What’s the Difference Between a Contested Matter and an Adversary Proceeding Anyway?

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Contributed by Doron P. Kenter.

The difference between a contested matter and an adversary proceeding is relatively simple – a contested matter involves a contested request for relief in the context of the main bankruptcy proceeding (pursuant to Rule 9014 of the Federal Rules of Bankruptcy Procedure), while an adversary proceeding involves the filing of a complaint, commencing a separate proceeding governed by the “7000” series of the Bankruptcy Rules. What necessitates an adversary proceeding, and under what circumstances will a simple “contested matter” suffice? Strictly speaking, certain matters must be resolved in an adversary proceeding, rather than upon a motion in the main bankruptcy case. Such matters are listed in Rule 7001 of the Federal Rules of Bankruptcy Procedure and include (but are not limited to) proceedings to:

  1. recover money or property (with certain exceptions);
  2. determine the validity, priority, or extent of a lien or other interest in property;
  3. object to or revoke a discharge;
  4. determine the dischargeability of a debt;
  5. obtain an injunction or other equitable relief, except when a chapter 9, chapter 11, chapter 12, or chapter 13 plan provides for the relief;
  6. subordinate any allowed claim or interest, except when a chapter 9, chapter 11, chapter 12, or chapter 13 plan provides for subordination;
  7. obtain a declaratory judgment relating to any of the foregoing.

This rule, however, may be subject to debate, and may be easily overlooked. But what if the relief being sought does not appear to implicate any of the proceedings referenced in Rule 7001, but objecting parties then raise questions that would be more properly resolved in an adversary proceeding? The Bankruptcy Appellate Panel for the Ninth Circuit Court of Appeals was one court to have faced this question recently.

In In re Gentile Family Industries, the debtor moved to assume a (purportedly unexpired) lease, which was critical to its ongoing business. Diatom, LLC, the lessor and a major creditor of the debtor, opposed the motion, arguing that the lease was not assumable because it had not been renewed according to its terms and was instead simply a month-to-month lease. Central to the dispute was the question of whether the debtor had properly renewed the lease several years prior to commencing its bankruptcy case. The bankruptcy court concluded that the lease had been properly renewed and that the debtor could therefore assume the lease. On appeal, Diatom argued that the judgment should be set aside because the dispute should not have been resolved through a contested matter, but instead through an adversary proceeding, including a complaint for a declaratory judgment regarding the validity of the lease.

Strictly speaking, Diatom may have been correct (the appellate panel did not conclusively decide whether the debtor should have commenced an adversary proceeding in the first instance). However, notwithstanding the fact that the contested matter involved questions regarding the validity of the lease, the appellate panel concluded that the error (if there was one) was harmless and did not warrant reversal. Quoting its previous decision in Ruvacalba v. Munoz (In re Munoz), the appellate panel held that even though it may be error to treat that which should be subject to adversary proceeding as a contested matter, “[s]uch an error may nevertheless be harmless when the record of the procedurally incorrect ‘contested matter’ is developed to a sufficient degree that the record of an adversary proceeding likely would not have been materially different for certain contested matter which should have been brought as an adversary proceeding.” In Gentile Family Industries, the parties had “ample time to air their positions” after a full opportunity to brief the issues and to introduce evidence in support of their respective positions. Indeed, the court observed that “for all practical purposes an adversary proceeding was held in this case.” Because Diatom could not show that it had been procedurally disadvantaged by the bankruptcy court’s approach to the dispute, the appellate panel saw no need to disturb the bankruptcy court’s conclusion that, as a matter of law, the debtor could assume the unexpired lease.

Gentile Family Industries and other similar cases point to the principle that form will not be elevated over substance in bankruptcy proceedings, so long as no parties are procedurally disadvantaged. But this case does point to a key question – what should be the result where an objecting party in a contested matter raises questions that would warrant the commencement of an adversary proceeding by the debtor? In the course of a contested matter, it is certainly possible that, as in Gentile Family Industries, an objecting party might introduce an issue that could, in turn, require the debtor to commence an action for a declaratory judgment, or to determine the nature, extent, and validity of lien. If the matter is simply treated as a contested matter in the case, a host of risks may arise, including, for example:

  1. The defendant(s) would not have an opportunity to move to dismiss the complaint without further evidentiary proceedings (potentially including discovery and other litigation expenses);
  2. The defendant(s) would not be able to file counterclaims against the debtor in the context of the contested matter, and would not be able to assert all of the defenses and objections that may be raised in an adversary proceeding;
  3. The default deadlines and other procedural requirements for adversary proceedings would not apply;
  4. Many of the Federal Rules of Civil Procedure that are otherwise applicable to adversary proceedings would not apply, nor would the specific Bankruptcy Rules set forth for adversary proceedings; and
  5. The court’s docket in the main bankruptcy case could become cluttered with discovery disputes and other procedural motions that implicate a dispute between a small subset of parties.

Of course, parties in interest and bankruptcy courts would be well-advised to consider the practical differences between an adversary proceeding and a contested matter in determining their course of action. But many of these distinctions may be immaterial – particularly in straightforward disputes between parties in interest in a bankruptcy case. Moreover, bankruptcy courts may conduct contested matters much the same way as an adversary proceeding would play out (indeed, Bankruptcy Rule 9014(c) provides that many of the “7000 series” of rules also apply to contested matters). If there is no material difference or disadvantage to any parties, it might simply be a waste of resources to put form over substance in differentiating between these two (frequently similar) types of proceedings.