Unsecured Claims in Bankruptcy

• Author: Gregory Germain
• Pages: 243-293

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Chapter 10: Unsecured Claims in Bankruptcy

10.1. What is a “Claim”?

The drafters of the Bankruptcy Code adopted an extremely broad definition of a “claim”

to resolve all of the debtor’s liabilities as part of the bankruptcy process. Section 101(5) of the

Bankruptcy Code defines a claim as either a “right to payment,” or the “right to an equitable

remedy” if the breach “gives rise to a right to payment.” Under the definition, one has a claim in

bankruptcy whether or not the claim is reduced to judgment, is liquidated or unliquidated, is fixed

or contingent, is matured or unmatured, is legal or equitable, or is secured or unsecured. Under the

statute, if a right to payment from the debtor exists in any fashion, it is a claim that will be subject

to the process of bankruptcy.

Despite the broad statutory definition, there is one fundamental limitation on the definition

of a claim – the constitutional requirement of due process mandated by the 5th Amendment. The

cases that follow attempt to draw the line between the policy of bankruptcy to resolve all of the

debtor’s liabilities at once, and the policies of due process and fundamental fairness that are so

fundamental to our system of justice.

10.2. Cases on Claims and Due Process

10.2.1.1. MULLANE v. CENTRAL HANOVER BANK &

TRUST CO., 339 U.S. 306 (1950)

Mr. Justice JACKSON delivered the opinion of the Court.

This controversy questions the constitutional sufficiency of notice to beneficiaries on

judicial settlement of accounts by the trustee of a common trust fund established under the New

York Banking Law. The New York Court of Appeals considered and overruled objections that the

statutory notice contravenes requirements of the Fourteenth Amendment, and that, by allowance

of the account, beneficiaries were deprived of property without due process of law. Common trust

fund legislation is addressed to a problem appropriate for state action. Mounting overheads have

made administration of small trusts undesirable to corporate trustees. In order that donors and

testators of moderately sized trusts may not be denied the service of corporate fiduciaries, the

District of Columbia and some thirty states other than New York have permitted pooling small

trust estates into one fund for investment administration. The income, capital gains, losses and

expenses of the collective trust are shared by the constituent trusts in proportion to their

contribution. By this plan, diversification of risk and economy of management can be extended to

those whose capital standing alone would not obtain such advantage.

Under [New York Banking Law, the assets of small trusts may be pooled. The Court can

issue a decree settling the accounts by publishing notice]. The decree, in each such judicial

settlement of accounts, is made binding and conclusive as to any matter set forth in the account

upon everyone having any interest in the common fund or in any participating estate, trust or fund.

In January, 1946, Central Hanover Bank and Trust Company established a common trust

fund in accordance with these provisions, and, in March, 1947, it petitioned the Surrogate's Court

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for settlement of its first account as common trustee. During the accounting period, a total of 113

trusts, approximately half inter vivos and half testamentary, participated in the common trust fund,

the gross capital of which was nearly three million dollars. The record does not show the number

or residence of the beneficiaries, but they were many, and it is clear that some of them were not

residents of the State of New York.

The only notice given beneficiaries of this specific application was by publication in a local

newspaper in strict compliance with [New York Banking Law]. Thus, the only notice required,

and the only one given, was by newspaper publication setting forth merely the name and address

of the trust company, the name and the date of establishment of the common trust fund, and a list

of all participating estates, trusts or funds.

At the time the first investment in the common fund was made on behalf of each

participating estate; however, the trust company had notified by mail each person of full age and

sound mind whose name and address was then known to it and who was [a beneficiary of the trust].

Included in the notice was a copy of those provisions of the Act relating to the sending of the notice

itself and to the judicial settlement of common trust fund accounts.

Upon the filing of the petition for the settlement of accounts, appellant was, by order of the

court appointed special guardian and attorney for all persons known or unknown not otherwise

appearing who had or might thereafter have any interest in the income of the common trust fund,

and appellee Vaughan was appointed to represent those similarly interested in the principal. There

were no other appearances on behalf of anyone interested in either interest or principal.

Appellant appeared specially, objecting that notice and the statutory provisions for notice

to beneficiaries were inadequate to afford due process under the Fourteenth Amendment, and

therefore that the court was without jurisdiction to render a final and binding decree. Appellant's

objections were entertained and overruled, the Surrogate holding that the notice required and given

was sufficient. A final decree accepting the accounts has been entered [and affirmed by the lower

courts]. The effect of this decree, as held below, is to settle "all questions respecting the

management of the common fund." We understand that every right which beneficiaries would

otherwise have against the trust company, either as trustee of the common fund or as trustee of any

individual trust, for improper management of the common trust fund during the period covered by

the accounting is sealed and wholly terminated by the decree. [The Court then recognizes New

York’s power to discharge trustees even if the beneficiaries live out of state]

Quite different from the question of a state's power to discharge trustees is that of the

opportunity it must give beneficiaries to contest. Many controversies have raged about the cryptic

and abstract words of the Due Process Clause, but there can be no doubt that, at a minimum, they

require that deprivation of life, liberty or property by adjudication be preceded by notice and

opportunity for hearing appropriate to the nature of the case.

In two ways, this proceeding does or may deprive beneficiaries of property. It may cut off

their rights to have the trustee answer for negligent or illegal impairments of their interests. Also,

their interests are presumably subject to diminution in the proceeding by allowance of fees and

expenses to one who, in their names but without their knowledge, may conduct a fruitless or

uncompensatory contest. Certainly the proceeding is one in which they may be deprived of

property rights and hence notice and hearing must measure up to the standards of due process.

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Personal service of written notice within the jurisdiction is the classic form of notice always

adequate in any type of proceeding. But the vital interest of the State in bringing any issues as to

its fiduciaries to a final settlement can be served only if interests or claims of individuals who are

outside of the State can somehow be determined. A construction of the Due Process Clause which

would place impossible or impractical obstacles in the way could not be justified.

Against this interest of the State, we must balance the individual interest sought to be

protected by the Fourteenth Amendment. This is defined by our holding that "[t]he fundamental

requisite of due process of law is the opportunity to be heard." This right to be heard has little

reality or worth unless one is informed that the matter is pending and can choose for himself

whether to appear or default, acquiesce or contest.

The Court has not committed itself to any formula achieving a balance between these

interests in a particular proceeding or determining when constructive notice may be utilized, or

what test it must meet. Personal service has not, in all circumstances, been regarded as

indispensable to the process due to residents, and it has more often been held unnecessary as to

nonresidents. We disturb none of the established rules on these subjects. No decision constitutes a

controlling, or even a very illuminating, precedent for the case before us. But a few general

principles stand out in the books.

An elementary and fundamental requirement of due process in any proceeding which is to

be accorded finality is notice reasonably calculated, under all the circumstances, to apprise

interested parties of the pendency of the action and afford them an opportunity to present their

objections. The notice must be of such nature as reasonably to convey the required information,

and it must afford a reasonable time for those interested to make their appearance. But if, with due

regard for the practicalities and peculiarities of the case, these conditions are reasonably met, the

constitutional requirements are satisfied.

But when notice is a person's due, process which is a mere gesture is not due process. The

means employed must be such as one desirous of actually informing the absentee might reasonably

adopt to accomplish it. The reasonableness, and hence the constitutional validity of, any chosen

method may be defended on the ground that it is, in itself, reasonably certain to inform those

affected, or, where conditions do not reasonably permit such notice, that the form chosen is not

substantially less likely to bring home notice than other of the feasible and customary substitutes.

It would be idle to pretend that publication alone, as prescribed here, is a reliable means of

acquainting interested parties of the fact that their rights are before the courts. It is not an accident

that the greater number of cases reaching this Court on the question of adequacy of notice have

been concerned with actions founded on process constructively served through local newspapers.

Chance alone brings to the attention of even a local resident an advertisement in small type inserted

in the back pages of a newspaper, and, if he makes his home outside the area of the newspaper's

normal circulation, the odds that the information will never reach him are large indeed. The chance

of actual notice is further reduced when, as here, the notice required does not even name those

whose attention it is supposed to attract, and does not inform acquaintances who might call it to

attention. In weighing its sufficiency on the basis of equivalence with actual notice, we are unable

to regard this as more than a feint.

Nor is publication here reinforced b y steps likely to attract the parties' attention to the

proceeding. It is true that publication traditionally has been acceptable as notification supplemental