Contributed by Marvin Mills
As our readers may recall, two years ago, Judge Ambro of the Third Circuit opined that “[t]he shadow of Frenville fades, but more slowly than we would like.” In Frenville, the Third Circuit established that a claim arose, for bankruptcy purposes, when the underlying state law cause of action accrued. Recognizing the flaws of the accrual test, the Third Circuit overruled Frenville in JELD-WEN, Inc. v. Van Brunt (In re Grossman’s), and held that a prepetition claim arises at the time of exposure or conduct giving rise to the injury. Although Frenville was overruled, it left its footprints behind. Recently, however, in In re Paul Ruitenberg, III, the Third Circuit has again rejected the Frenville accrual test, this time with respect to a debtor’s spouse’s interest in a pending divorce proceeding. Explicitly expanding the scope of Grossman’s beyond tort claims, the Third Circuit — which included Judge Ambro, Judge Smith and retired Associate Justice for the Supreme Court of the United States, Sandra Day O’Connor — broadened the scope of prepetition claims and firmly rejected application of the accrual test.
In Ruitenberg, the debtor commenced a chapter 7 case while a divorce proceeding with his spouse was pending in New Jersey state court. At the time of the debtor’s bankruptcy filing, the state court had not yet entered a judgment apportioning the couple’s marital assets. Nevertheless, the debtor’s spouse timely filed a proof of claim for her anticipated share of marital property.
The chapter 7 trustee for the debtor’s estate sought to expunge the spouse’s proof of claim. The trustee argued that the wife’s interest in the marital property was not a claim under bankruptcy law because the state court had not entered a final divorce decree prior to the commencement of the debtor’s bankruptcy case. The characterization of the spouse’s interest as either a prepetition claim or a postpetition claim would significantly impact her potential recovery. If the interest was a prepetition claim, the spouse would be eligible to receive a share of any distribution made to general unsecured creditors from the debtor’s estate. If the interest was a postpetition claim, however, the spouse’s recovery would be limited to the assets available after the debtor’s liquidation — a recovery that might be substantially less than she would receive from the estate as a general unsecured creditor. (We note that this may seem backwards to most situations we encounter in the chapter 11 context, where the debtor argues that a claim is a prepetition claim while the creditor argues that it is a postpetition claim.)
The United States Bankruptcy Court for the District of New Jersey concluded that the spouse’s interest in a potential distribution of marital assets arose prepetition and, therefore, was an allowable claim. The district court certified the case for direct appeal to the Third Circuit.
At the outset of its analysis, the appellate court explained that the Bankruptcy Code is the starting point for determining whether a spouse’s interest in an equitable distribution of marital assets in a divorce proceeding constitutes a claim. Section 101(5)(A) defines a claim (in pertinent part) as a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured[.]” According to the Third Circuit, when the debtor filed for bankruptcy, even though the state court had not entered a final judgment for the spouse, “her interest was, at the least, unliquidated and contingent on a final decree apportioning marital property, perhaps unmatured, and likely disputed. But, no matter, it literally [was] a ‘claim’ under [section] 101(5).”
In support of this view, the Third Circuit relied on its analysis in Grossman’s, in which it concluded that an asbestos-related claim — and thus a right to payment under the Bankruptcy Code — arises at the time of exposure even if the injury manifests postpetition. The Third Circuit reiterated that Congress and the Supreme Court have instructed that the term claim under the Bankruptcy Code should have “the broadest possible definition.” The court went on to explain that in Grossman’s it overruled the Frenville accrual test (pursuant to which a claim arose, for bankruptcy purposes, when the underlying state law cause of action accrued) because the Frenville test interpreted the definition of a claim under the Bankruptcy Code too narrowly. Grossman’s expanded the definition of a claim, and the spouse’s interest fell within the expanded definition.
The Third Circuit firmly rejected the chapter 7 trustee’s argument that the court should apply the Frenville accrual test because Grossman’s was limited to tort-related claims, and that under New Jersey state law a spouse’s claim to apportioned martial property arises upon entry of a judgment of divorce. Judge Ambro acknowledged that the formulation of the Grossman’s test was tailored to common law tort claims, but noted that in that decision the Third Circuit had highlighted the flaws of the accrual test, and that such test was inconsistent with section 101(5). Consequently, the court found that the underlying rationale of Grossman’s and the language of section 101(5) warranted a “broader rejection of the Frenville accrual test.”
The appellate court went on to note that allowing the spouse’s claim did not raise the due process concerns addressed in Grossman’s (e.g., adequacy of notice). Rather, the debtor and the spouse were fully aware of the pending divorce proceeding and the potential distribution of marital assets at the time of the bankruptcy filing.
The Ruitenberg decision has implications far beyond divorce proceedings. The Third Circuit’s expansive application of Grossman’s not only sounds a second and final death knell for Frenville (to the extent Frenville had any life post-Grossman’s), but also should be a warning to potential creditors in any proceeding in which an adverse party files for bankruptcy. Parties to proceedings commenced prior to another party’s bankruptcy filing should timely file proofs of claim if they seek a recovery from the bankruptcy estate, or else run the risk of their claims being discharged.
Copyright © 2019 Weil, Gotshal & Manges LLP, All Rights Reserved. The contents of this website may contain attorney advertising under the laws of various states. Prior results do not guarantee a similar outcome. Weil, Gotshal & Manges LLP is headquartered in New York and has office locations in Beijing, Boston, Dallas, Frankfurt, Hong Kong, Houston, London, Miami, Munich, New York, Paris, Princeton, Shanghai, Silicon Valley, Warsaw, and Washington, D.C.