount equal to the greater of (1) one year's rent or (2) fifteen percent of the remaining lease term, up to a maximum of three years' worth of rent. The starting date for calculating the claim is the earlier of the date when the bankruptcy petition was filed or when the landlord recovered possession of, or the tenant surrendered, the premises. A landlord with six years left on a rejected lease, for example, would have its claim capped at one year's worth of rent.

What's Covered By The Cap? This ability to cap a landlord's claim in bankruptcy can be a major benefit to debtor tenants. Ever since a 1995 decision by the Bankruptcy Appellate Panel (BAP) of the Ninth Circuit in In re McSheridan, 184 B.R. 91 (B.A.P. 9th Cir. 1995), debtors have been successful in many cases in capping a variety of claims by landlords. In McSheridan, the BAP held that the cap applied to all damages for the lessee's nonperformance of the lease, not just to claims based on future rent. Landlords have challenged that analysis but, at least in the Ninth Circuit, have had little success -- until this week.

The Ninth Circuit's El Toro Decision. In an eight-page opinion (available here) issued on October 1, 2007 in the In re El Toro Materials Company, Inc. Chapter 11 case,, the U.S. Court of Appeals for the Ninth Circuit took a very different view of the landlord cap under Section 502(b)(6). In the El Toro case, the debtor was a mining company that leased property from the Saddleback Community Church, paying $28,000 per month in rent. After the lease was rejected, Saddleback brought an adversary proceeding against El Toro for $23 million in damages alleging that El Toro left a million tons of wet clay "goo," mining equipment, and other materials on the property.

• The bankruptcy court held that Saddleback's claim, which asserted waste, nuisance, and other tort theories, would not be limited by the Section 502(b)(6) cap. 
• Following its McSheridan precedent, the BAP reversed and held that any damages would be subject to the cap. 
• Interestingly, two of the three judges on the BAP panel filed concurring opinions, voicing doubts about the wisdom of the McSheridan case. A copy of the BAP's unpublished El Toro decision from July 2005 is available here.

Judge Kozinski's Analysis. On appeal, the Ninth Circuit reversed the BAP's decision, holding that the cap did not apply to the landlord's tort claims. Judge Alex Kozinski authored the opinion and analyzed the key issues this way:

The structure of the cap—measured as a fraction of the remaining term—suggests that damages other than those based on a loss of future rental income are not subject to the cap. It makes sense to cap damages for lost rental income based on the amount of expected rent: Landlords may have the ability to mitigate their damages by re-leasing or selling the premises, but will suffer injury in proportion to the value of their lost rent in the meantime. In contrast, collateral damages are likely to bear only a weak correlation to the amount of rent: A tenant may cause a lot of damage to a premises leased cheaply, or cause little damage to premises underlying an expensive leasehold.

One major purpose of bankruptcy law is to allow creditors to receive an aliquot share of the estate to settle their debts. Metering these collateral damages by the amount of the rent would be inconsistent with the goal of providing compensation to each creditor in proportion with what it is owed. Landlords in future cases may have significant claims for both lost rental income and for breach of other provisions of the lease. To limit their recovery for collateral damages only to a portion of their lost rent would leave landlords in a materially worse position than other creditors. In contrast, capping rent claims but allowing uncapped claims for collateral damage to the rented premises will follow congressional intent by preventing a potentially overwhelming claim for lost rent from draining the estate, while putting landlords on equal footing with other creditors for their collateral claims.

The statutory language supports this interpretation. The cap applies to damages “resulting from” the rejection of the lease. 11 U.S.C. § 502(b)(6). Saddleback’s claims for waste, nuisance and trespass do not result from the rejection of the lease—they result from the pile of dirt allegedly left on the property. Rejection of the lease may or may not have triggered Saddleback’s ability to sue for the alleged damages.But the harm to Saddleback’s property existed whether or not the lease was rejected. A simple test reveals whether the damages result from the rejection of the lease: Assuming all other conditions remain constant, would the landlord have the same claim against the tenant if the tenant were to assume the lease rather than rejecting it? Here, Saddleback would still have the same claim it brings today had El Toro accepted the lease and committed to finish its term: The pile of dirt would still be allegedly trespassing on Saddleback’s land and Saddleback still would have the same basis for its theories of nuisance, waste and breach of contract. The million-ton heap of dirt was not put there by the rejection of the lease—it was put there by the actions and inactions of El Toro in preparing to turn over the site.

(Footnotes omitted.)

McSheridan Holding Overruled. The Ninth Circuit opinion noted the two concurrences from the BAP decision questioning McSheridan and suggested that the BAP consider adopting an en banc procedure to reconsider such doubtful precedents. Given the Ninth Circuit's holding, it will come as no surprise that the Court of Appeals also explicitly overruled McSheridan:

To the extent that McSheridan holds section 502(b)(6) to be a limit on tort claims other than those based on lost rent, rent-like payments or other damages directly arising from a tenant’s failure to complete a lease term, it is overruled.

The Ninth Circuit noted that McSheridan also holds that "damages flowing from the failure of a party that has rejected a lease to perform future routine repairs or pay utility bills are capped," but declined to address -- or overrule -- that holding.

Post-El Toro Ramifications.  At least in the Ninth Circuit, with McSheridan overruled landlords will work hard to characterize their damage claims as arising from tort theories or otherwise not being based on "lost rent, rent-like payments or other damages directly arising from a tenant's failure to complete the lease term." At the negotiation stage, when the market permits landlords may demand larger security deposits and letters of credit on the view that the Section 502(b)(6) cap no longer limits every type of damage recoverable against such security. They may also structure leases to separate claims for items such as clean-up costs, hazardous waste removal, property damage, and even tenant improvement repayments from rent claims, in an attempt to bolster the argument that these claims fall outside of the cap.

Conclusion. Like a bull charging a matador, the El Toro decision has ripped a hole in the Section 502(b)(6) cape previously used to turn away cap-busting landlord claims. Time will tell just how significant the decision turns out to be, but at first blush it seems that debtors and non-landlord creditors may be the ones who end up seeing red. 

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In March 2007, the U.S. Supreme Court overruled the so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision. (Click here for a copy of the decision.) That rule, named for the decision by the United States Court of Appeals for the Ninth Circuit in a case called In re Fobian, 951 F.2d 1149 (9th Cir. 1991), had barred unsecured creditors from recovering as part of their unsecured claim attorney's fees incurred post-petition litigating bankruptcy issues. 

The Open Question. As discussed in an earlier post, although the Supreme Court dispatched the Fobian rule, in Travelers it did not decide whether an unsecured creditor could actually recover its attorney's fees. Among other issues, it left for another day the issue of whether Section 506(b) of the Bankruptcy Code, which expressly allows attorney's fees to oversecured creditors, precludes recovery of post-petition attorney's fees as part of an unsecured claim.

A New Decision From Florida. Jordan Bublick has an interesting post on his Miami Florida Bankruptcy Law blog about a July 6, 2007 decision in the In re Electric Machinery Enterprises, Inc. Chapter 11 case. In the decision, the court held that an unsecured creditor is not permitted to add post-petition attorney's fees and costs to its unsecured claim. A copy of the decision, by Judge Michael G. Williamson of the the U.S. Bankruptcy Court for the Middle District of Florida, is available here. As Jordan points out, the Florida bankruptcy court held that the pre-Travelers majority rule denying unsecured creditors post-petition attorney's fees was still good law. Among the reasons the court cited:

• Section 506(b)'s language permits only oversecured creditors to receive interest and fees, and this effectively excludes recovery by unsecured creditors.
• The reasoning of the Supreme Court's decision in United Savings Ass'n v. Timbers, 484 U.S. 365 (1988), that post-petition interest can only be paid to secured creditors with the benefit of an equity cushion, applies to attorney's fees as well.
• Section 502(b) requires the amount of a claim to be determined "as of the date of the filing of the petition," before post-petition fees have accrued.
• Allowing fees to contract creditors would be inequitable because tort and many trade creditors, who lack the ability to recover attorney's fees, would have their relative recovery diminished.

Judge Williamson called out another reason for his decision:

Furthermore, the Court is particularly mindful of the practical impact a contrary ruling would have on the administration of a bankruptcy case. There would be no finality to the claims process as bankruptcy courts would constantly have to revisit the issue of the amount of claims to include ever-accruing attorneys' fees. The 'cash registers' would ring on a daily basis, as attorneys for unsecured creditors that were active in the case would continually be filing new claims or seeking to reconsider previously allowed claims in order to add post-petition attorneys' fees and costs. Essentially, there could be no finality to the claims resolution process if the ever-accruing fees and costs attendant to the representation of unsecured creditors were allowed as part of an unsecured claim.

An Earlier California Bankruptcy Court Decision. Interestingly, the Florida bankruptcy court did not cite to the In re Qmect, Inc. decision, issued by the U.S. Bankruptcy Court for the Northern District of California in May 2007 and discussed in this earlier post. In that decision, the California bankruptcy court took the opposite view. It held that an unsecured creditor could recover, as part of its unsecured claim, post-petition attorney's fees if its contract with the debtor provided for recovery of such fees. Adopting a different view of the bankruptcy policies at issue, that court held:

The strongest rationale for implying a prohibition on the inclusion of post-petition attorneys’ fees in a unsecured creditor’s pre-petition claim is that, unless the debtor is solvent, the unsecured creditor’s augmented claim will diminish the dividend to other unsecured creditors. However, a similar effect flows from allowing secured creditors to include their post-petition attorneys’ fees in their secured claims. While equality of distribution is one of the basic tenets of bankruptcy law, another important policy in bankruptcy is the preservation of nonbankruptcy legal rights except to the extent necessary to facilitate the purpose of the bankruptcy proceeding. Absent a clear provision of the Bankruptcy Code modifying a creditor’s nonbankruptcy legal rights, the Court concludes that those rights should be deemed to be left intact.

More Decisions To Follow. Bankruptcy courts are now beginning to address whether unsecured creditors can recover post-petition attorney's fees in the wake of the Travelers decision. These two early decisions have reached completely different conclusions. More decisions will undoubtedly follow as creditors with attorney's fees provisions in their contracts seek to include post-petition fees in their unsecured claims. With the issue far from settled, be sure to stay tuned.

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In March, the U.S. Supreme Court overruled the so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision. (Click here for a copy of the decision.) That rule, named for decision by the United States Court of Appeals for the Ninth Circuit in a case called In re Fobian, 951 F.2d 1149 (9th Cir. 1991), had barred unsecured creditors from recovering as part of their unsecured claim attorney's fees incurred post-petition litigating bankruptcy issues.

The Open Question. As discussed in a post on the Travelers decision, although the Supreme Court dispatched the Fobian rule, it did not decide whether an unsecured creditor could actually recover its attorney's fees. Left unresolved, among other issues, was whether Section 506(b) of the Bankruptcy Code, which expressly allows attorney's fees to oversecured creditors, precludes recovery of post-petition attorney's fees as part of an unsecured claim.

The Question Gets Asked Post-Travelers. In the In re Qmect, Inc. Chapter 11 cases pending in the U.S. Bankruptcy Court for the Northern District of California, an unsecured creditor sought allowance of post-petition attorney's fees, incurred litigating bankruptcy issues, as part of its unsecured claim against debtors who were individual guarantors of its debt owed by the corporation. The creditor had prevailed in an adversary proceeding on its guaranty (an appeal is pending) and sought post-petition attorney's fees as part of its judgment.

After first denying the creditor's request without prejudice last November, the Bankruptcy Court asked for supplemental briefing on the issue after the Travelers decision was decided. In the debtors' supplemental brief, they argued that Section 506(b) of the Bankruptcy Code implicitly provides for the disallowance of post-petition attorney's fees as part of unsecured claims (as opposed to secured claims). In the creditor's supplemental brief, it argued that all of the other circuits that have addressed the issue agree that such fees are recoverable and that there is nothing in Section 502(b) or Section 506(b) that prohibits their recovery. Both the debtors and the creditor filed reply briefs as well, further arguing their contentions.

California Bankruptcy Court Gives An Answer. On May 17, 2007, in perhaps the first post-Travelers decision to rule on the issue, Judge Leslie Tchaikovsky held that an unsecured creditor was entitled to include post-petition attorney's fees incurred litigating bankruptcy-related issues in its unsecured claim, where the parties' underlying contract provided for recovery of attorney's fees. In its Memorandum of Decision re Motion for Post-Petition Attorneys' Fees, the Bankruptcy Court held that (1) the creditor's post-petition attorney's fees qualify as a "claim" under Section 101(5) of the Bankruptcy Code, and (2) none of the exceptions in Section 502(b) of the Bankruptcy Code apply to require disallowance of the fees as part of the claim.

The Court's Analysis. In elaborating on the second holding, the Bankruptcy Court explained as follows:

The only category [of Section 502(b)’s exceptions] that arguably supports the disallowance of an unsecured claim for post-petition attorneys’ fees is 11 U.S.C. § 502(b)(1): i.e., that 'such claim is unenforceable against property of the debtor and property of the debtor, under any agreement or applicable law for a reason other than because such claim is contingent or unmatured....' 11 U.S.C. § 502(b)(1). The debtor contends that this category applies to post-petition attorneys’ fees because 11 U.S.C. § 506(b) renders the claim for post-petition attorneys’ fees unenforceable against the debtor and property of the debtor. Section 502(b)(1) refers to 'applicable law,' not 'applicable nonbankruptcy law.' Thus, Section 506(b) qualifies as 'applicable law.' Section 506(b) provides as follows:

(b) To the extent that an allowed secured claim is secured by property, the value of which is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and reasonable fees, costs or charges provided for under which such claim arose.

Thus, according to the debtor, by providing that a secured claim shall be allowed reasonable fees to the extent the claim is secured by property, the Bankruptcy Code is implicitly saying that fees are not available to an unsecured creditor. The Court finds this reading of 11 U.S.C. §§ 502(b) and 506(b) too strained to be persuasive. First, 11 U.S.C. § 506 is entitled 'Determination of Secured Status.' A statute so entitled would not be a logical place to provide for the disallowance of an element of an unsecured claim. If Congress, in enacting the Bankruptcy Code, had wanted to disallow claims for post-petition attorneys’ fees, the logical place for it to have done so was surely in 11 U.S.C. § 502(b). Moreover, 11 U.S.C. § 506(b) does not distinguish between pre-petition and post-petition attorneys’ fees. Thus, if 11 U.S.C. § 506(b) is read as an additional ground for objecting to claims, arguably, an unsecured creditor would be prohibited from including its pre-petition attorneys’ fees in its claim as well as its postpetition fees.

(Footnotes omitted.) After being unable to find any Court of Appeals decision decided under the Bankruptcy Code directly addressing the issue, the Bankruptcy Court then examined the policy argument underlying the debtors' objection:

The strongest rationale for implying a prohibition on the inclusion of post-petition attorneys’ fees in a unsecured creditor’s pre-petition claim is that, unless the debtor is solvent, the unsecured creditor’s augmented claim will diminish the dividend to other unsecured creditors. However, a similar effect flows from allowing secured creditors to include their post-petition attorneys’ fees in their secured claims. While equality of distribution is one of the basic tenets of bankruptcy law, another important policy in bankruptcy is the preservation of nonbankruptcy legal rights except to the extent necessary to facilitate the purpose of the bankruptcy proceeding. Absent a clear provision of the Bankruptcy Code modifying a creditor’s nonbankruptcy legal rights, the Court concludes that those rights should be deemed to be left intact.

Now What? If the Bankruptcy Court's decision is followed by other courts, the main question left open in Travelers will have been answered. However, this decision raises some additional issues:

• Will the potential allowance of post-petition attorney's fees for bankruptcy-related issues impact a debtor's reorganization prospects?
• What procedures will debtors propose for managing the process as unsecured creditors amend their claims to add attorney's fees incurred in protecting their rights during the course of a bankruptcy case?
• Will individual unsecured creditors become more active in Chapter 11 cases, particularly in those cases in which a large distribution is likely?
• What standards will bankruptcy courts use to assess the reasonableness of an unsecured creditor's post-petition attorney's fees for bankruptcy-related issues?  
• Will claims buyers pay more for unsecured claims based on contracts providing for recovery of post-petition attorney's fees now that bankruptcy-related fees are recoverable?
• Will creditors be more insistent on including attorney's fees provisions in contracts?

It will be interesting to see how these issues unfold as the impact of this decision, and those of other courts facing this issue, are felt. Stay tuned.

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As reported in this post last month, certain dollar amounts in the Bankruptcy Code were increased effective April 1, 2007. The dollar amount changes meant that some of the official bankruptcy forms, most notably the proof of claim form and the voluntary petition, had to be revised as well.

After I put up that post, the Administrative Office of the United States Courts (known in the trade as "the AO") made the revised forms available and released a formal notice of the dollar amount adjustments. Copies of the revised forms -- with handy arrows pointing out each place where they were revised -- are attached to the notice.

Of course, you'll need to get the forms in blank to use in bankruptcy cases. If you don't have special bankruptcy form software, a number of the official bankruptcy forms have been designed to allow you to type in information or select choices from drop-down menus before printing the form. Printing is the only way to go because the form won't let you save your changes. 

If you follow the links above you'll be able to access blank copies of the revised forms from the AO's website. That way, you'll be sure to have the most up-to-date versions.

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You're a creditor in a bankruptcy case and a bankruptcy notice arrives on your desk setting a deadline to object to an important motion. The address on the notice is a P.O. box located a thousand miles away, one used only for customer payments and not for legal notices. As a result, the notice took a long time to be routed to you. When you look at it more closely, you realize that so much time has passed that the deadline to respond was last week and the hearing took place yesterday. The situation can be even worse if the late-arriving notice is about a deadline (also known as a "bar date") for filing a proof of claim or perhaps for responding to an objection to your claim. 

Sound familiar?

Ability To Designate An Address. Well, one of the lesser known changes made by the 2005 amendments to the Bankruptcy Code, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), permits creditors to designate a preferred address for receiving bankruptcy notices. Section 342(f) of the Bankruptcy Code, added by BAPCPA, allows creditors to use one preferred address for cases in every bankruptcy court in the country or to designate different addresses for cases in specific bankruptcy courts.

National Creditor Registration Service. To implement this new rule, a National Creditor Registration Service ("NCRS") has been created. According to its website, the NCRS is "a free service provided by the U.S. Bankruptcy Courts to give creditors options to specify a preferred U.S. mail, e-mail address, or fax number to which bankruptcy notices should be sent." Creditors can choose to receive paper notices mailed to one or more designated addresses or faxed to specific fax numbers. Creditors also have the option of receiving bankruptcy court notices via email by registering for the Electronic Bankruptcy Noticing ("EBN") system.

• A creditor's preferred address and delivery method will be substituted for any address used in a bankruptcy mailing matrix (the official list of addresses for its creditors that a debtor files with the bankruptcy court) within 30 days of the creditor's registration. (Although Section 342(f) itself mentions only Chapters 7 and 13 of the Bankruptcy Code, as implemented the system is being applied to all cases, including Chapter 11 cases.)
• When registering, it's important to list all of the different versions of a creditor's name, including formal corporate names, a "doing business as" name, and even common misspellings of the creditor's name. The service's software will attempt to match the names the creditor supplied to the one listed in the debtor's mailing matrix. If a match cannot be made, the notice will be sent to the address listed by the debtor.
• NCRS allows you to complete forms online or to print them and send them in. You can find the registration forms here, here, and here, but I suggest going to the NCRS registration website itself to make sure you are using the most up-to-date forms and procedure.
• A creditor or its bankruptcy counsel can always file a request for special notice with the bankruptcy court in a particular case using a specific address for notices in that case. In that circumstance, the address listed in the case-specific notice request will be used instead of the NCRS-listed address.

Be Prepared. Regardless of which option creditors choose, they should be prepared to handle the volume of notices that may be directed to the physical or email address. If using a physical address, creditors should be sure to monitor that address regularly and be in a position to process the notices received. A dedicated P.O. box may make sense in some cases. If an email address is used, it may be helpful to use a special email address or account for notices, create email rules to direct notices to the right person, or use other software to monitor and process those notices. With good procedures in place, the NCRS and EBN services should help creditors receive important bankruptcy notices in time to protect their rights.

What If Something Goes Wrong? Another new provision, Section 342(g), governs the situation in which notice does not get to the right address. Although courts have not yet answered how it applies in various contexts, the section provides that a notice is not "effective notice" unless it's sent in compliance with the Bankruptcy Code's notice rules or it's actually brought to the creditor's attention.

• This section allows a creditor to designate "a person or an organizational subdivision" to be responsible for receiving bankruptcy notices. If the creditor also establishes "reasonable procedures" so that notices are delivered to the designated person or subdivision, a notice sent to the creditor other than in accordance with Section 342's procedures "shall not be considered to have been brought to the attention of such creditor until such notice is received by such person or such subdivision."
• In addition, a creditor that did not receive a notice of the bankruptcy filing complying with Section 342's provisions may have a defense to a claim that it violated the automatic stay.
• While helpful to creditors, these provisions raise questions about how debtors and trustees can be sure to send out effective notice, especially if they are not aware of which person or subdivision a particular creditor has designated for notice. That problem will be reduced if many creditors register with the NCRS or EBN system.

Get Advice. As always, if you have questions about these procedures or how they may affect you as a debtor or creditor, be sure to get advice from your bankruptcy counsel.

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If you're a creditor in a bankruptcy case and diligently file a proof of claim on time, often months or even years may go by before you hear anything further about your claim from the debtor, bankruptcy trustee, or any other party. In fact, the only thing you may hear about your claim for a long time is an offer to purchase it made by one or more claims buyers. 

No news is not always good news. Unfortunately, the passage of time may lead you to believe that no objection to your claim will ever be filed. However, the urgency of reorganizing a debtor's business or liquidating its assets means that the claims objection process is typically left until near the end of the bankruptcy case, often after a plan of reorganization has been confirmed in a Chapter 11 case. As a result, an objection to your claim may be brought long after you filed it. When filed, the objection may assert that your claim amount doesn't square with the debtor’s books and records or it may be based on any number of other grounds specific to the nature of your claim. 

Is that an objection to my claim? When an objection is filed, it may not always be obvious at first. While an objection may clearly identify that it is directed to your claim, in large cases the debtor or other estate representative has so many claims to address that the objection to your claim will most likely be combined with others. Instead of a pleading specifically mentioning your name in its title or text, the objection may have a name such as “Notice of Debtors' Fourteenth Omnibus Objections To Claims (Substantive)” or some similarly titled document. 

• Be careful: the format of these objections can be a trap for the unwary.  Buried within the objection’s many pages of text and attached exhibits may be a few lines, often in a list or chart, identifying that your claim is one of dozens to which an objection has been filed. 
• Whatever the objection's name or format, the point is the same: ignore it at your peril.  If you don't respond to the objection timely your claim will likely be disallowed and you will recover absolutely nothing from the bankruptcy estate.

Diligence is critical. As in other legal contexts, protecting your rights in a bankruptcy case requires diligence. This can be a significant task. In major bankruptcy cases, literally thousands of pleadings can be filed during the course of a case. Many of these will be served on creditors and other parties, whether in paper or electronic form, yet only a few may be important to you or your claim. For this reason, it is critical that you or your attorney keep track of the pleadings filed in a bankruptcy case. As mentioned in an earlier post, there are often special websites designed to assist creditors in following large bankruptcy cases, in addition to the Court's own electronic filing system. 

Protect your rights.  The bottom line is, if you see anything that looks like a claim objection, you should review all of the pages carefully, including its exhibits. If an objection to your claim is filed, a timely response will be required to protect your rights. Otherwise, you may find yourself with a disallowed and worthless claim.

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At one time or another just about every creditor in a large corporate Chapter 11 bankruptcy case will receive an offer to purchase the creditor's claim.  These offers typically come from professional claims traders, most of which are in the business of buying claims at a discount to what they believe will be the claims' ultimate value.  Some claims buyers, including hedge funds and other distressed debt investors, may buy claims with the strategic objective of controlling the direction of the Chapter 11 case by owing a substantial percentage of one or more classes of creditors. 

How do claims buyers find out about your claim? Within the first few weeks after a bankruptcy is filed, the debtor must file schedules of its assets and liabilities.  Creditors holding secured claims are listed on Schedule D and those with unsecured claims are listed on Schedule F.  These schedules show the amount the debtor believes it owes each creditor and whether it thinks the claim is disputed, contingent, or unliquidated.  Claims buyers will often first contact creditors with claims listed as being undisputed, not contingent, and liquidated because those claims are less likely to be subject to litigation later in the bankruptcy case. 

If you express interest in selling your claim, you may be sent a "confirmation" document with key terms such the percentage on the dollar to be paid and the amount of the claim to be purchased.  The actual document that transfers the claim, however, is usually a separate "claim assignment agreement."  You should carefully review all of the documentation, including the claim assignment agreement, before committing to sell your claim.

Selling a claim can sometimes be beneficial, but there are also risks.  When evaluating whether to sell your claim, here are some of the key points to keep in mind:

• Liquidity.  The main advantage of selling your claim is getting some cash for it now.  Although creditors often believe that selling their claim will also eliminate any further risk of loss, for the reasons discussed below claim assignment agreements usually keep you at risk even after you sell your claim.  If you're willing to accept those risks, you can get immediate liquidity by selling your claim instead of having to wait months or years to receive whatever payment -- which sometimes is in the form of stock or debt instead of cash -- the bankruptcy estate ultimately distributes.
• Price.  Given the claims buyer's usual objective of buying at a discount, coupled with the time value of money, the price you are offered could end up being lower than the value you could recover if you held your claim and waited for distributions to be made later in the case. The price offered for claims can also rise or fall over time as more information about creditors' likely recovery becomes available.  
• Read the fine print.  Occasionally, claims buyers add detailed provisions and representations to the claim assignment agreement that operate to give the buyer an option to "put" or sell all, or the disputed part, of the claim back to you upon the mere filing of an objection or other challenge to the claim -- even if the objection is ultimately defeated. Why? Well, if the price paid for your claim later turns out to have been too high, the claims buyer might use the filing of a claim challenge to get its money back, plus interest. Since commonplace events such as claim objections and preference actions may be classified as triggering "challenges," it's important to watch out for these provisions.
• Defending the claim.  Often the claims buyer will put a provision in the claim assignment agreement requiring you to defend the claim against any objection at your own expense, and to pay the claims buyer back for any portion of the claim that might be disallowed.  If a portion of your claim is disputed, however, you may well want the right to defend the claim so you can keep what you've been paid. Either way, you may incur costs in the bankruptcy case after you sell your claim.
• Setoff or other special claims.  Claim assignment agreements may also include provisions limiting your right to assert a setoff or recoupment against the debtor (concepts discussed in an earlier post) or requiring you to pay back all or a portion of the purchase price if you do.  If you have significant setoff rights, be careful to preserve those rights if you sell your claim. Likewise, if you have an administrative claim or reclamation claim (which could be paid at 100 cents on the dollar), be sure it's clear how those valuable rights will be treated.
• Creditors' committee.  If you're serving on the official committee of unsecured creditors in a Chapter 11 case, you should get legal advice on whether, or under what conditions, you may sell your claim.  You likely will have received confidential information about the debtor while on the creditors' committee, and this could restrict your ability to sell your claim.  Generally, you will also have to resign from the committee if you sell your claim.  
• Court-ordered restrictions.  In some cases, bankruptcy courts may restrict creditors -- especially those with very large claims -- from selling their claims.  This is done to preserve the tax benefits of a debtor's net operating losses or NOLs, which can be lost if ownership of a large amount of claims or equity interests changes.  As this example shows, these orders can be very complicated and you may want to consult with a bankruptcy attorney to determine whether any restrictions apply to you.

If you sell your claim, you will often be required to sign an additional document with a name such as "Evidence of Transfer of Claim," which does not mention the price paid and which will be filed with the bankruptcy court.  Thereafter, you may receive a notice from the bankruptcy court that the claims buyer has filed the Evidence of Transfer of Claim document and giving you 20 days to object to the transfer.  This notice is designed to prevent unscrupulous individuals from fraudulently assigning claims to themselves and is only a formality in a legitimate claims sale.

Claims buyers can provide creditors with a ready market for their claims, generating liquidity months or years before creditors otherwise would receive a distribution from the bankruptcy estate.  Selling a claim is not risk free, however, so be sure to consult with a bankruptcy attorney for specific advice on how best to protect your rights if you do choose to sell.

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Usually, businesses have claims against other businesses.  Still, you may occasionally have a claim against an individual and it's good to know what can happen in that situation. 

The "no asset" case. Unfortunately, most individuals who file bankruptcy, especially those who file the more common Chapter 7 liquidation case, do not have any significant assets that can be sold to pay creditors.  What's more, the assets they do have -- such as IRAs, 401(k) accounts, etc. -- are usually exempt from creditors' claims.  Cases in which no non-exempt assets are available to pay creditors are known as "no asset" cases.  (Bankruptcy lawyers love imaginative names.)  In a no asset case, the bankruptcy court's notice will actually instruct you not to file a proof of claim unless later notified to do so. 

The "asset" case.  Sometimes there are enough non-exempt assets to produce at least some distribution to unsecured creditors.  While not very common in Chapter 7 cases, it could be that the individual has filed a Chapter 13 "wage-earner" case or a Chapter 11 personal reorganization case and expects to pay creditors some amount over time.  If so, a claims filing deadline known as a "bar date" will be set.  If you file a proof of claim form by the bar date, you may eventually receive a check, although typically this will be months or even years after the bankruptcy was filed.  In most cases involving individuals, the distribution to unsecured creditors is painfully small.

The bankruptcy discharge. In general, when individuals file bankruptcy, they will get discharged, or excused, from their pre-filing debts.  This is especially true in Chapter 7 and 11 cases and also in Chapter 13 cases if the individual debtor makes all of the payments required under his or her plan.  The discharge is part of what is often referred to as the "fresh start" that bankruptcy offers. 

Nondischargeable debts. Although recent changes to the bankruptcy laws have made it harder for individuals to file bankruptcy and get a discharge, many people are still able to do so.  That said, the law does call out certain kinds of debts and makes them "nondischargeable," meaning that they can be excluded from the scope of the bankruptcy discharge. These include debts arising from the debtor's fraud or other intentional bad acts, including when he or she obtained credit, and also to obligations for alimony, child support, student loans, and many taxes.  (So it's clear, the concept of a debt being nondischargeable applies only to individuals, not to corporations or other business entities.) 

Action is required. With rare exceptions, if you are owed one of these nondischargeable debts, the bankruptcy law forces you to take prompt action to preserve your rights -- or the debt will be discharged anyway.  To stop an individual debtor from getting a discharge of such a debt, you must sue the debtor in his or her bankruptcy case for a declaration that your debt is nondischargeable. If the bankruptcy court declares the debt nondischargeable, it will not be discharged by the bankruptcy and you would have the right to attempt to collect the debt outside of bankruptcy.  

Be careful of deadlines. There are strict deadlines for filing such "nondischargeability" actions. Although the bankruptcy court should notify you of these deadlines, the burden is on you to figure out when the deadline will pass and to file a lawsuit before the deadline.  Usually, the deadline is 60 days after the first date scheduled for the official meeting of creditors listed on the bankruptcy court's notice of the case (whether or not the meeting takes place as scheduled), but you should be certain to confirm the precise deadline in the debtor's case.  This is critical because if you fail to file your complaint before the deadline, the debtor's discharge will cover your debt too. 

Call a bankruptcy attorney. It probably goes without saying, but if you believe your debt against an individual debtor might be nondischargeable, contact a bankruptcy attorney immediately upon learning of the debtor’s bankruptcy filing.  Of course, bringing the required lawsuit costs money.  Unless you think the debtor will be able to pay back your debt from his or her post-bankruptcy earnings, you may decide that it doesn't make economic sense to get the debt declared nondischargeable.

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