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The Case for Establishing Claim Objection Procedures

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Most chapter 11 debtors do not commence a meaningful claims-resolution process until after confirmation of a chapter 11 plan. Yet the benefits to a debtor of establishing its own procedures for resolving claims early are significant: Not only do they have a positive impact on the feasibility of a reorganization plan, but they also reduce the post-emergence costs for the debtors. In a competitive world, the claims-objection process offers one area where efficiencies and the introduction of procedures translate into considerable savings for the client and a competitive edge for the advisors. This article discusses the benefits of establishing claim-objection procedures early, as well as how to establish an effective claims-resolution process.

Benefits of Establishing Claim-Objection Procedures

By establishing claim-objection procedures early in a case and resolving even the most material claims pre-confirmation, particularly in light of the new deadlines imposed under the amendments to the Bankruptcy Code, the debtor reaps several benefits:

  1. A debtor may increase the likelihood of proposing a confirmable plan within the first 18 months of a case by establishing procedures for resolving claims, including material claims, on an expedited basis. When engaging in plan negotiations with creditor constituencies, creditors want access to a recovery analysis that includes estimates of allowed claims. The more claims that have been resolved and converted to allowed claims before the recovery analysis is completed and shared with creditors, the more meaningful the plan negotiations. In addition, this reduces the uncertainty surrounding the "downside" to claims and, consequently, helps all of the constituencies to evaluate the various reorganization plan options.
  2. Not only will a strong claims-resolution process established early on in the case create an advantage for the debtor from an optical standpoint, but it may help prevent the need for the debtor to develop and sell a complicated claims reserve under a plan.
  3. Establishing claims-resolution procedures specifically tailored to the debtor and the types of claims asserted against the estates will ensure that material litigation claims can be resolved during the chapter 11 case—preventing protracted and costly post-confirmation litigation.
  4. Perhaps most importantly, it is easier for a debtor to analyze, reconcile and resolve claims while employees with relevant knowledge are still employed by the debtor. Inevitably, many of the employees with important knowledge concerning contested claims have moved on by the end of a chapter 11 case, making it that much more difficult and costly to litigate contested claims.
  5. By establishing a clear process for resolving proofs of claim supported by the bankruptcy judge and the committee, the debtor can provide creditors and parties in interest with a useful roadmap for how the claims will be resolved while maintaining control over the process.
  6. Finally, early claims resolution allows for prompt payouts to creditors and provides them with an opportunity to liquidate their claims in a timely manner. In addition to reducing the post-emergence costs of the debtor, this reduces the need for a post-effective date committee to monitor the resolution process.

Establishing Effective Claims-Resolution Procedures

While the benefits of establishing claims-resolution procedures early are clear, what is not so easy is determining how to establish those procedures. The key to any successful claims resolution is to develop a process that is unique to the particular case and educate creditors and other parties in interest about how it will work.

The applicable provisions of the Code and Rules do not set forth any specific process for objecting to claims, and no new provisions have been added to the Code to address this. While some jurisdictions have adopted procedures for objecting to claims, the great majority of jurisdictions have not established any procedures. That a particular jurisdiction has not adopted claims-resolution procedures should not be of too much concern for a debtor. In fact, the lack of established procedures in a jurisdiction can provide the debtor with an opportunity to create its own procedures that fit the specific needs of the debtor and help the debtor avoid the pitfalls associated with uncertainties and any adverse authority in other jurisdictions.

Before developing claim-objection procedures, a debtor should conduct research and be aware of the due process requirements built into the Federal Rules of Bankruptcy Procedure. For example, Rule 3007 of the Federal Rules of Bankruptcy Procedure requires that a claimant be given at least 30 days to respond to a claim objection. Accordingly, proposed procedures should provide that claimants have no less than 30 days to respond to a claim objection.

Another due process provision of the Bankruptcy Rules, Rule 7004 (which incorporates Rule 4 of the Federal Rules of Civil Procedure), could be read to require service of a claim objection upon an officer of the company. Fed. R. Bankr. P. 7004(b)(3) provides, in pertinent part: "Service may be made...as follows... Upon a domestic or foreign corporation...by mailing a copy of the summons and complaint to the attention of an officer, a managing or general agent, or to any other agent authorized by appointment...to receive service of process." Not all proofs of claim are signed by an officer, and most debtors would prefer to serve claim objections upon any counsel of record and the party who signed the proof of claim. While Rule 7004 could be read to require service of an objection to a claim on an officer or agent
of the company, that portion of Rule 7004(b)(3) quoted above could also reasonably be read to allow for service upon the "authorized agent" who signed the proof of claim. While the better view is that the individual who signed the proof of claim is the "agent" appointed on behalf of the creditor to resolve the claim, the best practice is to build a provision into your claim-objection procedures providing that the debtor need only serve the claim objection upon the individual who signed the proof of claim and any counsel who filed an appearance in the case on behalf of the creditor.

Finally, drafters of claim-objection procedures should be aware of the case law holding that a claim objection is akin to an answer to a complaint.1 Such case law is relevant for purposes of establishing whether the bankruptcy court would be willing to adopt the reading of Rule 7004 described above; a court that adopts the view that a claim objection is akin to answering a complaint may be more willing to adopt the view that a claim objection need only be served on the party who filed the proof of claim. Whether the court views a claim objection as an answer to a complaint is also relevant to whether the creditor should be required to respond to the claim objection. Nothing in the Code or Federal Rules of Bankruptcy Procedure requires a claimant to respond to a claim objection. Regardless, claim-objection procedures drafted by a debtor should always require a creditor to file a formal response to a claim objection.

In In re Mirant Corp., the debtors developed procedures2 for objecting to omnibus proofs of claim because the jurisdiction in which the case was pending did not have established procedures for filing omnibus objections. The proofs of claim filed against Mirant could be divided into four groups: (1) duplicate and subsequently amended claims; (2) misclassified claims, protective rejection damage claims and claims that did not match the debtor's books and records; (3) claims that were based on the ownership of equity securities; and (4) contested material claims that were certain to be litigated. Given that pool of claims, Mirant proposed to assert omnibus claim objections in four waves or "Tiers." Tier I included duplicate claims or claims that were later amended or superceded claims. Tier II included claims that were based on ownership of equity securities. Tier III, for which the bankruptcy court gave the debtor's substantial discretion to resolve without the utilization of significant court time, included claims that did not agree with the debtor's books and records, or "protective" rejection damage or tax claims filed by parties anticipating the debtor's rejection of an executory contract or an estimated tax that would accrue. Finally, Tier IV claims included material disputed claims that were likely to be litigated. The debtor filed a motion for approval of the claim-objection procedures only after fully vetting the proposed procedures with the committees and court during a lengthy status conference. These tiers were specific to Mirant, but other types of cases might have a separate tier for personal injury, litigation or customer claims.

Even if the debtor's case is pending in a jurisdiction in which claims-resolution procedures have been adopted, a debtor should not hesitate to propose alternative procedures if the adopted procedures do not meet the needs to the debtor or creditor body in that specific case. An example of this might be to adopt formal alternative dispute resolution procedures if the debtor has numerous personal-injury-type claims. This would allow for expedited resolution of claims that usually have a longer resolution timeline.

With respect to timing, a debtor should propose claims-resolution procedures (modifications/exemptions to existing procedures) at the same time it moves for the establishment of a bar date. This will ensure that the debtor has enough time to implement the procedures in a meaningful way pre-confirmation.

Implementing Procedures

Once the claims-resolution procedures have been established, the debtor should determine the appropriate sequencing for the claims-resolution process. Most chapter 11 debtors object to and resolve misclassified claims pre-confirmation. But there is no reason why a debtor should not attempt to resolve duplicate, misclassified and even material claims, pre-confirmation.

Tracking Claim Objections with Estimation

Depending on the size of the case and the volume of material litigation claims, a debtor should consider requesting that the court establish expedited procedures for resolving material claims that could impact creditor recoveries. Such expedited material claims-resolution procedures could include a provision that the court will estimate any material claim that is not resolved within a specified period of time (generally three months) under §502(c) of the Code for all purposes, including distribution. Obtaining an order of the court directing that unresolved material claims will be estimated pre-confirmation can serve to motivate the parties to settle or diligently pursue litigation of material claims.

Tracking Claim Objections with Avoidance Action Review

Claim-objection settlements often include general releases, including releases of chapter 5 actions. Thus, a debtor should not begin implementing a claims-resolution process aimed at forcing settlements with creditors before knowing whether colorable chapter 5 claims exist against each settling creditor. A debtor's claims-resolution and avoidance-action analysis teams often overlap. Before the bar date passes, that team can both focus on developing claim-objection procedures and analyzing the debtor's pre-petition transactions to establish a preliminary list of avoidance-action targets. Commencing an avoidance-action review early on in the case will help prevent waivers of chapter 5 actions that were not bargained for in the claim-objection settlement negotiations. Moreover, the avoidance action review again will be much easier at the beginning of a case when employees with relevant knowledge are still employed by the debtor.

Conclusion

If little or no claims-resolution work has been completed during the pendency of a case, it often comes as a shock to debtor management that they have additional post-emergence costs associated with claims resolution in addition to any required distributions. In addition, creditors are often confused and upset to find out that their distribution may take months or years because claims resolution isn't complete. Many times, the creditors will request that a post-emergence committee monitor the claims-resolution process. The new company also traditionally pays for this committee. Depending on the size of the case and the complexity of the claims, this cost may be substantial. Another benefit of resolving claims early is that the debtor eliminates the need for costly temporary allowance litigation, which serves as a band-aid to get a debtor through confirmation, but is not a permanent fix. Resolved claim objections don't traditionally require additional litigation barring an appeal. For most debtors, this cost is considered a "restructuring" cost during the course of the case, but is considered an operating expense post-emergence. For many debtors, these are costs that were not contemplated when developing a business plan or post-emergence budget.

As bankruptcy practices evolve, additional focus on efficient administration of cases will be required to achieve a successful outcome.


Footnotes

1 See O'Neill v. Continental Airlines (Matter of Continental Airlines), 928 F.2d 127, 129 (5th Cir. 1991) ("the filing of a proof of claim is analogous to the filing of a complaint in a civil action, with the bankrupt's objection the same as the answer"); Simmons v. Savell (In re Simmons), 765 F.2d 547, 552 (5th Cir. 1985) (same). Return to article

2 These procedures can be viewed at http://www.alixpartners.com/cms under the Mirant case heading. Return to article

Bankruptcy Rule: 
Journal Date: 
Thursday, December 1, 2005

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