The Problem with Late Claims in Chapter 13

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Sep 2002

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The failure of a chapter 13 debtor to notify a creditor in time to file a proof
of claim creates a myriad of problems for the debtor and the creditor alike. The
debtor's failure to give timely notice will likely result in the creditor retaining its
claim after entry of the discharge.<a href="#2" name="2a">2</a> In turn, the late-notified creditor who files
an untimely proof of claim will be precluded from participating in the bankruptcy
proceeding and will not receive distributions from the chapter 13 trustee. In short,
both lose.

Recent cases have addressed the issue of whether a bankruptcy court may consider a
late-filed proof of claim from a late-notified creditor. Courts being what they are,
the decisions on this point have been anything but consistent. Thus, two schools of
thought have emerged: In the view of the majority, a bankruptcy court cannot accept
a late-filed claim from a late-notified creditor, period. The minority disagree, and
cite notions of fundamental fairness and equity for the proposition that a bankruptcy
court may entertain a late-filed proof of claim under these circumstances. This article
examines the two views and argues in favor of the minority.

<h3>The Majority Rule</h3>

The majority rule holds that bankruptcy courts lack authority to consider late-filed
proofs of claim under any circumstances. Its adherents contend that bankruptcy courts
have no authority under either the Bankruptcy Code or Federal Rules of Bankruptcy
Procedure (FRBP) to extend the deadline for filing a proof of claim in a chapter
13 case.

Support for this position is based on a literal reading of the law. A proof of
claim may be filed upon the commencement of a bankruptcy proceeding.<a href="#3" name="3a">3</a> The deadline
for filing a proof of claim in a chapter 13 proceeding is 90 days after the date
of the order for relief.<a href="#4" name="4a">4</a> Although a bankruptcy court may extend many deadlines,
a literal interpretation of the Rules preclude it from accepting untimely proofs of
claim.<a href="#5" name="5a">5</a> This is a departure from the general rule that permits an act to be done
out of time upon a showing of excusable neglect.<a href="#6" name="6a">6</a> Read together, Rules 3002(c)
and 9006(b) establish an immutable deadline for filing proofs of claim in chapter
13 proceedings.<a href="#7" name="7a">7</a> Courts adhering to the majority view subscribe to the belief that
by failing to include a provision under which late-notified creditors could file claims
out of time, Congress "...had in mind the purpose of chapter 13 and its
framework—to allow debtors to commence repayment as soon as possible of some or all
of their debts."<a href="#8" name="8a">8</a>

Clearly, this approach has the potential for inequity—a point not lost on at least
one majority-view court. In the case of In re Brogden,<a href="#9" name="9a">9</a> one of the few to
address the fundamental fairness issue, the court balanced the disallowance rule in
§502(b)(9) against "at least six remedies, almost all of which offer substantial
advantages...over participation in plan payments." The alternative remedies identified
by the court are (1) relief from the automatic stay, (2) dismissal for cause,
(3) conversion to chapter 7, (4) relief from the confirmation order, (5)
revocation of confirmation and (6) exception to discharge. The court concluded that
the availability of these remedies temper the harsh impact of the disallowance rule,
thereby preventing it from offending traditional notions of fundamental fairness.

<h3>The Minority View</h3>

Courts that adhere to the minority view have a less rigid adherence to the literal
language of the Bankruptcy Code and Rules while focusing on the equitable nature of
bankruptcy. Perhaps the most cogent discussion of the minority view is contained in
the case of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Revenue Service v. Hildebrand III Trustee, 245 B.R.
287 (M.D. Tenn. 1999)</a>, appeal dismissed for lack of jurisdiction, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
F.3d 484 (6th Cir. 2001)</a>. In that case, the bankruptcy court disallowed
claims in three unrelated chapter 13 cases because they were filed after the
§502(b)(9) claim deadline. In overruling a prior reported decision of the
bankruptcy court,<a href="#10" name="10a">10</a> the district court held that "[t]o deem the claims barred under
this circumstance would be fundamentally unfair. It would reward debtors who failed to
fulfill the statutory requirements of listing all creditors and relieve the court system
of its obligation to ensure that appropriate notice is provided."<a href="#11" name="11a">11</a>

<h3>Argument for Allowing Late Claims</h3>

The majority view's straightforward application of the statutes and rules results in
late-notified creditors receiving fundamentally unfair treatment in an equitable
proceeding.

It is well-settled that creditors are entitled to appropriate notice. Bankruptcy
Code §342 requires that all claim-holders be given notice of the order of relief.
Depriving a creditor of the right to participate in a chapter 13 proceeding is a
deprivation of enormous magnitude. The bankruptcy court's acceptance of a proof of claim
permits a creditor to receive several valuable benefits, and to exercise a battery of
very important rights. For instance, under §§1322 and 1325, priority creditors
are entitled to full payment of their claims, and secured creditors are entitled to
receive an amount equal to the value of their claims as of the effective date of the
plan. All creditors are entitled to object to the confirmation of a plan on several
different bases, including lack of feasibility, the failure to file in good faith,
and the failure to meet the "best interests of creditors" or the "disposable income"
tests (§§1324, 1325). Creditors also have the right to request modification
of a confirmed plan (§1329) and to object to entry of a discharge (§1328).
Additionally, and perhaps most important, the right to receive uncoerced payments today
from a debtor with the income and inclination to make such payments is far more
valuable than the opportunity to attempt to wrest payments from that debtor tomorrow.

None of the alternative remedies set forth in the Brodgen decision restore these
lost rights to a late-notified creditor whose proof of claim has not been accepted,
nor do they provide an alternative remedy of equal value. Simply stated, being allowed
to forcibly collect a debt from a debtor with limited assets is simply incomparable
to being paid without having to resort to enforced collection.

The doctrine of equitable tolling also provides bankruptcy courts with the authority
to accept late-filed proofs of claim from late-notified debtors. Under the doctrine
of equitable tolling, a court may make narrow exceptions to a limitations period when
equity so requires.<a href="#12" name="12a">12</a> All that need be shown is that by the exercise of reasonable
diligence, the party who seeks the extension of time could not have discovered
essential information bearing on the claim.<a href="#13" name="13a">13</a>

In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. United States, ____ U.S. ____, 122 S.Ct. 1036, 152
L.Ed.2d 79 (March 4, 2002)</a>, the Supreme Court recently applied the
doctrine of equitable tolling to the three-year look-back provisions utilized in
determining priority status and dischargeability of federal tax claims. In applying the
tolling doctrine, the unanimous court noted that "it is hornbook law that limitations
periods are customarily subject to equitable tolling...unless tolling would be
inconsistent with the text of the relevant statute." Thus, "Congress must be presumed
to draft limitations periods in light of this background principle."<a href="#14" name="14a">14</a>

It is clear that Congress has not expressed any intention to deny the application
of equitable tolling to the claims filing process in bankruptcy. Indeed, the existence
of §105, as well as the bankruptcy system as a whole, reveals Congress's intent
that it be an equitable process. Moreover, equitable tolling is entirely consistent
with §501. Indeed, its application is but a slight modification of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
3002(c)(1)</a>, which permits the enlargement of the claims filing deadline as long
as the request is made prior to the filing deadline. These considerations lend weight
to the conclusion that the otherwise harsh impact of the claims filing deadline is
tempered by the doctrine of equitable tolling, as recently espoused by the Supreme
Court in the Young decision.

Implementing the equitable tolling approach to the issue of late-filed claims involves
a relatively simple case-by-case analysis. Courts should consider the size and nature
of the claim, as well as the stage of the proceeding in deciding whether to permit
its allowance. Courts are free to deny the application of equitable tolling when, in
light of all of the other factors then known to it, acceptance of the claim would
undermine the rest of the proceeding. For example, it is appropriate to deny equitable
tolling when the case is only a few months from completion and the claim cannot be
appropriately treated within the remainder of the plan. Under such a scenario, it is
much more appropriate to deny the creditor the right to participate in the proceeding
and allow it to retain its non-discharged debt. Alternatively, if the proceeding is
in its infancy, and the proposed claim can be adequately treated during the remainder
of the plan, then fundamental notions of equity and the principles underlying the
bankruptcy system auger in favor of permitting the claim to be filed and accepted.

Under the majority view, late-notified creditors are unquestionably denied the right
to payment on untimely proofs of claim through no fault of their own. Further, the
remedies to which they are relegated are insufficient to the task of making them whole
or something close thereto. Traditional notions of fundamental fairness and the doctrine
of equitable tolling provide bankruptcy courts with the authority and flexibility to make
appropriate exceptions to this otherwise harsh rule. In light of the Supreme Court's
decision in Young, it appears that the minority view cases had it right all along.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> The views expressed in this article do not necessarily reflect the views of the Department of Justice or the United States of
America. Portions of this article were drawn from briefs of the United States filed in federal courts. <a href="#1a">Return to article</a>

<a name="2">2</a> It is widely held that the discharge of a claim without reasonable notice is violative of the <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Amendment. See Reliable
Elec. Co. v. Olson Constr. Co., 726 F.2d 620, 623 (10th Cir. 1984)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Avery, 134 B.R. 447,
448 (Bankr. N.D. Ga. 1991)</a>. In chapter 13, courts have held that a claim cannot be considered to have been "provided for
by the plan" if a creditor does not receive proper notice of the proceedings. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… States v. Hairopolous (In re Hairopolous), 118
F.3d 1240 (8th Cir. 1997)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Cash, 51 B.R. 927, 929 (Bankr. N.D. Ala. 1985)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §501</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> F.R.P.B. 3002(c). <a href="#4a">Return to article</a>

<a name="5">5</a> Compare Rule 9006(b)(3), <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. with In re Miranda, 269 B.R. 737, 740 (Bankr. S.D. Texas 2001)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. 9006(b)(1)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Nyeste, 273 B.R. 148 (Bankr. S.D. Ohio 2001)</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> Of course, an enlargement of the time within which to file a proof of claim may be granted if the request is made before the
filing deadline. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. 9006(b)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Bennett, 278 B.R. 764, 766 (Bankr. M.D. Tenn. 2001)</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. 287, 293 (Bankr. M.D. Tenn. 2001)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re McQueen, 228 B.R. 408 (Bankr. M.D. Tenn. 1998)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… B.R. at 291</a>. See, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Smith, 217 B.R. 567 (Bankr. E.D. Ark. 1998)</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Armbrecht, 327 U.S. 392, 397 (1946)</a>. <a href="#13a">Return to article</a>

<a name="13">13</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re United Insurance Management Inc., 14 F.3d 1380, 1386 (9th Cir. 1994)</a>. <a href="#14a">Return to article</a>

<a name="14">14</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 122 S.Ct. at 1040</a> (citations omitted). <a href="#15a">Return to article</a>

Journal Authors

Robert Coulter

Journal Date

Sunday, September 1, 2002 - 12:00

Bankruptcy Rule

2002