Allowed Secured Claims

Allowed secured claims

After a bankruptcy petition has been filed by or against a debtor, any creditor holding a claim against the debtor may file a proof of that claim in the debtor's bankruptcy proceeding. Bankr. Code 501(a). Under Bankr. Code 502(a), a claim for which a proof of claim has been filed is deemed "allowed" unless a party in interest (e.g. a bankruptcy trustee) objects to the claim, in which case the bankruptcy court will conduct a hearing to determine whether or the extent to which a claim should be allowed. Bankr. Code 502(b). The bankruptcy trustee might object, for example, if the claim is barred by an applicable statute of limitations. Where a claim is allowed, the creditor is entitled to the treatment provided under the Chapter of the Bankruptcy Code under which the debtor's case is proceeding (e.g. distribution of the proceeds of a liquidation under Chapter 7, participation in a payment plan under Chapter 13, or participation in a plan of reorganization under Chapter 11). Where a creditor fails to file a proof of claim and is not excused from doing so, the creditor's claim is subject to discharge without any payment.

In most consumer Chapter 7 cases creditors do not file a proof of claim because, in most such cases, all of the debtor's property is exempt and therefore none is available for liquidation and there is no distribution of proceeds to creditors. Accordingly, the notice sent to creditors by the bankruptcy court shortly after the filing of the petition advises: "At this time there appear to be no assets available from which payment may be made to unsecured creditors. Do not file a proof of claim until you receive notice to do so." If assets are later discovered, a subsequent notice advises creditors to file a proof of claim.

In Chapter 11 cases, a creditor whose claim is listed in the debtor's schedule of liabilities will typically not have to file a proof of claim in order to receive the treatment that Chapter 11 affords such a creditor. In other words, such a creditor is deemed to have filed a proof of claim. Bankr. Rule 3003.

The creditor who is not secured and who has filed (or is deemed to have filed) a proof of claim will, absent objection to the claim, hold an "allowed unsecured claim." Under Bankr. Code 502(b)(2), such a claim will not accrue post-petition interest, but it will include any unpaid interest accured prior to the filing of the petition on the principal amount of the obligation together with any pre-petition attorney's fees to which the creditor is entitled under the terms of the obligation.

Under Bankr. Code 506(a), the creditor who is fully secured and who has filed (or is deemed to have filed) a proof of claim will, absent objection to the claim, hold an "allowed secured claim" in an amount equal to the amount of the debt, unless the lien can be avoided. Moreover, under Bankr. Code 506(b), such a creditor's claim will include post-petition interest on the claim together with post-petition attorney's fees and other costs provided under the agreement under which the claim arose to the extent that the value of the collateral permits. The creditor whose claim is not fully secured and who has filed (or is deemed to have filed) a proof of claim, will, absent objection to the claim, hold an allowed secured claim to the extent of the value of the collateral and an allowed unsecured claim for the balance (the deficiency, i.e., the difference between the amount of the debt and the value of the collateral). In other words, an undersecured creditor is treated as having two claims each of which will be treated differently in the bankruptcy case. Interest does not accure on the allowed unsecured claim (Bankr. Code 502(b)(2)) and does not accure on the allowed secured claim because the collateral is not worth more than the amount of the claim.

Consider the following examples:

1. A debtor owes $500,000 to a lender secured by an unavoidable deed of trust on real property owned exclusively by the debtor. If the property is worth $750,000 and the lender's deed of trust has highest priority (i.e. it is a "first" deed of trust), the lender has an allowed secured claim in the amount of $500,000. If the property is worth $350,000, the lender has an allowed secured claim in the amount of $350,000 and an allowed unsecured claim in the amount of $150,000. If the property is worth $750,000, but the lender's deed of trust is subordinate to a deed of trust securing a debt of $300,000, the lender who is junior has an allowed secured claim in the amount of $450,000 and an allowed unsecured claim in the amount of $50,000.

2. A debtor owes $10,000 to a lender secured by a security interest in the debtor's automobile. There are no other liens on the automobile. If the automobile is worth $12,000, the lender has an allowed secured claim in the amount of $10,000. If the automobile is worth $8,000, the lender has an allowed secured claim in the amount of $8,000 and an allowed unsecured claim in the amount of $2,000.

The amount of an allowed secured claim obviously depends critically on the value of collateral. As we have noted elsewhere, value is elusive and imprecise. As a consequence, in a bankruptcy case, the parties in interest will frequently negotiate an agreed value. If they are unable or unwilling to do so, the bankruptcy court will determine value.

Treatment of the allowed secured claim differs in some important particulars depending upon whether the case is a Chapter 7, Chapter 13, or Chapter 11. See Commentary.Consumer Chapter 7, Commentary Chapter 13, and Commentary.Chapter 11. But one common theme is clear: under any chapter of the Bankruptcy Code the allowed secured claim fares better than the allowed unsecured claim. In the referenced commentaries, and in associated cases and problems, we provide a basic foundation for understanding the rights of the secured creditor in bankruptcy proceedings. For more detailed treatment and for strategic planning for secured creditors, see L.LoPucki, Strategies for Creditors in Bankruptcy Proceedings (3rd Ed. Aspen Law & Business1999).