7 Reasons a Claim Payout Is Not Guaranteed

After receiving a Notice of Bankruptcy, many Creditors unexpectedly involved in a Chapter 11 Bankruptcy are often advised to take prudent action and submit a Proof of Claim in the bankruptcy case. If you’re a Creditor who has dotted your “I’s” and crossed your “T’s” by filing your Proof of Claim accurately and expediently, there might be a certain peace of mind that the bankruptcy legal process will take care of the rest as far as your claim interests are concerned.

A common misconception amongst Creditors is that filing a Proof of Claim is sufficient to receive a payout from the bankruptcy case. Unfortunately, filing a Proof of Claim does not automatically entitle a Creditor to be guaranteed payment.

In this article, we’ll explore the common setbacks that can impact a Creditor’s chances of receiving payment at the conclusion of the Chapter 11 process.

What is the purpose of filing a Proof of Claim?

At the onset of a Chapter 11 Bankruptcy case, the court implements an order known as an automatic stay—which prohibits any Creditors from collections activities for amounts owed against the Debtor. Without being able to collect on outstanding debts, Creditors have little choice but to ensure their claim is represented in the case.

Filing a Proof of Claim allows a Creditor to assert their legal right to receive payment from the Debtor’s bankruptcy estate when the case settles. Doing so also ensures that their claim is accurately represented to the bankruptcy court.

When a Debtor files their Schedule of Assets and Liabilities in the case, it is not uncommon for Creditors’ bankruptcy claims to be stated incorrectly or left out completely in the court filings. Additionally, these claims may be listed as disputed, unliquidated, or contingent—complicating matters for the Creditor in their recovery attempts. When this happens, a Creditor must file a Proof of Claim with the necessary supporting documentation that substantiates their bankruptcy claim. As a result, the Creditor’s Proof of Claim is admitted into the case as a formal court document.

Guaranteed Payment...A Common Creditor Misconception in Bankruptcy

Doesn’t filing a Proof of Claim mean that a Creditor will automatically be repaid? Unfortunately the answer is not so simple, it depends.

While filing a Proof of Claim preserves the Creditors right to repayment, the action of filing paperwork alone does not guarantee payment owed to them by the Debtor. In fact, not all Creditors in a bankruptcy case are fortunate enough to be fully repaid. Some Creditors end up receiving only partial payment, and some Creditors ultimately end up with nothing at all when the case resolves. The complexities of Creditor payment are dependent on several procedural components in the Chapter 11 Bankruptcy process that can vary from case to case.

If you’re a Creditor involved in a bankruptcy case, it is crucial to not only understand the fundamental procedure, but also the complexities that affect the claim recovery you desire.

7 Factors that Affect Creditor Claim Payout  

As a Creditor eagerly awaiting resolution on your claim, you should understand the dependencies in the bankruptcy process that determine your chances towards remediation.

Claim Validity

If a Creditor does not submit their Proof of Claim with the proper documentation and information necessary to support their bankruptcy claim, it can be deemed invalid. The bankruptcy court maintains the right to reject any bankruptcy claims filed that are invalid or fraudulent.  

Claim Objections

After receiving all of the filed bankruptcy claims, both the Debtor and the bankruptcy court review the claims for validity and accuracy.

Valid and accurate bankruptcy claims that have been submitted on time and with sufficient documentation are typically allowed and reserve their right to receive eventual repayment. However, the Debtor or appointed trustee reserves the legal right to file objections against Creditor claims. If the Debtor chooses to pursue filing objections on claims to invalidate or disallow them, the Creditor is less likely to receive repayment from the bankruptcy estate.

Creditor Error

Oftentimes, a Creditor’s rate of recovery is affected by their own error. Filing a Proof of Claim and keeping track of the proceedings of the case can be complicated if you do not have a complete understanding of the process. If a Creditor’s Proof of Claim is turned in too late, lacks enough information, or if a Creditor fails to respond when the Debtor objects against their claim, they can forfeit their right to receive payment.

Creditor Priority

Creditor prioritization is a determining factor when it comes to the likelihood of a creditor recovering their claim amount. During Chapter 11, Creditor claims are categorized into classes and each Creditor class is prioritized in order according to Federal Bankruptcy Procedure. These Creditor classes determine the priority of each bankruptcy claim, which then dictates the likelihood and sequential order in which each creditor will be paid. Claims of the highest priority level (Secured Creditors) are paid first and in full before any subsequent classes of bankruptcy claims (Unsecured Creditors) out of what is remaining in the bankruptcy estate. For these lower priority Unsecured Creditors, they are often at risk of being left out in remediation opportunities, and may even receive nothing at all.

Claim Subordination

Under Ch.11, the bankruptcy court is allowed to legally rearrange priorities within a class of creditors based on equitable principles. This is known as equitable subordination and it can further delay or complicate a creditor’s repayment. Claim subordination can result in a creditor receiving a lower payment priority within their class, which can lead to decreased or postponed payout.

Claim Impairment

Another factor that can affect Creditor recovery and devalue a bankruptcy claim is known as claim impairment. A bankruptcy claim becomes impaired when it is deemed defective by the proposed terms of the Debtor’s Plan of Reorganization and the Creditor’s rights to enforce its claim are altered or depreciated.  

Other indications of claim impairment include if the bankruptcy claim is not paid in full under the terms of the Plan or if any of the obligations outlined in the original agreement upon which the claim is based are not met. The Debtor has the ability to resolve this issue and make a Creditor’s claim to be no longer impaired by curing the obligation. This would mean that the obligation is made current, the Creditor is compensated for any expenses they might have incurred due to the process, and the Creditor’s rights under the obligation are untouched from that point forward.

Approval on Debtor’s Plan of Reorganization  

Once the Debtor has formulated a Plan of Reorganization, they must present it to the bankruptcy court and Creditors for review. After the bankruptcy court reviews the Plan and Disclosure Statement and provides feedback or objections, the Plan can then be put up to vote by the eligible Creditors, or those with allowed claims within a class of impaired claims.

Each qualified Creditor is given a sufficient amount of time to review the proposed terms of the Plan, the Disclosure Statement, and then cast a vote to accept or reject the Plan. For the Plan to be approved and confirmed by the bankruptcy court, a vote of approval must account for at least two-thirds in dollar amount of claim value or more than half in number of creditors in the class.

After waiting for months for the Debtor to formulate and submit their Plan of Reorganization, the process is further extended by Creditor voting and the court’s approval. And unfortunately, payment does not always commence immediately following the confirmation of the Plan. It can take several months for Creditors to receive remediation.

The Good News: for Secured and Priority Creditors

Among the Classes of Creditors, Secured Creditors and Priority Unsecured Creditors are the most likely to be repaid in full. A secured bankruptcy claim is one that is secured by the value of collateral or a lien on property owned by the Debtor, while an unsecured bankruptcy claim is one that is not. This means that secured creditors will receive payment first and in full (up to the value of their secured collateral or lien interest) from the available funds of the Debtor’s bankruptcy estate.

For those with priority claims, although they are not secured by collateral, these claims are entitled to special treatment under Federal law, and thus are able to receive priority in payment under the Chapter 11 process over the majority of other claims. Because of their priority status, these claims cannot be dismissed and the Debtor must fulfill these debt obligations even after a case concludes.

Having filed a Proof of Claim as a secured or priority Creditor, the prospect of receiving a payout is highly certain.  

The Good News: for General Unsecured Creditors

Because secured claims and priority claims must be paid first before lower tier unsecured claims receive payment, it is possible for the bankruptcy estate to run out of available funds to pay all remaining Creditors. For this reason, several of the lower-tier creditors may not be repaid, or receive the full value of their claim. General unsecured (non-priority), senior subordinated, junior subordinated, and equity stake holders are among the Creditor Classes that are likely to receive only partial payment or nothing at all. It is also common for the Debtor to offer payment in forms other than cash reimbursement, including loan arrangements or equity in the newly reorganized company.

Even if an Unsecured Creditor has filed a valid Proof of Claim, recovering full repayment on unsecured claims at the conclusion of the Ch.11 bankruptcy case is anything but certain. While there is a chance for partial payment distribution for unsecured claims, there is also the possibility of no payout at the end of the Chapter 11 process.

Thankfully, there is an alternative to waiting for this uncertain outcome from the Chapter 11 case proceedings. Claims Trading is a popular out-of-court solution for Creditors where their bankruptcy claim is sold and claim ownership is legally transferred to the purchaser in return for immediate cash payment. For Unsecured Creditors, selling your bankruptcy claim is a worthwhile option to consider for minimizing uncertainty and gaining a faster payout.  

In Conclusion

For a Creditor, the process of Chapter 11 bankruptcy is riddled with uncertainty and complexities. The road does not always lead to a full recovery. Although filing a Proof of Claim is the first step and most important part of the process for a Creditor to exert their legal rights, it does not come without its challenges.  

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