Can A Debtor Challenge A Creditor’s Right To Payment On A Proof Of Claim?
For this question, I’m once again going to resort to the old weasel answer: It depends.
Let’s start with the answer as it pertains to Chapter 7 bankruptcy. In a Chapter 7 bankruptcy, there is a trustee assigned to manage the case. If it’s a business Chapter 7 bankruptcy, the debtor has no say in the trustee’s actions. The trustee takes all the debtor’s business assets and liquidates them. The trustee will then use that money to pay the debtor’s creditors. Similarly, in a personal Chapter 7 bankruptcy that is an asset case, the trustee takes all the debtor’s nonexempt assets, liquidates them, and uses the proceeds to repay the debtor’s creditors.
In order to be paid in a Chapter 7 case, creditors file proofs of claim. It is the right and responsibility of the trustee to challenge those proofs of claim that are partially or totally invalid, perhaps because they are grossly inflated or fraudulent. The trustee does this as a contested matter — not an adversary proceeding — on behalf of the bankruptcy estate. The debtor typically does not have the authority to do so because the debtor has no interest in the estate.
In certain limited circumstances, a debtor might have standing to challenge a proof of claim. For example, suppose a creditor files a grossly inflated claim, which if allowed, makes it impossible to pay all claims in full through the liquidation. If any debt is determined to be nondischargeable, the debtor may have standing to challenge the claim because of the potential post-bankruptcy liability.
Chapters 11 And 13
Things are different in Chapters 11 and 13. In a Chapter 11 or Chapter 13, the debtor pays creditors through a plan of reorganization. Therefore, the debtor has standing to challenge to any illegitimate claim. Otherwise, the debtor will have to pay that claim.
I’ve prosecuted quite a few claims objections on behalf of clients in Chapter 11 and Chapter 13 cases.
Common Grounds For Claim Objections
Here a few common grounds for claim objections:
- Duplicative Proofs Of Claim
Creditors sometimes file the same proof of claim multiple times, either due to carelessness or to force the debtor to mistakenly pay the debt multiple times. I had a case some time ago where a creditor filed three separate proofs of claim. These three claims were identical, asking for the same (fairly large) amount of money. If I hadn’t challenged at least two of those claims, then the debtor would have had to pay the same debt three times. Filing duplicative proofs of claim is frivolous, so in addition to challenging these proofs of claim, we sought sanctions against the creditors
This was not an isolated case. In fact, I recently had another case where I filed a claim objection because the judge had already previously disallowed the very same claim.
- Barred By A Statute Of Limitations
Creditors also file claims that are barred by statute of limitations. In April 2021, a creditor filed a claim in one of my cases on a debt from 2004. Therefore, we successfully objected to the claim.
- Grossly Inflated
Another recurring problem is creditors filing grossly inflated claims, perhaps because of inaccurate interest accrual.
For example, I successfully objected to a claim in which the creditor used the wrong interest calculation. The judgment rate in California is 10% per annum, but simple interest rather than compounded interest. The creditor in that case used compounded interest in its claim, and arrived at a much higher claim amount.
If you’re unfamiliar with the difference between simple and compounded interest, here’s a very simple example to illustrate it:
Suppose the original balance is $100, and the interest rate is 10%. Suppose further that the interest calculation in both cases is done once a year. If no payments are made for two years, what is the balance at the end of the second year?
With simple interest the interest is calculated on the original balance each year, and then added to the existing balance:
- Year 1 balance = $110 (= $100 + ($100 × 0.1)).
- Year 2 balance = $120 (= $110 + ($100 × 0.1).
With compounded interest the interest is calculated on the balance at the end of the year, and then added to the existing balance:
- Year 1 balance = $110 (= $100 + ($100 × 0.1)).
- Year 2 balance = $121 (= $110 + ($110 × 0.1)).
This is, admittedly, a very simple example. Usually the compounding takes place much more frequently than annually, with the upper limit being what is referred to as instantaneous compounding.
In sum, in certain circumstances a debtor can challenge a creditors’ right to payment on a proof of claim. Furthermore, a debtor may challenge part of a claim, or the entire claim.
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