What’s Not a Claim In Bankruptcy?

Before joining his firm, I visited Professor Hayes’ Bankruptcy class which he teaches at the University of West Los Angeles. The topic of the day was “claims.”  As we parsed through the case law, I gave the students a hint, if there is any question whether something is a claim, it’s a claim! In fact, I couldn’t think of something that wasn’t a claim!

The reason is claims are BROADLY defined. Under 11 U.S.C. 101(5), a claim is defined as:

“(5) The term “claim” means—

(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or

(B) right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured.”

A typical bankruptcy puts a stop to virtually all claims, and so if you’re paying attention, it puts a stop to virtually every adverse action against the bankrupt.

But that’s not what this article is about. It’s about how Leslie Cohen Law, with their combined horsepower of three attorneys fought against the juggernaut that is Pachulski Stang Ziehl & Jones LLP and came out on top by discovering, finally, something that is not a claim!

This is important because a creditor is defined as “(A) entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor; (B) entity that has a claim against the estate ….”

At this point, most people would be thinking, well, why wouldn’t I want to have a claim? Why wouldn’t I want to be a creditor? How could this be useful?

I am not going to go into the history of it all, as exciting as it may be, but Congress decided that it wouldn’t be fair for some creditors to receive money before a company filed for bankruptcy – to the exclusion of other creditors. It came up with a rule where, but for a few exceptions, creditors paid by a bankrupt company/individual, would have to pay back whatever they were paid within ninety days of the bankruptcy. If those creditors had inside knowledge of the company, they had to pay back whatever they were paid within one year of the bankruptcy. This is done through what’s commonly referred to as a preference action under 11 U.S.C. 547; one of the Trustee’s “clawback” powers.

The key here is, CREDITORS who receive payments are the only people subject to preference actions. If you’re not a creditor – that is, you don’t have a claim, you’re not worried about a preference action! This element is hard coded into Section 547(b) which allows trustees to avoid transfers “(1) to or for the benefit of a creditor;”

In the particular case at issue, Leslie Cohen’s client was the President of a company. He guaranteed debt of about $8.5 million. The company paid off about $5 million of the debt nine months before filing for bankruptcy. This meant that the President had received a $5 million dollar benefit by this payment because he had to pay the bank $5 million less on the guarantee that he made. But wait, was he a creditor?

He is clearly a creditor because any payment he would have to make to the bank would be indemnified by the company and so he had a contingent, unliquidated right to payment against the company. There is one fact I left out though. The bankruptcy court found that the President had waived, unequivocally, any of his right to repayment by the bankrupt company.

So to answer the question, what is not a claim? A claim that is unequivocally waived is not a claim! On April 6, 2015, the 9th Circuit Court of appeals agreed, meaning this client saved $5,000,000.  You can find the case here.

Author’s commentary: This is clearly an incorrect decision. As the dissent pointed out, every other bankruptcy court to address this issue has gone the other way. It’s simple, you shouldn’t be able to contract around a preference. Furthermore, as the judge pointed out, this unequivocal waiver is actually a sham because “such a waiver has no economic impact. —if the principal debtor pays the note, the insider guarantor would escape preference liability, but if the principal debtor does not pay the note, the insider could still obtain a claim against the debtor, simply by purchasing the lender’s note rather than paying on the guarantee. Thus, the [waiver] could only be seen as an effort to eliminate, by contract, a provision of the Bankruptcy Code. The attempted waiver of subordination rights was thus held to be a sham provision, unenforceable as a matter of public policy.”

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