Can You Preserve Your Claims Against a Borrower After Filing a 1099-C Cancellation of Debt?

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[authors: Diane P. Furr, Lisa P. Sumner]

​Borrowers who file a bankruptcy petition are always looking for creative new challenges to claims asserted by their bank creditors.  In recent years, debtors have argued that a bank’s issuance of an Internal Revenue Code form 1099-C “Cancellation of Debt” has the effect of waiving the bank’s claims against the borrower, and should preclude the bank from having an allowed claim in the bankruptcy case.  Fortunately, some recent court opinions state that a bank’s issuance of a 1099-C does not constitute a waiver, and the bank remains entitled to enforce its claim in a subsequent bankruptcy case.

Bankruptcy courts around the country have expressed differing opinions about whether a 1099-C forgives or discharges the debtor from further liability on a debt.  For example, courts in Connecticut have said that filing a 1099-C has the effect of discharging the underlying debt.  Arizona courts have declined to state a definitive answer, whereas courts in Indiana have held that filing a 1099-C does not excuse the debt, and instead is an administrative filing made merely to meet IRS requirements.  Similarly, in a recent bankruptcy case in Pennsylvania, In re Zilka, a bankruptcy court held that filing a 1099-C does not waive the debt, operate as a release or discharge the borrower’s liability.  In addition, the bankruptcy court in Zilka held that the lender’s issuance of a written statement to the borrower citing the outstanding loan balance as $0.00 due to a “charge off” only reflected the bank’s internal accounting procedure and was not an admission that the loan balance was forgiven.

A recent North Carolina decision follows the Pennsylvania bankruptcy court’s reasoning in Zilka.  In FDIC as receiver for Bank of Asheville v. Cashion, the United States District Court for the Western District of North Carolina rejected the debtor’s argument that the note was cancelled when the bank filed a 1099-C.  Citing Zilka, the North Carolina court held that the 1099-C did not operate to discharge the debtor’s liability, and was issued only to comply with IRS administrative requirements.

A few practical tips may help banks protect themselves from challenges to their proofs of claim or debt collection activities following issuance of a 1099-C: 

  • The bank can attach a notice to the 1099-C when sent to the debtor stating that the 1099-C is being filed due to administrative requirements of the IRS, but in no way constitutes a waiver of the bank’s claims against the debtor, which claims the bank expressly reserves the right to pursue.
  • Note that the 1099-C  form includes a box for the bank to provide an “identifiable event” code.  A bankruptcy filing by the debtor is an identifiable event so the bank should make sure to list the bankruptcy code in this box as doing so may bolster the argument that the bankruptcy case triggered the bank’s duty to file a 1099-C, but does not signify that the bank released its claim or will forego its right to file a proof of claim in the bankruptcy case. 
  • In the event a bank realizes that it has made an erroneous 1099-C filing, the bank should make a corrective filing promptly because some courts have shown a greater inclination to deny or subordinate a bank’s claim due to an erroneous 1099-C filing, especially if collection activity was ongoing. 
  • Finally, the most prudent course of action is for a bank to carefully evaluate the necessity and timing of filing a 1099-C and refrain from filing one until it is clear that the bank has exhausted collection options, an “identifiable event” has occurred within the meaning of I.R.C. Section 6050P, and the bank is prepared to forgive the remaining balance owed.

 

Published In: Bankruptcy Updates, Civil Remedies Updates, General Business Updates, Finance & Banking Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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