A district judge in Houston announced a liberal reading of an already liberal rule in the Fifth Circuit allowing an informal proof of claim when the creditor has failed to file a formal claim by the bar date. Ironically, documents filed by the debtor sufficed as informal proofs of claim on behalf of the creditors.
The result is perhaps not surprising, because the debtor continued litigating the claims long after the bar date had passed, without even hinting it would later contend that the claims were untimely and should be expunged. The equities tilted in favor of the creditors because only the debtor’s insiders would have benefitted by disallowance of the claims, thus undercutting the precedential value of the decision in other cases.
Still, the opinion throws a lifeline to creditors who are actively litigating in or outside of bankruptcy court but forget to file timely proofs of claim. The lifeline only extends to situations where the claims in state court have been recited in filings with the bankruptcy court.
There were two creditors in the same boat for not having filed timely, formal proofs of claim. Here’s the background:
Creditor A had a suit pending in state court for more than 10 years claiming unpaid royalties on an oil and gas lease. The corporate debtor was joined as a defendant seven years before bankruptcy. The state court found the debtor liable and was on the cusp of fixing the amount of damages when the debtor filed chapter 11. Creditor A alleged that bankruptcy was designed to prevent the entry of judgment.
A few days after the chapter 11 filing, the debtor removed the suit from state court to the bankruptcy court. The notice of removal appended all of the pleadings from state court.
On motion by creditor A, the bankruptcy court remanded the suit to state court and partially modified the stay. With the debtor still litigating, the state court entered a $1.3 million judgment in favor of the debtor about one year after the bar date. Although represented by counsel, creditor A had not filed a formal proof of claim before or after the bar date.
Creditor B sued the debtor in state court three years before the chapter 11 filing, also claiming unpaid royalties. The debtor likewise removed the suit to bankruptcy court, again appending the entire record from state court. With the debtor continuing to litigate, the bankruptcy court entered summary judgment in favor of creditor B seven months after the bar date.
The debtor had scheduled creditors A and B with disputed claims.
Shortly before approval of the disclosure statement, the creditors evidently discovered their mistakes and filed a motion for various filings to be treated as informal proofs of claim.
Bankruptcy Judge Marvin Isgur of Houston recognized the filings in bankruptcy court as informal proofs of claim, but he ruled that they would not have prima facie validity because they were incomplete.
The debtor appealed, but District Judge Sim Lake of Houston upheld Judge Isgur on June 14, citing Nikoloutsos v. Nikoloutsos (In re Nikoloutsos), 199 F.3d 233 (5th Cir. 2000), as governing Fifth Circuit authority.
Judge Lake said that the facts fit within the five-part test in Nikoloutsos for recognition of an informal claim.
First, the notices of removal and their exhibits indisputably were in writing.
Second, the pleadings from state court, which were filed in bankruptcy court along with the notices of removal, contained “demands on the debtor’s estate.” Judge Lake said that the lack of a demand for a specific amount of damages was “not fatal to their being considered as informal proofs of claim.”
Third, the pleadings filed in bankruptcy court by the debtor showed the creditors’ intent to hold the debtor liable.
Fourth, Judge Lake said that the notices of removal were sufficient to satisfy the requirement of filings with the bankruptcy court.
Fifth and last, Judge Lake said that the bankruptcy judge did not abuse his discretion in finding that the recognition of informal proofs of claim was equitable.
By analogy to Nikoloutsos, recognizing the informal claims was equitable because the debtor filed bankruptcy to avoid paying a judgment. Furthermore, creditors A and B were the debtor’s only non-insider creditors. Given that one of the creditors had a $1.3 million judgment, disallowing the claims would be “extremely harsh,” Judge Lake said.
Waiver or estoppel might have contributed to the same result, because the debtor had continued litigating the merits long after the bar date. The issue was not raised in the briefs, so Judge Lake had nothing to say on the topic of waiver or estoppel.