18: Unsecured claims – allowance, distributions, priority © Charles Tabb 2010

“Allowance” Why does it matter whether a claim is allowed?

Proof of claim What role does a “proof of claim” play in the allowance process? What IS a proof of claim? Who files it?

Proof not needed? When is it not necessary for a creditor to file a proof of claim in order to have its claim allowed?

How find out? How does a creditor know that it needs to file a proof of claim?

What if no notice? What happens if a creditor for some reason does NOT get notice of the bankruptcy in time to file a proof of claim?

time How long does a creditor have to file a proof of claim?

What if late? What happens to a creditor’s claim if it files late? Does it matter HOW late? Does it matter whether it is a priority claim?

Effect of filed claim What is the legal effect of a properly filed proof of claim?

Contesting claims What is the process by which a filed proof of claim could be contested? Which court resolves a claim dispute?

estimation How does the Code deal with the fixing of contingent or unliquidated claims?

Problem 5.2(a) Which of the following asserted “claims” will be disallowed, in whole or in part? Creditor purchased a gizmo from Debtor in Debtor files chapter 7 in Creditor files a proof of claim, asserting for the first time that the gizmo is defective. Under Article 2 of the UCC, the statute of limitations for breach of warranty actions is four years from tender of delivery.

Answer 5.2(a) Disallow § 502(b)(1): unenforceable under non- bankruptcy law UCC statute of limitations bars claim

5.2(b) Debtor filed chapter 7 on May 1, On June 1, 2009, Debtor defrauded Creditor by selling a “pirated” DVD as authentic. Creditor files a proof of claim, demanding a refund.

Answer 5.2(b) Disallow § 502(a): “as of the commencement” – This claim arises POST-petition

5.2(c) Creditor A loaned Debtor $1,000, at 10% annual interest, on January 1, Creditor B loaned Debtor $1,000, at 8% annual interest, on January 1, On January 1, 2009, when the prevailing interest rate on similar loans was 8%, Debtor filed chapter 7, having paid only accrued interest on each loan through December 31, 2008.

Answer 5.2(c) Allow – for the principal balance of $1,000 only Disallow – § 502(b)(2) – For the unmatured interest

Unmatured interest Bankruptcy accelerates all claims back to the date of the commencement of the case So even though a loan with higher interest is obviously more valuable than one with lower interest, we ignore that difference in bankruptcy b/c the post-bankruptcy interest wont’ be paid!

5.2(d) Creditor loaned Debtor $5,000 in Debtor was to repay $6,000 in Debtor filed chapter 7 in 2007, and Creditor filed a proof of claim in the amount of $6,000

Answer 5.2(d) Allow: – Principal balance of $5,000 – Matured interest of $500 (simple interest) IMPUTE an OID (original issue discount) Disallow: – Unmatured interest of $500

5.2(e) , Lessor leased military base to Debtor for 99 years, annual rent of $100, , Debtor repudiated the lease, surrendered possession, owing no back rent , Debtor filed chapter 7. Lessor immediately relet the premises for remaining term of 91 years at an annual rent of $50,000.

Answer 5.2(e) $ claim as of date of bankruptcy, IF no special bankruptcy caps: 91 years X $100,000 = $9.1 million in payments remaining 91 years X $50,000 = $4.55 million in mitigation by reletting years X $50,000 =Present Value ($4.55 million) actual damages ============== In most states, the present value of receiving that $4.55 million in 91 annual increments of $50,000 each would be Lessor's damages. The present value of that payment stream aggregating $4.55 million depends on the interest rate you use for discounting those amounts back to present value. So let’s say that’s Lessor’s state law damages are $650,000 (using about a 7% interest rate).

Answer 5.2(e) Lessor does not get full $650K in state law damages, though In bankruptcy, special cap in § 502(b)(6) for long-term real estate leases Policy: keep from eating up too much of estate

502(b)(6) formula Formula in 502(b)(6) is: – the greater of: (I) one-years' rent or (ii) rent for 15% of the remaining term, not to exceed three-years' rent

Calculating 502(b)(6) Greater of: 1 year’s rent ($100K) Or 15% of remaining term (91 years x 15% = years), NOT to exceed 3 year’s rent, so = 3 year’s rent ($300K)  $300K … so Lessor is forced to give up $350K of $650K actual damages claim

Short-cut to 502(b)(6) If the remaining term is less that 80 months, the one-year cap will apply. If the remaining term is greater than 80 months and less than 20 years, the 15% cap applies. If the remaining lease term is greater than 20 years, the three-year cap applies

5.2(f) In 2007, Creditor signed a 10-year contract to play baseball for the Texas Strangers at a salary of $25 million per year. January 1, 2009, Strangers discontinued operations, terminated all player contracts, and filed chapter 7.

Answer 5.2(f)? $ claim as of date of bankruptcy, IF no special bankruptcy caps: Unpaid wages (8 years x $25 MM = $200 MM) Mitigation (assume $10 MM/yr. = $80 MM) present value ($120 MM) actual damages, ~ $70 MM

Apply cap – employment K However have a special cap in § 502(b)(7) for damages under an employment K Cap: one year’s salary  So only gets $25 MM

A digression … While we’re talking baseball (sort of), consider whether the runner was safe or out. This play cost STL the 1985 World Series (sorry Ralph)

Distributions on unsecured claims AFTER exempt property taken out AFTER secured claims paid Thus may have a no asset case – NOTHING left for unsecured Crs

How pay in 7 IF have $ left? Chapter 7: § 726 controls distribution order for unsecured claims: 1. Priority (if filed in time) 2.General unsecured (ditto) 3.late claims 4.non-compensatory fines, etc. 5.post-petition interest 6.debtor

Not enough to go around? If the estate does not have enough $ to pay everyone in a class in full, what happens?  Share pro rata * Everyone take same % of claims

Reorg cases -- unsecured Basic premises of paying unsecured claims in reorg cases: – Pay over time (usually) – According to terms of confirmed plan

Priority claims in reorg cases Basic premise of priority claims in reorg cases: PAY IN FULL Requirement to confirm a plan

Non-priority claims in ch. 11 PLAN says how much get Placed in a class of similar claims All class members treated alike Class votes – If class votes yes, binds everyone in class – Including dissenting CRs

Absolute priority rule If class in chapter 11 votes no: – Plan may only be confirmed if satisfy absolute priority rule: 1129(b)(2)(B)(2) – Must either pay class 100% OR – Eliminate all junior classes (e.g., equity) – Compare with 1325(b)(1)(B)

Protection for class dissenter Even if class votes yes, EVERY member of class, even if a dissenter, is entitled to “best interests” test – Paid as much as would be in hypo chapter 7 – § 1129(a)(7)

Chapter 13 1.NO VOTING 2.Put in class with similar claims – Same treatment – May not discriminate unfairly between classes 3.“Best interests” test, 1325(a)(4) 4. Projected disposable income test, 1325(b) * remember Lanning: this is the C13 analog to the Absolute Priority Rule in C11

Priority claims What is a “priority” claim? Why does it matter?

Priority: secured or unsecured? A priority claim is unsecured

Statutory only Priority claims are solely creatures of statute § 507(a) is the exclusive list COURTS: no power to establish non-statutory priorities

Federal only Only the federal government may create bankruptcy priorities State law priorities are preempted

Disfavor priority claims Policy is against priority claims Construe narrowly WHY? How serve goals of bankruptcy?

Ranking priority claims Rank ordinally, in order specified in § 507(a) Pay one class in full before go to next Within same ordinal class: pro rata

“super” priorities Statutory provisions -- higher (super) priority: – § 364(c)(1): post-petition lender – § 507(b): adequate protection fails – § 726(b): “burial” expenses

De facto priorities Some Code provisions are not called priority rules, but the practical effect is to force estate to spend $ to pay certain claims, so de facto those claims have priority Example: payments under collective bargaining agreement, prior to rejection,§ 1113(f)