Restructuring

Contributed by Dana Hall
The United States Court of Appeals for the Fourth Circuit, in Gentry v. Siegel (In re Circuit City Stores, Inc.), recently held that class proofs of claim are permissible under the Federal Rules of Bankruptcy Procedure, but only on a conditional basis.  Unfortunately for the plaintiffs in Circuit City, to the extent that a bankruptcy court refuses to apply Bankruptcy Rule 7023 to a contested matter (a case-by-case determination), the mere ability to file class proofs of claims may be cold comfort for class action plaintiffs.
In Circuit City, four named plaintiffs, each a former employee of the defunct (and now liquidating) electronics retailer, timely filed class proofs of claim in Circuit City’s chapter 11 cases alleging approximately $150 million, collectively, in unpaid overtime wages on behalf of themselves and other unnamed, “similarly situated,” former employees.  Each of the four named plaintiffs had filed separate class actions in various state courts, but none of those actions had yet been certified at the time that the plaintiffs filed their proofs of claim.  The Debtors subsequently objected to each of the class proofs of claim to the extent that such claims sought relief with respect to the unnamed plaintiffs.  Following the Debtors’ claims objection, the named plaintiffs moved under Bankruptcy Rule 9014 to proceed with resolving the class claims pursuant to Bankruptcy Rule 7023 (which incorporates Federal Rule of Civil Procedure 23 – providing the framework under federal law for certifying and prosecuting a class action lawsuit).  The bankruptcy court determined that: (i) the named plaintiffs were not “authorized representatives” of the unnamed plaintiffs and the class proofs of claim with respect to the unnamed plaintiffs were, therefore, invalid; (ii) the claimants’ Bankruptcy Rule 9014 motion had not been timely filed; (iii) even if the motion had been timely, the bankruptcy court had discretion to determine and did determine that, in light of the facts and circumstances, the bankruptcy claims resolution process was superior to potentially cumbersome and expensive class action litigation under Bankruptcy Rule 7023; and (iv) because notice of the bar date had been adequate and proper with respect to the unnamed plaintiffs, all of the unnamed plaintiffs were barred from asserting their claims.  The United States District Court for the Eastern District of Virginia affirmed the bankruptcy court’s decision, and the named plaintiffs appealed to the Fourth Circuit.
Courts differ with respect to whether claimants are permitted to file class proofs of claim.  The Bankruptcy Rules are silent with respect to whether claimants can do so, and Bankruptcy Rule 3001(b) states that a claim can be filed only by a creditor or a creditor’s “authorized agent,” but provides little additional guidance.  Because a proof of claim can only be filed by a creditor or a creditor’s “authorized agent,” where a class action has not been previously certified in a state court, it is unclear whether a creditor can permissibly file a proof of claim on behalf of other unnamed (and often unknown) purported creditors.  Bankruptcy Rule 7023, which incorporates Federal Rule of Civil Procedure 23 wholesale, establishes the bankruptcy framework for class actions initiated in an adversary proceeding context.  Part VII of the Bankruptcy Rules, however, does not apply to contested matters such as a debtor’s objection to a proof of claim.  Bankruptcy Rule 9014, on the other hand, sets forth the framework for resolving contested matters in bankruptcy cases and incorporates, by default, certain provisions (not including Rule 7023) from Part VII of the Bankruptcy Code.  Rule 9014 also permits a party to a contested matter to, on motion, request the application of other Part VII provisions (e.g. Bankruptcy Rule 7023) in the context of a contested matter.  On appeal, the debtors argued that because, at the time that the class proofs of claim had been filed, the class actions had not been certified in state court and Rule 7023 had not been made applicable in the bankruptcy cases (because the named plaintiffs had not filed an adversary complaint and had not filed a motion under Rule 9014 to make Rule 7023 applicable to the contested matter), the named plaintiffs were not “authorized agent[s]” of the unnamed plaintiffs and, accordingly, could not file proofs of claim on behalf of such claimants.
The Fourth Circuit, reversing, in part, the bankruptcy court and district court decisions, rejected the debtors’ argument and instead found that, although the named claimants did not constitute “authorized agent[s],” such claimants could file class proofs of claim as “putative agents” of the unnamed claimants.  According to the court, such class proofs of claim would then “serve their function only on a conditional basis” and, in the event that a bankruptcy court later approved class representation under Rule 7023, such approval would “function retroactively to legitimize the class proof of claim.”  On the other hand, if the bankruptcy court were to later reject the claimants’ request for class certification, the court would be required to “establish a reasonable time within which the individual putative class members [would be] allowed to file individual proofs of claim.”  In permitting the named claimants to file proofs of claim as putative agents of unnamed claimants, the Fourth Circuit Court of Appeals adopted the majority approach and joined the handful of other circuits – the Sixth, Seventh, Ninth, and Eleventh – that have expressly permitted the filing of such class claims.
The Fourth Circuit also reversed the bankruptcy court’s ruling to the extent that the bankruptcy court had rejected the plaintiffs’ 9014 motion as having been untimely filed.  The Court of Appeals found the debtors’ argument that the bar date should apply to the filing of a 9014 motion unsupportable and, further, noted that the 9014 motion was filed only shortly after the debtors’ objection to the class proofs of claim.  According to the court, prior to the debtors’ objection, the claimants could not have filed a 9014 motion to make Rule 7023 applicable because there was had been no underlying “contested matter” to which Rule 9014 could have applied.
Unfortunately for the plaintiffs in Circuit City, the Fourth Circuit determined that the bankruptcy court had not abused its discretion in finding that, given the circumstances of the debtors’ chapter 11 cases, the process for resolving individually filed proofs of claim was superior to the class action process under Rule 7023.  The bankruptcy court had determined that, even assuming that the putative class could be certified under Rule 7023, such a process would result in “expensive, time-consuming, protracted litigation that could delay and lessen the distribution of the Debtors’ assets to the creditors.”  Specifically, the bankruptcy court had determined that the typical arguments offered in support of class actions were inapplicable – there was no legitimate concern regarding inconsistent judgments because all claims would be considered before the same court and deterrence of improper defendant behavior was an inapplicable explanation in liquidating cases such as Circuit City’s.  The bankruptcy court and the Fourth Circuit noted that the bankruptcy court’s claims resolution process had worked successfully in resolving nearly 7,800 contested proofs of claim and that the plaintiffs had offered little reason to think that the bankruptcy claims process could not efficiently resolve several hundred additional employee claims on an individual basis.  The Fourth Circuit also found that the named plaintiffs lacked standing to challenge the adequacy of notice provided to the unnamed plaintiffs and, accordingly, did not issue a ruling on the merits of that issue or state whether it would extend the time for such plaintiffs to file proofs of claim.
Although the Circuit City decision is significant because of its affirmation of the permissibility of class claims, the decision also highlights the significant procedural hurdles faced by putative class action plaintiffs.  Not only must such plaintiffs succeed in moving the court to apply Bankruptcy Rule 7023, they must then also succeed in satisfying the requirements of numerosity, commonality, typicality, representation, and maintainability set forth in Federal Rule of Civil Procedures 23(a)-(b) (incorporated in Bankruptcy Rule 7023).  Although in the Fourth Circuit, class action plaintiffs may now be able to get a quick start out of the gates, the multiple hurdles that lie ahead are sure to keep many from ever crossing the finish line.