(Reprinted with permission from the ABI Journal, Vol. XXXI, No. 10, November 2012.)
By Henry E. Hildebrand III, Office of the Chapter 13 Trustee, Nashville, Tennessee
The duties imposed upon all bankruptcy trustees are significant and stem from statute, from rule, and from the common law of fiduciaries, whether the cases are under chapter 7, chapter 11 or chapter 13. These duties are assumed by all trustees in varying degrees, but the nature of these duties may depend upon the chapter under which the case is filed. Clearly, the principal responsibility of a chapter 7 trustee is to convert property of the estate into cash1, although the statute outlines other responsibilities of equal import. Among those other responsibilities is the requirement that chapter 7 trustees examine all proofs of claim and, where a purpose would be served, object to inappropriate proofs of claim.
For a chapter 7 trustee, the question of whether a purpose would be served in contesting a claim is often based on whether there is to be any distribution to unsecured creditors: if no distribution is anticipated, then clearly no purpose would be served by challenging a claim in a chapter 7 case2.
Although a chapter 13 trustee does not have the same obligation of a chapter 7 trustee to convert property of the estate into cash, a chapter 13 trustee shares with the chapter 7 trustee the statutory responsibility of reviewing and contesting claims filed in a chapter 13 case where a purpose would be served3. In a chapter 13 case, this statutory duty is more important.
Unlike the situation faced by a chapter 7 trustee, chapter 13 cases often result in some distribution to unsecured creditors, even when the distribution is very low. When a claim subjected to challenge is a secured claim, then disallowance or re-characterization of the claim can result in a substantial benefit to other creditors.
For several decades, much discussion has revolved around the growing abuse of the bankruptcy system by consumer debtors. Initially § 707 was enacted to stem the “substantial abuse” of debtors seeking a discharge of debts when need was not apparent. Now, after BAPCPA, the stated purpose of the section is to stem simple “abuse.” The abuses sought to be curtailed by the “means test” and the remaining provisions of § 707 are, however, abuses by debtors only.
Recently, however, there has been heightened scrutiny of claims asserted by putative creditors. Many creditors attempt to file proofs of claim without documentation or support for the claim, relying on the statutory presumption that a filed claim is an allowed claim4. Increasingly, chapter 13 trustees started carefully examining proofs of claim to determine whether the putative claimant establishes a right to payment and whether the claimant has standing to assert the claim. This effort, however, is not undertaken by all chapter 13 trustees. In fact, many chapter 13 trustees, believing that the task of objecting to claims more properly belongs to a debtor, have resisted and only reluctantly embraced the obligations of § 704(a)(5).
Chapter 13 debtors, too, have something to fear if a creditor asserts a defective claim. Chapter 7 debtors, content to continue paying secured claims as long as they can continue to possess and use the property that serves as collateral, fear that if the claim or lien is defective, the chapter 7 trustee will sell their property—not the intended result. Chapter 13 debtors, seeking to pay only minimal amounts to unsecured creditors, are similarly content to pay car and house notes as long as they do not have to account for the value of the property they intend to keep in paying their unsecured creditors5. Debtors often propose chapter 13 plans proposing to pay secured claims directly. In doing so, they hope to avoid any scrutiny by the standing trustee of the standing or enforceability of any security interest. Secured creditors are only too happy to accommodate these debtors, and many elect to simply forgo the filing of the claim, even though a failure to file a proof of claim may prevent a secured creditor from receiving distributions under a plan6. After all, if no claim is filed, no trustee can contest it and the debtor will still be making the payments, irrespective of enforceability and the standing of the creditor to file a claim.
Many claims filed by secured creditors lack documentary support as contemplated by the Rules Committee when it adopted Rule 3001(c) and (d)7. Courts have often applied the doctrine of estoppel in curtailing the ability of a debtor to contest a filed claim that was scheduled, noting that it is disingenuous for a debtor to schedule an obligation to a creditor and then contest the allowance of that obligation because the proof of claim lacks full documentation. The estoppel impediment, however, does not and should not apply to chapter 13 trustees. If we assume that a trustee’s responsibility includes the obligation to maximize recovery to unsecured creditors, then the trustee should contest the allowance of all claims where there is inadequate documentation provided by the creditor to establish the validity of the claim.
Courts have generally looked to chapter 13 trustees to carefully examine claims. A chapter 13 trustee is required to fully examine attachments submitted with a proof of claim and if the claim is not clear, the trustee has an obligation to object to the allowance of the claim8. “[I]f the attachments to [a creditor’s] proof of claim did not inform the trustee of the amount and classification of the claim, the trustee should have objected to the proof of claim.”9 Similarly, a chapter 13 trustee should challenge the allowance of a claim when a creditor had abandoned its claim rights and had refused to accept payments on the claim from the chapter 13 trustee.10 By doing so, the trustee increases the distribution to creditors with allowed claims who intend to, and actually do, pursue their claims.
Chapter 13 trustees bear a responsibility to make certain that creditors who do not hold valid secured claims are not treated in a confirmed plan as secured creditors. Invalid but uncontested secured claims divest other creditors of the distributions to which they might be entitled. For example, a chapter 13 trustee should pursue lien avoidances under 11 U.S.C. § 522(f) because the trustee has an obligation to prevent an unsecured claim from being treated as a secured claim. And it is no answer to assume that the responsibility to police defective claims should be regulated to the debtors’ duties. “It is extremely important to recognize that a debtor may have little or no motivation to file a motion to avoid a non-purchase-money security interest. Because of the disposable income test found in § 1325(b), the monies that would otherwise be paid to the secured creditor which are released as a result of the avoided lien, are not retained by the debtor but are made available to the trustee for distribution to all of the debtor’s unsecured creditors.”11
When a secured bankruptcy claim is filed without documentation adequate to demonstrate the existence of a valid, enforceable security interest, the trustee has an obligation to challenge both the classification and status of the claim. Whether the challenge to the allowance of a claim arises from an objection or from some other form of litigation, “if the holder of that claim has not complied with the requirements of [Rule 3001], the Court may preclude it from presenting any of the omitted information.”12 That result makes the enforcement of the claim problematic. And challenging an incomplete claim is uniquely a trustee’s fight. In most cases, a debtor will be estopped from pursuing the same type of challenge because the debtor had scheduled the obligation.13
When a trustee challenges a secured creditor’s right to be treated as a secured creditor because its proof of claim fails to establish the existence of a perfected security interest by the creditor, or where the creditor has failed to establish its standing to pursue a lien or claim, that trustee is preserving property of the estate—the debtor’s income—for the benefit of creditors holding allowed and uncontested claims.
By holding creditors to the simple task of proving their basic claims, equity and fairness can be maintained in chapter 13 cases. It might be helpful to further the equity and fairness of the system if all creditors would be obligated to file proofs of claim, allowing just scrutiny of their claims. That, however, is a decision left to the Bankruptcy Rules Committee.
The chapter 13 trustee plays a vital role and has a critical responsibility in “assuring that only proper claims are allowed and paid from the debtor’s estate.” 14 Because so many claims asserted by secured creditors, and mortgage servicers in particular, lack the appropriate documentation to demonstrate that the mortgage servicers (or mortgage “nominees” or holders of notes) have standing to enforce the note,15 and because the chapter 13 debtor lacks both the inclination and the ability to contest the allowance of the claims, it falls to the chapter 13 trustee to assume the responsibility of contesting defective claims, preserving the integrity of the bankruptcy system, and assuring for the benefit of all other creditors that the operation of the bankruptcy system will fairly and equitably distribute available assets or income to creditors.16
The burdens imposed on chapter 13 trustees have substantially increased since the enactment of BAPCPA. This burden is now compounded by adding the challenge of wading through the complex, confusing and incomplete claims of mortgage servicers (or mortgage nominees, and mortgage sub-servicers). Despite this burden, however, it is the chapter 13 trustee who is in the best position to effectively challenge defective claims for the benefit of the system. Trustees should all do so.
1 11 U.S.C. § 704(1).
2 See In re Miranda, 269 B.R. 737 (Bankr. S.D. Tex., 2001).
3 Section 704(a)(5) is incorporated into the obligations of a chapter 13 trustee in accordance with 11 U.S.C. § 1302(b)(1).
4 See § 501.
5 See 11 U.S.C. § 1325(a)(4).
6 See In re Falwell, 424 B.R. 779 (Bankr. W.D. Va., 2009).
7 Subsections (b) and (c) of Rule 3001 clearly contemplate that secured creditors will file proofs of claim and will document their right to do so, along with their right to assert a security interest in property of the debtor or property of the estate.
8 See In re Avery, 272 B.R. 718 (Bankr. E.D. Ca., 2002).
9 See Avery at 724.
10 See In re Lee, 189 B.R. 692 (Bankr. M.D. Tenn., 1995).
11 See In re Kennedy, 139 B.R. 389, 391 (Bankr. N.D. Miss., 1992).
12 See In re Reynolds, 470 B.R. 138 (Bankr. D. Col., 2012).
13 See In re Reynolds at 132.
14 See In re Hess, 404 B.R. 747 (Bankr. S.D. N.Y., 2009).
15 See In re Veal, 450 B.R. 897 (9th Cir. BAP, 2011).
16 See Keith M. Lundin and William N. Brown, Chapter 13 Bankruptcy, 4th Edition, 621, at ¶.5, sec. rev. April 30, 2004. www.ch13online.com.