Chapter IV Claims

• Jurisdiction: United States

IV. Claims

A. What Constitutes a Claim

The trustee reduces the debtor's assets to money and distributes the money to pay "claims." But what exactly is a claim? In most cases, this is an easy question [§ 101(5)]. Your credit card bill is a "claim." Your hospital bill is a "claim." The vendor who sold you a load of widgets holds a "claim."

A less-obvious claim might be: You were driving your car and your mind wandered. You hit a pedestrian. You are culpable for negligence. The pedestrian now has a "claim."

Less obvious still, the pedestrian holds his claim whether or not he has a judgment from a court of law. Indeed, he holds his claim whether or not he has filed suit. The Code says that a "claim" is any right to payment, even if it is still uncertain and even if you do not know the amount of the claim, so you might say that the pedestrian is a "creditor" from the moment of impact.

If a debtor does not know the amount of a claim against it, how can a bankruptcy court deal with that claim? The cases where this problem has proven most important are those adjudicating liability for "mass torts," particularly those seeking to establish liability stemming from the production or use of asbestos. Corporate debtors in asbestos cases face claims that, on the face of things, often exceed the value of all the assets in the company, in some cases by many times.

It is easy to imagine the different ways in which these asbestos "claims" can be classified. There are those who have sued and reduced their claim to judgment before a bankruptcy begins. There are those who are in mid-trial. There are those who have not yet sued, but who are thinking about it. Most intractable of all, there are those who have been exposed to the asbestos fibers and who will fall victim to the disease, but who do not themselves know yet that it will happen to them. By an expansive reading of the "claims" definition in the Code, these "unknown claimants" may well be part of the claims pool in the bankruptcy.

A number of observers have remarked that the management of these "unknown claims" has proven to be one of the most intractable issues in mass tort cases. If you exclude them from the bankruptcy, then they lie like a shadow over the future of the company and make reorganization difficult or impossible. If you include them, you have to find some way to strike a balance between the "known" present claims and the uncertainties of the unknowns. In mass tort cases that result in a reorganization, the plan of reorganization sometimes includes the establishment of a trust to pay the unknown claims. In appropriate cases, the court will issue an injunction prohibiting actions to collect such claims from the debtor if a trust is established to pay such claims.²⁰

The statutory definition says that the class of "claim" also includes "the right to an equitable remedy" [§ 101(5)]. This is a concept clear enough among lawyers. It denotes a case where you have a right to the thing itself, not just to money compensation for loss. For example, suppose you have a building near the river with the "right" to a river view. Suppose someone sticks up a new building in between

you and the river, blocking your view. A judge might say that your home is worth 10 percent less without its view, so we grant you a right to payment of a sum equal to 10 percent of the value of your building — i.e., "money damages — or the judge might order the building torn down — i.e., an "equitable remedy."

It might be clear enough on its face, but it is far from clear just how it is supposed to work in bankruptcy. For example, suppose Delbert owned the Snope diamond, which he agreed to sell to Thyra before filing for bankruptcy. Before delivering the diamond, Delbert files for bankruptcy, having not yet delivered the diamond. State law might very well provide that the court should compel Delbert to deliver the diamond to Thyra — an "equitable remedy." If we recognize this right in bankruptcy, however, then we are "making Thyra whole," while other creditors are stuck with little tiny bankruptcy dollars. A lot of bankruptcy types would say that this cannot be the rule — that if Congress had intended to have Thyra "made whole," it would have said so explicitly and not by indirection, yet that it is what the Code seems to say.

A word about the interest on claims: The ordinary rule is "no post-petition interest" — i.e., interest stops at the time of the filing of the petition. This rule is perhaps not as radical as it might seem [§ 502(b)(2)]. Recall that (almost) all debtors in bankruptcy are insolvent; their liabilities exceed their assets. If nobody is going to get paid in full anyway, the added interest is pretty much hypothetical. The rule does, presumably, harm a creditor who has a right to a high rate of interest while competitors have a right to little or none, but those are the breaks.

Creditors with security interests do get a break on this rule: If the value of their collateral exceeds the value of the claim, they can continue to accrue interest up to the value of the collateral. If BankCo has a claim for $100 plus interest at 10 percent, secured by Blackacre with a value of $121, BankCo can continue to accrue interest for two years.²¹ Note that this kind of money comes out of the pockets of competing creditors, not the debtor.

B. How Unsecured Claims Get Paid

1. In Chapter 7

The claims process in the ordinary chapter 7 liquidation case is straightforward. The debtor lists the claims against her; the court then sends notice to the creditors on the schedule. If there are no assets to distribute, the notice says so, and creditors are told not to bother to file. If there are assets to distribute, the notice specifies a deadline, and the creditor, before the deadline, must file a claim.²²

Once the trustee has liquidated the assets, he undertakes to pay out via the statutory formula. He objects to claims he thinks are improper, and sometimes there is a mini-trial to sort out competing assertions. Indeed, sometimes there will be a need to carry out a full-scale lawsuit to decide the nature and validity of a claim. The trustee will then pay all claims according to the priorities set forth in the Bankruptcy Code.²³ Similarly situated claims are treated equally (furthering the bankruptcy goal of equal treatment of creditors). Therefore, if the debtor owes $1,000 each to three credit card issuers and the debtor has $300 to distribute after all priority claims are paid, each credit card issuer will be paid $100. The remaining $900 on each claim will be discharged, meaning that the credit card companies can never try to collect that from the debtor.

2. In Chapter 13

In chapter 7, the trustee takes control of the assets and turns them into cash. In chapter 13, the debtor retains his assets, but he proposes a "plan" to pay some or all of her claims out of post-bankruptcy earnings [§§ 1322 and 1325]. The plan will last from three to five years. Most above-median debtors will be required to file a five-year plan. If the court confirms the plan, the trustee takes control of the debtor's earnings as necessary to fund the plan, then makes the distributions to creditors.

Creditors do not get to vote on the chapter 13 plan, although they have the power to object to it if they think they have good grounds for objection. The plan becomes binding if it is approved by the court after hearing the objections.

The debtor submits his earnings net of expenses to the court as necessary to fund the plan [§ 1322(a)(1)]. The plan may be confirmed only if creditors will receive not less than they would receive in a chapter 7 liquidation — a kind of "best interest" test, in bankruptcy jargon [§ 1325(a)(4)]. Since most unsecured creditors would receive nothing from most debtors in chapter 7, it would be possible to meet this test by paying them just a penny in chapter 13, but another rule prevents this result. It says that if a creditor or the trustee objects to the payout, then the court may not confirm unless the plan commits all of the debtor's projected disposable income for the plan period — a kind of "best efforts" test [§ 1325(b)(1)].

It is important to note that the "means test" rears its head again in chapter 13 in several significant ways. First, the starting point in determining "disposable income" is "current monthly income," which means the debtor's monthly income for the six months before the bankruptcy filing. By following this strict backward-looking formula, a debtor who receives some unusual income (such as a severance check) during the six-month period might be forced to propose a plan that pays more than she can afford and a debtor who will receive more income after filing might underpay her creditors in a plan. The Supreme Court weighed in on this issue in 2010 in Hamilton v. Lanning²⁴ and ruled that a court may, in calculating the debtor's projected disposable income, take into account any changes in income and expenses that are "known or virtually certain" to occur.

A strict application of the means test can result in other strange consequences as well. A below-median debtor gets to use his actual expenses to calculate his disposable income, and the court will determine whether those expenses are reasonable. According to the Code, an above-median...