Secured Creditors and Several Proof of Claim Options

Under the Bankruptcy Code, a secured creditor has varied choices in terms of how to file a proof of claim in bankruptcies. And these choices should be thought through before going ahead with one as certain choices may have significant unexpected consequences which would outlive the bankruptcy and affect a secured creditor’s subsequent rights in state court actions.

In a scenario where a debtor file a bankruptcy petition and the proof of claims are allowed, the secured creditors have four options. The secured creditors may a) disregard the entire bankruptcy proceedings and choose to rely on their security; b) file a secured proof of claim before the bankruptcy court; c) let go off their security interest and declare their claim as unsecured through a proof of claim in the bankruptcy court; d) file a proof of claim declaring their security interest but also availing themselves on the general assets of the bankruptcy estate as to the unsecured balance. When a creditor choses one of the aforementioned option, especially the one allowing to share in distributions from the assets of the bankruptcy estate as an unsecured creditor, it may not be necessarily alter its position and instead, later ask to be treated as a secured creditor. This happens to be true especially when a secured creditor had filed an unsecured proof of claim in the bankruptcy and then attempted to recover as a secured creditor in a subsequent state court action or to receive insurance proceeds if the collateral security is destroyed.[1]

In the matter of In Re Taylor, the creditor was a mortgage lien holder and filed an unsecured non-priority proof of claim under the Chapter 13 of the Bankruptcy Code. When the reorganization plan was executed, there was still a balloon payment due. If the creditor would have filed a proof of claim as a secured creditor, the lien would have survived the plan and discharge of the debtors. However, as the creditor had filed an unsecured proof of claim, it waived the secured status and the lien ceased to exit upon the completion of the reorganization plan payments which essentially released the mortgage in state court. Filing of unsecured proof of claims would also affect a secured creditor’s lien priority in a state-court foreclosure action. It is imperative for the secured creditors in a state foreclosure action to pay attention to how other secured creditors have filed their proof of claims as it is possible that some state court liens are on record with the Register of Deeds Office which were actually waived and/or released in a prior bankruptcy case. The issue came up in the South Carolina state foreclosure action in the matter of South State Bank v. Greer et. al, 2019-CP-23-00720 (Mar. 25, 2021). In the case, the foreclosure sale of commercial property resulted in surplus funds. American Express National Bank (“AMEX) had filed a state court judgment against the landowner, which was in line in the state records office after the foreclosed mortgage. Clayton Tile Distributing Co., Inc. (“Clayton Tile”) thereafter filed a judgment against the landowner. During the landowner’s Chapter 7 bankruptcy, assets were declared as per the procedure. AMEX filed an unsecured proof of claim while Clayton Tile filed a secured proof of claim. The Master in Equity for Greenville County held that claim by AMEX to the surplus fund was waived or abandoned. In several cases[2], the courts have stated that when a secured creditor deliberately files a claim as an unsecured creditor with the hope of participating in the distributions of a bankruptcy estate, the creditor waives its right to also seek collection from the collateral. Thus, the creditor cannot switch its position from unsecured to secured when it sees that there can be an unforeseen benefit in the collateral. Therefore, a secured creditor should be diligent and thoughtful in deciding whether to file a secured proof of claim or an unsecured one.

[1] In re Bailey, 664 F.3d 1026 (6th Cir. 2011); In re Taylor, 280 B.R. 711 (Bankr. S.D. Ala. 2001).

[2] In re Devey, 590 B.R. 706 (Bankr. D.S.C. 2018); In re Workman, 373 B.R. 460 (Bankr. D.S.C. 2007)

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