Restructuring

In a recent decision enforcing the discharge injunction under Section 1107(d)(1)(A) of the Bankruptcy Code, the Bankruptcy Court for the Western District of Pennsylvania blocked a creditor from asserting a claim against the debtor after confirmation of the plan.  The case of In re Trustees of Conneaut Lake Park, Inc.), No. 14-11277, 2018 Bankr. LEXIS 1447 (JAD) (Bankr. W.D. Pa. May 15, 2018) serves as a harsh object lesson in the need for creditors to file timely proofs of claim to protect their rights with respect to any and all potential claims they may have against the debtor, including contingent and unmatured claims.

The Facts:  Taxes Always Come First

The Trustees of Conneaut Lake Park, Inc. (the “Debtor”) owned a parcel of land on Conneaut Lake, the largest natural lake in Pennsylvania, including a one-acre parcel known as the “Beach Club,” which was managed by Park Restoration LLC (“PRL” or the “Creditor”) pursuant to a long-term lease with the Debtor.  The Debtor did not carry fire insurance on the Beach Club even though it was required to do so under state law.  The Creditor, however, maintained a $611,000 fire insurance policy on the Beach Club through Erie Insurance (“Erie”).  After a fire destroyed the Beach Club, the Creditor submitted a claim to Erie for the full amount of the policy.  Under Pennsylvania state law, fire insurance proceeds associated with realty must first satisfy any delinquent tax claims of state and local taxing authorities (the “Taxing Authorities”) before such proceeds are distributed to the loss payee under a fire insurance policy.  Erie informed the Creditor that it had discovered the Debtor owed $478,260.75 in delinquent taxes on the parcel and that it would be paying the delinquent taxes to the Taxing Authorities before paying the remaining balance of the insurance proceeds to the Creditor.  In September 2013, the Creditor sued Erie in Pennsylvania state court seeking a declaratory judgment that the Creditor was the only party entitled to the insurance proceeds given that it was not the subject property owner and had no responsibility for payment of the parcel taxes.  Shortly thereafter the Debtor filed its chapter 11 petition for relief in the Western District of Pennsylvania and removed the state court declaratory judgment action to the bankruptcy court as an adversary proceeding.

Release the Proceeds!

The bankruptcy court ultimately granted partial summary judgment in the adversary proceeding in favor of both the Creditor and the Taxing Authorities, finding that (a) the Taxing Authorities were entitled to $478,000 on account of the delinquent taxes and (b) the Creditor was entitled to the balance of the insurance proceeds.  The bankruptcy court’s decision was appealed to the District Court for the Western District of Pennsylvania, where the district court partially reversed the bankruptcy court’s summary judgment order.  On appeal to the Third Circuit, the Third Circuit reversed the district court and upheld the bankruptcy court’s summary judgment decision in full.  By the time the Third Circuit had rendered its decision, the Debtor had confirmed its chapter 11 plan (the “Plan,” confirmed on September 6, 2016), which provided for the delinquent taxes to be paid in full.  Following the Third Circuit’s decision, in June 2017, the bankruptcy court ordered the insurance proceeds released to the Taxing Authorities from the court’s registry, where they had been parked since December 2014.

Enforcing the Discharge Injunction

Still apparently irked by the injustice of having to pay TCLP’s tax obligations, in January 2018, the Creditor sued the Debtor in Pennsylvania state court, asserting claims sounding in unjust enrichment and indemnity against the Debtor.  The Debtor immediately moved the court to enforce the discharge injunction and impose sanctions against the Creditor for a violation of the confirmation order (the “Enforcement Motion”).  The Creditor defended itself against the Enforcement Motion by arguing that, to the extent it had a claim against the Debtor, such claim arose after entry of the order confirming the Plan, and thus, its claim was not subject to the discharge injunction.  The Creditor’s arguments can be summarized as follows:

• Because the insurance proceeds were released from the court’s registry after the bankruptcy court entered the order confirming the Plan, the Creditor’s claim (a) did not “arise” prior to confirmation and (b) was not a “mature” claim that could have been asserted prior to confirmation;
• The Debtor’s failure to schedule any claims held by the Creditors was evidence that the Creditor’s claim did not exist at the commencement of the chapter 11 case; and
• The Creditor would otherwise be deprived of its due process rights should the court deny it the right to pursue its claims in state court.

Claims Are Good.  Filed Claims Are Better.
Noting that a claim “arises when an individual is exposed …  to  … conduct giving rise to an injury, which underlies a right to payment under the Bankruptcy Code,” the court relied on the well-established, broad temporal and conceptual contours of a “claim” under the Bankruptcy Code and Third Circuit precedent to dismantle each of the Creditor’s arguments defending its right to assert its claims.¹

First the court pointed out that the undisputed factual record established that the conduct that gave rise to the claims asserted in the Creditor’s post-confirmation lawsuit occurred not only prior to confirmation of the Plan, but prior to the commencement of the chapter 11 proceeding itself.  That the insurance proceeds were held in abeyance until after confirmation was not prejudicial to the Creditor because (a) such proceeds had been in the court’s registry long before confirmation of the Plan and (b) the Creditor’s litigation itself was the ultimate reason that the proceeds were not released until after confirmation.  Moreover, the court found that the Creditor itself had articulated the existence of these very same claims in the state court declaratory judgment action when it characterized any payment to the Taxing Authorities as being “unjust and inequitable” and as a “windfall.”  Further, in the course of litigating the adversary proceeding before the court, the Creditor had actually sought leave to pursue these very same claims by way of asserting counterclaims, but had withdrawn its request prior to confirmation of the Plan.

Next the court addressed the Creditor’s argument that its claim did not “mature” until the insurance proceeds were actually released by the court, and thus, the post-confirmation release date of the insurance proceeds was the point at which the Creditor’s claims actually arose.  The court pointed out that the definition of a “claim” under Section 101(5) of the Bankruptcy Code explicitly included “contingent” debts and liabilities that are “unmatured,” thus, taking the Creditor’s assertions at face value, it was established that the Creditor held “unmatured” or “contingent” claims, prior to confirmation that were squarely within the Bankruptcy Code’s definition of a claim.

The court also summarily dismissed the Creditor’s argument that the Debtor’s failure to schedule any of the Creditors’ claims somehow established the nonexistence [strike hyphen] of its claims pre-confirmation or otherwise represented a deprivation of the Creditor’s due process rights.  Expressing incredulity at the Creditor’s failure to file a claim or contest confirmation of the Plan, the court noted that not only had the Debtor listed the Creditor as a “party in interest” in its Statement of Financial Affairs filed pursuant to Bankruptcy Rule 1007(b)(1)(D), which indicated that the Debtor may have simply believed it owed nothing to the Creditor, but that the Debtor had also (a) served the Creditor with a notice of the claims bar date and (b) listed the Creditor and its counsel on its creditor mailing matrix — scorching any argument that the Creditor was prejudiced in any way with respect to its ability to timely assert its claims.

Conclusion

Although there are scenarios where simply filing an adversary proceeding can serve as an “informal proof of claim,” bankruptcy courts are unlikely to entertain such a theory when the putative claims are not asserted until well after a chapter 11 plan has been confirmed and the moving creditor fails to object to confirmation of a plan on the basis that a plan does not address its claims.  Absent any concerns about submitting to the jurisdiction of a Bankruptcy Court — none of which were present in Conneaut Lake — creditors should always file a defensive proof of claim.  Otherwise, they are liable to get burned.

Weil Summer Associate James Zaleski contributed to this blog post.