1 17: Unsecured Claims -- definition © Charles Tabb 2010

2 Why “claim” matters (1) Only a claim may get paid in bankruptcy distribution – See O’Connor concurrence in Kovacs This was the issue in Piper Note must also be “allowed”

3 Why claim matters (2) Only a claim may be discharged This was the issue in Kovacs, also in Jones v Chemetron

4 Why claim matters (3) Holder of a claim is stayed from collecting during bankruptcy See this at issue in the Robins and in other proceedings in Kovacs (see footnote 2)

5 Impact of “claim” - individual For a DR who is a human being, if = “claim” then – Is discharged and – Stayed  facilitates Dr’s “fresh start”

6 Impact “no claim” – individual DR But if “no claim”, then – Not discharged AND – Not stayed AND – Not paid any $ in bk distribution  So the CR can pursue DR fully to collect debt

7 Impact of “claim” – corporate DR, ch. 7 Cr shares in bk distribution If held ≠ “claim” then CR is out of luck – Corporate DR ceases to exist after bk liquidation, so who cares that not “discharged” – So the bankruptcy is the ONLY possible source of money – Justice O’Connor made this point in Kovacs

8 Impact of “claim”: corporate DR, ch. 11 Now CR is thrilled if “no claim” – Not stayed – Not discharged by terms of plan – Can collect full amount vs. reorganized DR

9 Policy decision 1978 Expand scope of “claim” Prior law – was more restricted – Had to be “provable” – eliminated many contingent, unliquidated claims from the bk case 1978 change: bring in EVERYTHING as of date of bk petition

10 Legislative history “all legal obligations of the DR, no matter how remote or contingent, will be able to be dealt with in the bankruptcy. It permits the broadest possible relief.”

11 Consistent with approach to “property” Goal – complete resolution of DR’s finanical past  ALL property, ALL claims, as of date of bankruptcy, sort out in the bk case

12 Code definition 1 st : “right to payment” (Flip side of debt) – § 101(5), (A) & (B) – So at minimum the Cr must have some potential possible right to get paid $ by Dr – Look to state law to decide this Consistent with “property of estate” approach Take non-bk law re: claims and property as find it

13 Right to payment”? example Assume that I call on you in class, and ask you a question, and you give an incorrect answer. I say, “sorry, that is the wrong answer.” I then file bankruptcy Do you have a “claim” vs. me? – Only if state law says that me telling you that you had the wrong answer = cause of action, which is very unlikely!

14 Unliquidated? What if I crash into your car, but before you can get a judgment vs. me, I file bankruptcy? Do you have a “claim”? – Sure – your cause of action arose prior to bk filing Fact has not yet been liquidated does not matter Is part of my financial past

15 Disputed? What if I dispute your claim – say it was your fault? You still have a “claim” Part of my financial past The Bk ct will sort this contested claim out

16 Contingent? Example: guarantee DR CR Guarantor -- G has contingent reimbursement claim against DR: that is, IF Dr does NOT pay CR, and G has to pay CR, then G’s can go against Dr for reimbursement (the purple arrow)

17 Unmatured? CR holds Dr’s promissory note, due in 2011 Dr files bankruptcy 2010 Cr has “claim” vs DR, even though “unmatured”  The DR issued the note to the Cr prior to Bk – so was part of Dr’s pre-bk financial past

18 Equitable remedy? What if Cr has an equitable remedy vs. DR, but under state law it would be possible for that remedy to be satisfied in alternative by payment of $? Then has a “claim” – See 101(5)(B)  Difficult Q in environmental cleanup orders, see, e.g., Kovacs

19 Estimation role Code gives bankruptcy court the express power to estimate the amount of claims if it would delay the bankruptcy case to fix otherwise § 502(c)

20 Timing problems Accelerating all possible rights to payment against DR that have roots in pre-bk past to the date of the bk petition may be tricky when that payment right is not fully realized until AFTER Bk Some stuff happensfull payment right

21 Robins Robins conduct (manufacture, distribute Dalkon Shield; knew dangerous) Rebecca Grady uses defective product Robins files chapter 11 Grady manifests symptoms, discovery of injury – under state law, right to sue in tort cognizable Grady sues Robins

22 Why matters If Rebecca Grady ≠ “claim”: – NOT stayed – Can proceed with lawsuit vs Robins – If gets judgment can collect vs Robins – Not limited by or bound by terms of any plan  Grady would be better off than other CRs  Would make very difficult for Robins to put together workable plan to deal with mass tort debt

23 Example of Grady vs other Crs Robins filed ch 11 on August 21, 1985. Assume 2 injured parties, Grady and Jane Doe Everything about Grady and Doe identical – Robins same conduct – Bought & used Dalkon shield same time Doe discover injury August 20, Grady Aug. 21  If Grady ≠ “claim” she will be treated better than Jane Doe * No Q that Doe has “claim”

24 When does claim arise? Issue: when does bankruptcy “claim” arise? Possibilities: – DR (Robins) conduct (manufacture, distribute defective product) – Victim exposed (Grady uses defective product) – Victim manifests injury, so has state law cause of action

25 “accrued state law” test? Grady argued for last option – that she did not have a bk “claim” until she had a right to sue under state law – Which was when she discovered injury Which was post-filing Argues that this approach properly defers to the state law that creates the “right to payment” in the 1 st place

26 Frenville Facts: – Dr hire A & B accounting firm to prepare financials – A & B acts – gives financials to banks – DR files bk – Banks sue A & B Under state law, this is when A & B has action vs. DR – A & B alleges “claim” vs DR for indemnification  3 rd Circuit held ≠ claim * No ‘claim’ until could sue under state law

27 wrong Frenville’s accrued state law approach has been universally panned as wrong. Why?

28 Is this like “wrong answer” hypo? Remember the hypo about whether you have a claim vs me because I told you that you gave the wrong answer We said have to look to state law to decide if have claim  Is this same or different?

29 State/federal  what/when Raises Q of what it is we defer to state law for in making the “claim” determination Identical issue AND resolution as for “property of estate”  Look to STATE law to determine if these acts = a right to payment. i.e., the what  BUT look to FEDERAL bankruptcy law to fix the when

30 Apply state/federal If telling you that you gave a wrong answer is simply not actionable under state law, then nothing about being in a federal bankruptcy case makes it a “claim” -- you just do not have a right to payment at all

31 Robins application So, too, in Robins, if under state law it just is not actionable to manufacture and distribute defective products that cause personal injury, then nothing about bankruptcy changes that result BUT if under state law it IS actionable, then we must turn to federal bk law to determine WHEN that claim arises

32 Applying federal timing Courts then look to the congressional goal of having the “broadest possible” scope of “claims” Including unliquidated, unmatured, contingent, disputed. What is the basis for establishing the date a tort claim can be brought (when there is a claim) under state law? – The basis is the statute of limitations: don’t’ want the statute to start running until the injured party has the opportunity to discover the injury.

33 accelerate In bankruptcy must “accelerate” all claims down to date of bankruptcy filing, even if no present right to sue under state law

34 Examples how state law timing fails Thinking of this “acceleration” point, and the language of Code § 101(5), see that cannot have deference to state law timing rules – Under state law, could not sue on an unmatured debt prior to the date of maturity – Ditto a contingent claim, prior to occurrence of contingency  Yet clear under § 101(5) that DO have bk claim

35 Holding Robins 4 th Circuit holds that Grady DOES have a “claim” as of date of bankruptcy filing Said she had a “contingent” claim – with contingency being manifestation of injury

36 “conduct” or “exposure”? So 4 th Circuit rejected the “accrued state law” theory for time of claim What did they use as test? – Robins’ conduct (manufacture, distribute defective product) OR – Victim’s exposure to the defective product  Said “when the acts constituting the tort … have occurred”

37 Robins: facts = “exposure” On the facts in Robins, Rebecca Grady WAS exposed to the defective product prior to the bankruptcy filing, so court did not have to decide whether there would be a claim if the bk filing came after the DR’s conduct but before the victim’s exposure. Here, it was: – Conduct – Exposure – Bankruptcy ConductBkptcyExposure

38 Effect of Robins holding Rebecca Grady has “claim” Cannot sue Robins outside of bankruptcy case and collect Instead will participate IN the bankruptcy case – File a proof of claim – Vote on plan – Be paid pursuant to bankruptcy plan  Channeling function (i.e., get all pre-bankruptcy claims into the case to deal with Dr’s entire pre-B financial history).

39 Piper The Q of whether a bk claim arises when the Dr commits an act, i.e., conduct, or not until the Cr has been exposed, was squarely raised in Piper Aircraft case: Piper conduct (manufacture, sell defective planes) Bankruptcy filing Exposure: Victims in plane, which crashes

40 Piper

41 Why matters Epstein as representative of class of “future claimants” filed $100MM proof of claim in the bankruptcy If allowed, then: – Future Claims class could vote on plan – FC class would share in distribution under plan – FC claims would be discharged by the confirmation of the plan

42 Held no claim 11 th Circuit held: NO CLAIM Rationale: the specific future claimants had not yet been identified; indeed, by definition were unidentifiable – Could be anyone in the world!  No prepetition relationship with Piper

43 Test: “relationship” Court required BOTH (1)Prepetition conduct by DR AND (2) a relationship between claimant and DR: – E.g., Contact, exposure, impact, or privity-when? – TIMING: prior to confirmation of plan Would be able to identify the particular claimant for purposes of the bankruptcy case

44 ramifications By holding that future claimants do NOT have a claim, Piper court is making it very difficult to deal with mass tort cases in fair way EITHER – Future claimants get windfall -> recover in full vs reorganized DR, whereas prior claimants get % OR – Future claimants get nothing – pot of $ all gone

45 Any way to deal with future claims? Piper court held could not have a “claim” if did not know the specific ID of claimant in time to deal with in the bankruptcy case – Said it can’t be “anyone in the world” Is that right? Any solutions?

46 What about a “class” with a rep? Would it be possible to do what was tried (but rejected) in Piper: – create a “class” of future claimants – Appoint a fiduciary to represent the interests of the class in the bankruptcy case – Estimate $ of claims – epidemiological stats Claim Future CLASS: $100 MM

47 Collective? Would this facilitate the collective action goal of bankruptcy?CR CRCR Future CLASS: $100 MM

48 What about Due Process? Jones v. Chemetron case pointed out due process violation if discharge claims of persons with no notice of or opportunity to participate in bankruptcy case, in which their rights are altered But wouldn’t class rep model possibly allay DP concerns?

49 Timing issue in environmental cases The claim timing problem has arisen in pollution cases Facts: – DR pollutes – BK filed – Govt finds out  Issue – does govt have claim for cleanup?

50 “fair contemplation” Similar problem to Piper – DR has committed acts giving rise to liability – But claimant doesn’t yet know  Courts have adopted similar “you’ve got to know” idea here as well  Sometimes called “fair contemplation” test

51 Kovacs: Cleanup orders as “claims” a huge Q has been whether an injunctive order directing the Dr to clean up polluted property = “claim” Why matters? – Dr hopes to discharge the cleanup obligation

52 Kovacs Facts: – Dr Wm Kovacs CEO of polluting company – State of Ohio – consent decree ordering cleanup – Not comply – State had receiver appointed – DR filed Bk

53 issue Issue in Kovacs: was the cleanup obligation = “claim”? If so, was dischargeable in Kovacs’ chapter 7

54 statute Definition of claim: can be an equitable remedy (including a cleanup order) IF also gives rise to a “right to payment” § 101(5)(B)

55 difficulty The problem the courts have had in the environmental cleanup cases has been determining what the linkage must be between the equitable remedy and the “right to payment”

56 Kovacs – practical reality The Supreme Court in Kovacs found = “claim” How? – Dr could not clean up if he wanted to b/c had been replaced by a receiver – All the state wanted from him was $

57 Not deciding Kovacs Court made clear was NOT holding: – No protection from criminal prosecution – Not discharge if “fine or penalty” – Dr cannot keep polluting

58 O’Connor concurrence Justice O’Connor pointed out how decision not necessarily bad for govt: – Could fix “LIEN” on DR’s property for cleanup obligation Under Butner the state law property rights would be honored – Might need a claim to get paid anything If corporate DR, liquidating under chapter 7

59 Other approaches How have other courts dealt with the environmental case where facts are: – Dr pollutes – Cleanup order issued – DR files bankruptcy

60 If DR still operating, must clean up 1 st – if the Dr is continuing its operations and is in possession of the site – Must clean up – Ongoing obligation to obey the law – Which includes complying with cleanup orders

61 Can government choose to take $ instead? One factor – does law allow the govt to opt to take $ from DR in lieu of forcing the DR to clean up itself? – That is, can DR effectively ‘buy off” the cleanup obligation? If so, then = “claim”

62 Prevailing approach: dual purpose Most courts hold that if cleanup order has dual purpose of (i) cleaning up prior pollution AND (ii) ameliorating ongoing pollution, ≠ claim Under this view almost all cleanup orders ≠ claim

63 What if government DOES clean up? What happens if govt does come in and clean up pollution, then sues DR for reimbursement?  Obviously = claim * Right to payment – to be reimbursed for cleanup expenses

64 Incentives? Think about incentives if have rule that (i) govt has claim (which then can be discharged) if steps in and clean up but (ii) does NOT have claim (and thus is not dischargeable in bankruptcy) if does not clean up, but tries to get DR (or trustee) to do so  Incentive for govt NOT to clean up itself

65 Problem 5.1 Debtor employed (salary = $40,000) by Employer, Inc. (EI). Debtor’s employment contract contained a covenant not to compete after termination of the contract for one year within thirty miles. Under state law such a covenant would be considered reasonable and thus enforceable. State law would allow EI to enforce the noncompete covenant by a negative injunction. The employment contract provided that EI also was entitled to liquidated damages of $5,000 if Debtor breached the contract and left EI’s employment prior to the expiration of the contractual term. Debtor received offer from Competitor, Inc. (CI) at a salary of $75,000 a year. CI is located within the prohibited 30-mile radius under the noncompete clause. Debtor has six months remaining on her contract with EI. Debtor has unsecured debts of $33,000.  Debtor wants to know if she can file chapter 7 and thereby discharge EI’s right to enforce the noncompete covenant by negative injunction, thus freeing her up to take the more lucrative job immediately

66 issue Issue is whether under 101(5)(B) the equitable remedy (injunction to enforce non-compete clause) is a “claim” because there is a “right to payment”

67 held 7 th circuit held ≠ claim The injunctive right itself has to be compensable in $

68 Note fresh start problem Case like 5.1 could implicate fresh start policy