Restructuring

In a decision that could have far reaching implications on the manner and level of secured creditor participation in bankruptcy cases, the Court of Appeals for the Seventh Circuit recently held that the deadline for filing proofs of claim under Bankruptcy Rule 3002(c) applied to all creditors – both unsecured and secured.  Previously, secured creditors had relied on conflicting cases that permitted secured creditors to file proofs of claim in chapter 7 or chapter 13 cases at any time prior to a plan’s confirmation, but the Court of Appeals eliminated any confusion.  In so holding, however, the Seventh Circuit left unchanged its long standing rule that a secured lender’s lien is largely left unaffected by bankruptcy. 
Background
In Pajian, a secured mortgage lender filed a proof of claim for approximately $330,000 more than three months after the expiration of the deadline for filing proofs of claim in the individual debtor’s chapter 13 case.  The lender’s claim covered two debts: one was a secured debt for a first mortgage on a commercial property jointly owned by the debtor, and the second was an unsecured claim for a deficiency judgment resulting from a state foreclosure proceeding on a residential property.
The debtor objected to the claim, arguing that it was barred from inclusion in his chapter 13 plan because the lender had missed the deadline imposed by Bankruptcy Rule 3002(c).  In response, the lender argued that (i) a secured creditor did not need to file a proof of claim in order to secure distributions under a chapter 13 plan; (ii) a pleading the lender previously had filed prior to the deadline amounted to an “informal” proof of claim; and (iii) Rule 3002(c) was inapplicable to secured claims.  The bankruptcy court rejected the first and second arguments but agreed with the lender on the third, concluding that a secured creditor seeking distributions under a plan need only file a proof of claim prior to the plan’s confirmation.  In so holding, the bankruptcy court sustained the debtor’s objection with respect to the unsecured portion of the claim, but overruled the objection as to the secured portion and deemed that latter portion allowed.  Thereafter, the debtor took a direct appeal to the Seventh Circuit Court of Appeals to contest the bankruptcy court’s decision to allow the secured portion of the claim.
The Seventh Circuit certified the debtor’s appeal, noting that the appeal raised legal question that would require the court to “break new ground” and resolve conflicting decisions among bankruptcy courts.  The Court of Appeals further noted that the case involved “matters of public importance” because the issue had been “a thorn in the side of many Chapter 13 cases involving secured creditors.”
Analysis
Under Bankruptcy Rule 3021, a creditor must file a proof of claim in order to participate in plan distributions.  This rule applies to all cases under the Bankruptcy Code, including chapter 11.  Although all creditors — secured and unsecured — must file a proof of claim in order to receive a distribution, the Seventh Circuit previously held in In re Penrod, that a secured creditor that fails to do so, and does not participate in the bankruptcy proceeding, can still enforce its lien through a foreclosure action, even after the debtor receives a discharge.  The Weil Bankruptcy Blog has written about Penrod and decisions of other courts, which fail to address adequately how these holdings translate to the chapter 11 context and might be affected by a chapter 11 bar date order, a chapter 11 plan, or discharge under chapter 11.
Bankruptcy Rule 3002 governs the filing of proofs of claim in chapter 7, chapter 12 and chapter 13 cases.  Bankruptcy Rule 3002(c) provides that “a proof of claim is timely filed if it is filed not later than 90 days after the first date set for the meeting of creditors called under § 341(a)….”  Rule 3002(c) then goes on to enumerate six limited exceptions which may result in an extension of the general 90-day deadline (i.e., claims of governmental units, claims of infants or incompetent people, unsecured judgment claims, rejection damage claims, claims filed after a notice of no dividend was previously given but a dividend later appears possible, and claims of foreign creditors where insufficient notice was given) none of which applied to the debtor’s case.
The issue of whether Rule 3002(c)’s deadline applied to all creditors or merely unsecured ones has led to conflicting opinions in the Seventh Circuit.  In Pajian, however, the Court of Appeals resolved this conflicting by holding that all creditors—unsecured and secured alike—are bound by the Rule 3002(c) deadline.
First, the Court of Appeals stated that subsection (c) on its face applied to any “proof of claim” and did not distinguish between the claims of secured and unsecured creditors.  Second, the Court noted that the 90-day general deadline enumerated in Rule 3002(c) mentioned both “claims” and “unsecured claims,” and the use of both terms suggested to the court that the drafters knew how to distinguish between all claims and unsecured claims.
The Seventh Circuit further noted that principles of sound judicial administration supported holding that Rule 3002(c) applied to all creditors.  Concerned that tardy filings from secured creditors likely would require the debtor to modify a carefully constructed plan, the Court of Appeals noted that allowing secured creditors to file last minute proofs of claim could “wreak havoc on the ability of the debtor and the bankruptcy court to assemble and approve an effective plan.”
Finally, the court noted that the recent proposal of the U.S. Judicial Conference’s Advisory Committee on Bankruptcy Rules to amend Rule 3002(a) to make clear that it applies to secured and unsecured creditors supported its conclusions.
In rendering its decision, the Court of Appeals disregarded the fact that subsection (a) of Rule 3002, which sets forth the requirement to file a proof of claim so that the claim will be allowed, was limited to unsecured creditors, noting “that fact does not undermine our conclusion.”  The Court of Appeals stated that it made sense for section (a) to apply only to unsecured claims.  The Court explained that, if an unsecured creditor did not file a proof of claim, it would not share in the recovery authorized under the plan and its claim would be discharged in bankruptcy.  According to the Court, and consistent with Penrod, the same did not apply to secured creditors as secured debts are non-dischargeable, and secured creditors can enforce their liens even if they do not participate in the debtor’s chapter 13 plan.  The court stated that “subsection (a) is thus about who must file in order to collect on debts.  There is no reason why its limitation to unsecured creditors should carry over to subsection (c).”
Conclusion
Although the Seventh Circuit reaffirmed its position that a secured creditor’s lien is largely left unaffected by bankruptcy, its recent decision in Pajian could have far reaching implications on the manner and level of secured creditor participation in bankruptcy cases.  In holding that secured and unsecured creditors alike are bound by the deadline imposed under Bankruptcy Rule 3002(c) for filing proofs of claim, the Seventh Circuit has limited the ability of secured creditors to take a “wait and see approach” in deciding whether to participate in chapter 7 or chapter 13 cases.  Secured creditors can no longer wait until confirmation to decide whether to file a proof of claim and now may need to engage with debtors earlier in the bankruptcy process to determine whether to participate in a bankruptcy (i.e., file a claim) or simply seek to enforce their existing liens post-confirmation.
Although the Seventh Circuit had an opportunity to retreat from its holding in Penrod, it expressly reaffirmed the principle that a secured debt may “ride through” a bankruptcy.  Although Pajian arises under chapter 13, this decision creates uncertainty about how these principles might be applied in a chapter 11 context, and reflects that courts continue to embrace the “lien rides through” caselaw that developed prior to the enactment of the Bankruptcy Code.