Chapter VIII Creditor Concerns

• Jurisdiction: United States

VIII. Creditor Concerns

A. Trustee's Avoidance Powers

See Chapter IV for a discussion of avoidance of preferential and fraudulent transfers.

B. Protecting the Interests of Secured Creditors

1. Defined

A creditor is an "entity that has a claim against the debtor that arose at the time of or before the order for relief."⁵³⁴ A secured creditor holds a "charge against or interest in property to secure payment of a debt or performance of an obligation."⁵³⁵ A creditor is secured to the extent of the value of the creditor's interest in the collateral and unsecured to the extent that the obligation exceeds that value.⁵³⁶

The lien may be created by an agreement,⁵³⁷ by statute⁵³⁸ or by judicial action.⁵³⁹ Not only do the means of creating the liens differ, but they are treated differently in many areas of the Bankruptcy Code.

2. Pre-Petition Review

Protection of the interests of a secured creditor must begin before the bankruptcy petition is filed. Any errors or omissions in the documentation or actions taken shortly before a petition is filed can be hazardous to the claim.

a. Documentation Review

Loan documentation should be carefully reviewed to ensure that any potential defenses to the underlying obligation are either negated or, at least minimized. For example:

i. Are all necessary signatures present?
ii. Has authorization of the signatory to a corporate or partnership debtor obligation been properly documented or authenticated?
iii. Have there been any waivers of rights that could be construed as an ongoing waiver (e.g., systematic and continuous acceptance of late performance as waiver of a "time is of the essence" clause)? or
iv. Have proper notices or demands been given to place the debtor in a default status?

If any defect is discovered, immediate steps should be taken to rectify it; once the petition is filed, it is probably too late to correct it.

b. Collateral Review

i. All documents creating the security interest should be reviewed in the same manner as the loan documents for any defects in form or execution. The security agreement and related documentation should include a full, complete and accurate description of all collateral in which the creditor claims and declares a security interest. Fundamental to the collateral review is ensuring that the security interest is properly perfected; if not, the claim will be only a general unsecured claim. If the security interest was not properly perfected initially, or has lapsed by operation of law, and the debtor files within the 90-day period after perfection or re-perfection, the transfer may be avoidable as a preferential transfer.
ii. Collateral review is not complete without determining current adequacy of the collateral. Value of collateral can diminish over time due to conditions such as normal depreciation and obsolescence. If the value has declined to a point where the claimant is undersecured, additional collateral should be obtained, if possible. However, additional collateral obtained during the 90-day period immediately preceding the date the petition is filed is susceptible to avoidance as a preferential transfer.

3. Proofs of Claim

One of the first things the holder of a secured claim should consider is filing a proof of claim. In fact, under the amendments to Federal Rule of Bankruptcy Procedure 3002 effective Dec. 1, 2017, the rule is clarified to establish that a secured creditor must file a proof of claim in order for the claim to be allowed.⁵⁴⁰ Notwithstanding this provision, the amended rules also clarify that the mere failure to file a claim does not impact the validity of that secured creditor's lien.⁵⁴¹

The notice from the clerk's office of the filing of the case will state whether a chapter 7 case is a no-asset case, in which event no proof of claim will be required. Chapter 13 cases, by contrast, always contemplate distributions by the trustee. However, some chapter 13 trustees take the position that distributions may not be made to a creditor if that creditor has failed to file a claim. Such a position arguably contradicts the holding of United Student Aid Funds Inc. v. Espinosa and the language of 11 U.S.C. § 1327(a) that bind the parties to the terms of a confirmed plan.⁵⁴² Nonetheless, to ensure its right to the receipt of all distributions earmarked for a secured creditor under a debtor's plan, the creditor should timely file its proof of claim.⁵⁴³

a. Time for Filing

i. In cases filed under chapters 7 and 13, the deadline for filing a proof of claim is 70 days after the filing of the debtor's petition or after the conversion of a chapter 7 case to chapter 12 or 13. Secured creditors are given an additional 50 days to file supporting documents required by Rules 3001(c)(1) and (d).⁵⁴⁴
ii. A governmental taxing authority has until 60 days after the return is filed, or 180 days after the order for relief, whichever is later, to file a proof of claim in a chapter 13 case.⁵⁴⁵
iii. If the claim arises out of the rejection of an executory contract or unexpired lease, it must be filed as ordered by the court.⁵⁴⁶

b. Form

A creditor filing a proof of claim should use Official Form B410.⁵⁴⁷

i. In preparing a proof of claim, care should be taken to ensure that the amount of the claim is as of the date the petition was filed, not as of the date the claim is filed.
ii. Supporting documents (e.g., billing, promissory note, security agreement, evidence of perfection, guarantee, contract or judgment) that establish the claim and its status as secured should be attached.⁵⁴⁸

c. Effect of Filing Claim

If the creditor files a proof of claim, it is prima facie evidence of the validity and amount of the claim, and unless an objection to the claim is made and sustained, the claim is allowed as filed.⁵⁴⁹

d. Objection to Claim

Any interested party may object to a proof of claim filed by any creditor. Normally, however, an objection to claim is filed by the trustee or the debtor. An objection to a claim must be in writing and filed with the court. A copy of the objection, together with a notice of the hearing, must be served at least 30 days before the scheduled hearing date.⁵⁵⁰ Common reasons for claim objections include:

i. There is insufficient information or documentation from which the validity of the claim can be determined. This usually results from a failure to attach to the claim the documents supporting the obligation.
ii. The claim includes unmatured interest as of the date the petition was filed, i.e., post-petition interest.⁵⁵¹
iii. The debtor is not a liable party on the obligation; for example, an individual debtor objects to a claim asserting that it is the obligation of the company employing the debtor.

e. Collateral Valuation

A secured claim is determined by the lesser of the amount owed to the creditor or the value of the collateral.⁵⁵²

i. Where the collateral is to be retained by the debtor, the proper value is the "replacement value" of the collateral.⁵⁵³
ii. Where the creditor repossesses and disposes of the collateral, as long as the disposition is in accord with otherwise applicable law, usually in a commercially reasonable manner, the value of the claim will be determined by the amount realized upon disposition. This amount is also used to determine the deficiency claim, if any, which is then allowable as an unsecured claim.

4. Cash Collateral

A major issue that may confront the secured claimant is the use of the cash or cash equivalent realized from the use or consumption of the creditor's collateral ("cash collateral"). Although usually confined to business cases, it may arise in the consumer...