A Timely Filed Proof of Claim Is Not a Requirement to Establish Co-Liability under Section 502(e)(1)(B)

Contributed by Elisa Lemmer
Clarifying the parameters of section 502(e)(1)(B) of the Bankruptcy Code, Judge Robert E. Gerber of the United States Bankruptcy Court for the Southern District of New York held in a recent bench decision that, among other things, the filing of a proof of claim by one creditor is not necessary to establish co-liability of the debtor to that creditor with another.

Section 502(e)(1)(B) of the Bankruptcy Code requires a court to disallow a claim for “reimbursement or contribution of an entity that is liable with the debtor on or has secured the claim of a creditor to the extent that – such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim for reimbursement or contribution.”
Debtors often use the section to disallow claims of other potentially responsible parties (PRPs) in environmental claims where the other PRPs have not expended any funds in connection with an environmental clean-up.  They also use the section to disallow contribution or indemnification claims (whether based in contract or otherwise) of litigation co-defendants.  In re Chemtura Corp., Case No. 09-11233 (REG) [Docket No. 3799] (Bankr. S.D.N.Y. Sept. 7, 2010) involved the latter situation.  Chemtura objected to proofs of claim filed by five claimants that were corporations for contribution and/or indemnification in connection with certain amounts the corporate claimants already had paid or might be called upon to pay in the future in certain litigation.  The claims arose out of personal injury lawsuits asserted by various tort plaintiffs and fell into three general categories: (a) claims for contribution in litigation in which Chemtura was already a named defendant or had been brought into the litigation by another defendant, (b) indemnification or contribution claims for litigation pending against the corporate claimants but where Chemtura was not a named defendant and (c) contribution or indemnification claims the corporate claimants might bring in the event they were to be sued in future litigation.
Chemtura objected to the corporate claimants’ claims contending, among other things, that where corporate claimants had not yet incurred any obligation to the tort plaintiffs, the unliquidated and contingent portion of the corporate claimants’ claims (the unliquidated contribution claims) should be disallowed.
Because the corporate claimants conceded that they satisfied the first prong of section 502(e)(1)(B) (i.e., that their claims were contribution or indemnification claims), Judge Gerber focused his analysis on whether the corporate claimants were co-liable with the debtor to a third party and whether the unliquidated contribution claims were contingent.
The corporate claimants argued that they were not co-liable with the debtors on the claims asserted by the tort plaintiffs because, among other things, (i) several of the tort plaintiffs had not filed proofs of claim against Chemtura (and thus Chemtura would not likely “pay twice” on account of the same liabilities), and (ii) the “co-liability” requirement of section 502(e)(1)(B) required Chemtura to show that the successful prosecution of a claim by a tort plaintiff would automatically establish liability.  The Bankruptcy Court disagreed.  It cited existing case law in multiple jurisdictions and a textual reading of the Bankruptcy Code in holding that section 502(e)(1)(B) applied to the unliquidated contribution claims regardless of whether the tort plaintiffs had filed underlying proofs of claim.  Were the filing of underlying proof of claims necessary to establish co-liability under section 502(e)(1)(B), the Bankruptcy Court reasoned, Bankruptcy Rule 3005(a), which would have allowed the corporate claimants to file proofs of claim for the tort plaintiffs, would be superfluous.  The Bankruptcy Court similarly rejected the corporate claimants’ “automatic liability” argument, finding nothing in the plain language of section 502(e)(1)(B) mandated this conclusion.
Finally, the Bankruptcy Court distinguished Judge Sontchi’s decision in In re RNI Wind Down Corp., 369 B.R. 174 (Bankr. D. Del. 2007) (Sontchi, J.), which, arguably, adopted a more limited definition of “contingent” than previous courts that had interpreted section 502(e)(1)(B).  Prior to RNI, courts routinely interpreted section 502(e)(1)(B)’s “contingent” requirement to be synonymous with “not yet paid,” but Judge Sontchi in RNI appeared to apply “contingent” to mean “dependent upon a future occurrence.”  Judge Gerber limited Judge Sontchi’s distinction between “unliquidated” and “contingent” to be applicable to the creditor’s request for an advancement of defense costs, which is a direct right that the creditor may have against the debtor.  The Chemtura court held that, although the unliquidated, but non-contingent defense costs remained allowable, the unliquidated contribution claims (which would only arise if a tort claimant succeeded against a corporate claimant) remained contingent and subject to disallowance under section 502(e)(1)(B).
The Chemtura decision, among other things, shows that the absence of a timely filed proof of claim by one creditor may be insufficient for another creditor to defeat an objection based on section 502(e)(1)(B).  Practically speaking, if one creditor fails to file a timely proof of claim and the other co-liable creditor’s claim is disallowed under section 502(e)(1)(B), a windfall could result to the debtor who would, therefore, not be required to make any distribution on account of either claim.  Recognizing this potential injustice (as well as the fact that a creditor’s failure to file a timely proof of claim does not automatically foreclose an objection, based on section 502(e)(1)(B), to a co-liable creditor’s claim), the United States Court of Appeals for the First Circuit in In re Hemingway Transport, Inc., 993 F.2d 915 (1st Cir. 1993), noted that the trustee’s burden in disallowing claims under section 502(e)(1)(B) was to establish co-liability.  Because the creditor had not filed a proof of claim, the First Circuit held that the trustee had not overcome his burden in establishing co-liability with the creditor whose claim had been disallowed under section 502(e)(1)(B).  In so doing, it vacated the bankruptcy court’s disallowance order and instructed the bankruptcy court to establish a bar date for the chapter 7 trustee or the co-liable creditor to file a surrogate proof of claim on the other creditor’s behalf.  It further held that if the surrogate proof of claim were not timely filed, then the section 502(e)(1)(B) objection could not prevail and the co-liable claim should be estimated as a contingent claim against the debtor’s estate.
Notwithstanding the First Circuit’s equitable approach to the issue, other courts (like Chemtura) may focus on a more textual interpretation of the Bankruptcy Code and disallow a co-liable creditor’s claim even though the other creditor has not filed a proof of claim against the debtor.  Although the co-liable creditor always retains the right to have its claim reconsidered “for cause” pursuant to section 502(j) of the Bankruptcy Code, it should also take proactive steps to minimize the risks attendant to disallowance.  For example, it should consider filing a proof of claim on behalf of the creditor, as provided in Bankruptcy Rule 3005(a), if that creditor has failed to do so.  While this will not avoid disallowance under section 502(e)(1)(B), it may enable the co-liable creditor to reduce the amount it may be required to pay to the other creditor by the amount that creditor may have received in a distribution on its claim.