Restructuring

Contributed by Doron P. Kenter.

“Mister! Mister! Get me outta here!” – Helen Honeywell, in Happy Gilmore

Although recent bankruptcy decisions have made DIP financing, make-whole premiums, and credit bidding (not to mention the availability of Twinkies) interesting to the public (including parties who may not be involved in a specific bankruptcy case), generally, the particulars of a bankruptcy case usually are most important to those directly involved.  Creditors, for example, pay close attention to see whether and how their claims will be resolved and treated.  What happens, however, if a creditor decides its claim, for whatever reason, is no longer worth pursuing?  Once a proof of claim is filed, creditors cannot simply lose interest, pick up their marbles (so to speak) and walk away from a bankruptcy case.  Not if Bankruptcy Rule 3006 has anything to say about it.
Bankruptcy Rule 3006 provides that “[a] creditor may withdraw a claim as of right by filing a notice of withdrawal.”  If, however, an objection is filed to that claim, the creditor has voted on the debtor’s plan or the creditor has “participated significantly in the case,” she must first seek leave from the court to withdraw the claim, after a hearing on notice to the trustee or debtor in possession and to any official committee appointed in the bankruptcy cases.
Bankruptcy Rule 3006 is derived from Rule 41 of the Federal Rules of Civil Procedure, which requires leave of the court to dismiss actions that are already “underway” (my word).  An underlying (and oversimplified) principle behind Rule 41 is as follows: once an issue is before the court and litigants have expended time and money on the issue, each party has (theoretically) submitted to the court’s jurisdiction and each party is (theoretically) entitled to a judgment in connection with the dispute before the court.
Claims filed in bankruptcy cases are different.  Though some claims may be significant, others may be negligible (especially in the scheme of large bankruptcy cases).  Some claims objections look very much like full-blown litigation, while others may be “omnibus objections” to hundreds of claims (or more).  Should a creditor asserting a $100 claim against MegaCorp be required to file a motion, appear in court, and obtain a court order, simply to be let out of a bankruptcy proceeding where she has cast a vote or where the debtor has included her on a schedule to an omnibus claims objection?  And this is to say nothing of the difficulty in assessing whether a claimant has “participated significantly” in the bankruptcy case!
On the other hand, Bankruptcy Rule 3006 can also serve several important purposes. Withdrawal of a claim results in the complete extraction of a creditor from a bankruptcy case.  Any proceedings involving that creditor relating to that claim essentially become moot.  This can have serious implications regarding issue preclusion, res judicata, forum selection, consent to the court’s jurisdiction (and/or its constitutional authority to adjudicate claims), and other concerns regarding the precedential effect of a court’s judgments.
For example, in In re Appleseed’s Intermediate Holdings, LLC, the State of Ohio Department of Taxation (“ODT”) filed a claim for taxes, penalties, and interest allegedly imposed pursuant to an Ohio statute.  The reorganized debtors subsequently objected to ODT’s claim, arguing that the tax violated the Commerce Clause of the United States Constitution.  After extended motion practice by both parties, ODT sought to withdraw its claim with prejudice, on the grounds that ODT had cancelled the tax assessment, rendering the claim unenforceable under section 502(b) of the Bankruptcy Code.  Though the debtors did not oppose the withdrawal in principle, they sought to condition the withdrawal with prejudice on language providing for issue preclusion, preventing ODT from issuing any other related tax assessments against any of the reorganized debtors.  The court rejected the debtors’ argument and allowed ODT to withdraw its claim, holding that the constitutional issue before the court had not been sufficiently litigated for preclusion purposes and that, in any event, issue preclusion raised serious constitutional and jurisdictional questions that the court had not yet had sufficient opportunity to consider.  Even though withdrawal without such conditions would prejudice the debtors – in that they had already devoted significant resources to litigating this issue – such prejudice did not rise to the level of justifying what would have amounted to a determination of constitutional issues on the merits prior to a “full” litigation.
Appleseed’s demonstrates that claim withdrawal is not a simple issue and that there are important circumstances in which court involvement (and due process) in the context of a claim withdrawal may be necessary.  Given the increased chatter regarding bankruptcy courts’ authority to adjudicate claims, withdrawal of claims could pose problems for plaintiffs arguing that their affirmative claims against creditors would necessarily be resolved in the claims allowance process and are, therefore, within the bankruptcy courts’ final adjudicative authority.  Similarly, substantial participation in a case may be deemed to be “implied consent” to adjudication of claims before the bankruptcy court, and unilateral claim withdrawal could be used as a tactic to dodge the bankruptcy court’s authority or jurisdiction over a matter.
In many circumstances, these policies seem fair.  Once a creditor votes on a plan, that creditor has “skin in the game” – to the extent that it has an interest in the case, it has expressed its interest, either by voting for or against the proposed plan.  Once that vote is cast, a creditor should be bound to it.  Similarly, once a creditor chooses to become “significantly involved” in the bankruptcy case, it should be bound by its decision to throw its proverbial “hat in the ring.”  As a matter of basic fairness, creditors should not be allowed to steer a case in one way or another and then unilaterally “opt out” of the proceedings, rather than have their claims fully adjudicated and resolved in the bankruptcy case.  On the other hand, where withdrawal raises no specter of prejudice to any party, it may be inefficient to require full-blown motions and hearings to consider whether claim withdrawal is appropriate.