In a recent advisory, we reported on an apparently favorable decision to secured creditors from the Fifth Circuit Court of Appeals that held that a secured creditor’s claim survives bankruptcy where the secured creditor received notice of the case and was found to have not actively participated in it.
Now, a recent decision from the Bankruptcy Court for the Northern District of Illinois reinforces the obligation placed on secured creditors to file a timely proof of claim, despite the generally acknowledged rule that liens pass through bankruptcy unaffected, if the secured creditor would like to participate in the plan confirmation process as a creditor. In In re Batista-Sanechez, 2013 Bankr. LEXIS 4499 (Bankr. D. Ill. Oct. 25, 2013), the secured creditor, SunTrust Mortgage, Inc. (“SunTrust”) filed a late proof of claim, asserting security consisting of a mortgage on certain real property. Because it had a valid in rem right against the real property, argued SunTrust, its claim could not be disallowed. While the Court agreed that SunTrust’s lien cannot be avoided because of a late-filed claim, the Court held that SunTrust’s secured claim should nevertheless be disallowed because it was filed late.
But what are the consequences of a secured claim being disallowed, if the lien survives? In that scenario, explained the Court, the secured creditor loses its right to vote on the debtor’s plan and to a distribution. Further, this situation creates consequences for plan confirmation for the debtor. If the secured claim is secured by different property than other claims, which is often the case, the claim of the secured creditor should be classified separately from all other claims. This separate claim, held the Court, should be deemed to reject the plan. In the face of a dissenting class of creditors (e.g., the secured creditor), the debtor must obtain the affirmative vote of at least one class of impaired claims. Thus, the only way for the debtor to confirm the plan is through cramdown, which adds complexity and expense to confirmation. Questions also arise as to the secured creditor’s rights in the collateral after confirmation of the plan, and what ability the creditor has to pursue the collateral — questions that could have been avoided with a timely proof of claim.
Because late-filed secured claims typically will be disallowed, secured creditors should not rely solely on the fact that their liens will survive bankruptcy in order to protect their interests. Rather, secured creditors who want to file claims should be sure they are timely — a relatively simple endeavor. Failure to do so may compromise the secured creditor’s ability to participate in the confirmation process, and also may limit recovery.