When a products defendant files for bankruptcy; timely action can protect your client.

At some time every plaintiff's personal injury lawyer will probably face a situation where a defendant in a products liability action files for protection under the U.S. Bankruptcy Code. What should the plaintiff's counsel do when this happens? That depends on the size of the client's claim, the solvency of other defendants in the case, and the extent of the debtor/defendant's liability insurance coverage.

These factors also will be relevant in determining what steps to take in the bankruptcy court to protect the client's interest--not an easy task for attorneys who do not practice bankruptcy law on a regular basis. Moreover, the bankruptcy court may be in a distant jurisdiction, making participation difficult.

In many such cases, practitioners often take no action in the bankruptcy case. They may assume that if the debtor is insured, they need not worry. If the debtor is not insured, they may assume that there is nothing that they can do that will make a difference. One bankruptcy judge has lamented that "it is unfortunate and disturbing that this lack of reaction to bankruptcy notices is so common among injury and commercial attorneys."(1)

The judge is right. There are several ways a lawyer can protect a client's rights without spending a great deal of time or money. This article discusses aspects of a bankruptcy case on which a practitioner should focus and the steps he or she can take to protect a client's interests.

Notices of Bankruptcy Filing

Information that the defendant has filed a bankruptcy petition may come in one of two forms. The attorney representing the debtor/defendant may serve upon the other parties a notice that the debtor/defendant has filed a petition for relief under the Bankruptcy Code. The notice typically also says that the case is stayed as to the debtor/defendant by virtue of the automatic stay under the Bankruptcy Code.(2)

Alternatively, the clerk of the bankruptcy court may send you a notice of the bankruptcy filing: "Notice of Commencement of Case Under Chapter [7][11] of the Bankruptcy Code, Meeting of Creditors, and Fixing of Dates."(3) The notice usually is mailed within 20 days after the filing of a voluntary petition to all those whose names appear on the list of creditors that the debtor must file with the petition.

Often the notice will be sent to you rather than to your client because the debtor may not have your client's address. Courts have held that notice to the attorney in these circumstances constitutes adequate notice to the plaintiff.(4)

The notice should be read carefully because it contains important information about the bankruptcy case:

* debtor's name and address;

* name and address of the debtor's bankruptcy attorney;

* date, time, and location of the first meeting of creditors;

* the automatic stay; and

* procedure and deadline for filing proofs of claim--the most important data.

If the case is a Chapter 7 case, a claims bar date will be indicated. This date will be 90 days from the date first set for the creditors' meeting.(5) If the case is a "no asset" Chapter 7 case, the form will indicate that you should not file a proof of claim. If the case is a Chapter 11 reorganization, the form will either give the deadline for filing proofs of claim, or it will say that the court will set a filing deadline.

Proofs of Claim

The most important step to preserve your client's rights is to timely file a proof of claim. The time this takes is negligible and well worth the effort. Not timely filing may bar your client from participating in any distribution from the debtor's estate.

File a proof of claim even if the client's claim is covered by liability insurance. The debtor may have a per claim or aggregate per year self-insured retention that must be satisfied before the insurer's obligation to pay claims arises. In that situation, failure to timely file may prevent your client from proceeding against the debtor to recover up to the limits of the debtor's self-insured retention. As a result, the insurer's obligation to pay may not be triggered.

The proof of claim is a one-page form that may be on the reverse side of the notice of commencement of the case.(6) If not, you can get the form from the local bankruptcy court clerk's office. The form provides space for you to check the nature of your client's claim. If the claim arises from an injury incurred before the filing of the bankruptcy case, the client has an unsecured nonpriority claim, and you should check that box.

The form will also provide space for the amount of the claim. Here you should insert either the word "unliquidated" or the amount set forth in the complaint. Attach a copy of the complaint to the proof of claim.

Place your firm's address in the box "Name and Address Where Notices Should Be Sent," so that you will receive future notices from the bankruptcy court. Your client should sign and date the proof of claim. If you move offices, be sure to file a change of address with the court.

Send the claim by certified mail or an overnight delivery service to the bankruptcy court. Include an extra copy of the proof of claim and a self-addressed stamped envelope, so that you can have a stamped copy of the proof of claim returned to you if it is misplaced by the clerk's office and never filed.

It is always advisable to file a proof of claim as soon as you receive notice of the commencement of a case, even if the bankruptcy court has not yet set a claims bar date. In a Chapter 11 case, the claims bar date might not be set for several months. It is always possible that a later notice of the bar date could be misdelivered or misplaced.

The Bankruptcy Code accepts a timely filed proof of claim as true unless an objection to the claim is filed.(7) Therefore, filing shifts the burden to the debtor to file an objection, which the debtor must serve on you.(8) If you fail to timely file and later ask to file a late proof of claim, the court may deny the motion unless you establish "excusable neglect."(9)

The Automatic Stay

As mentioned earlier, the filing of a Chapter 7 or Chapter 11 petition acts as a stay of the commencement or continuation of any action against a debtor. The stay is automatic, and any action taken in violation of the stay is void, even if done innocently.(10)

The scope of the automatic stay is limited to actions against the debtor or its property. It does not stay the underlying products liability action as to all parties--only as to the debtor.(11) A case may proceed against other defendants regardless of the stay, so long as they are not debtors in a bankruptcy case. Also, the automatic stay may be modified "for cause."(12)

The stay frequently is modified where a products claim is covered in its entirety by liability insurance.(13) If you have such a case, quickly seek a stipulation from the debtor's attorney. Ask for modification of the automatic stay to permit the personal injury action to go to trial against the debtor.

In turn, your client should agree to look only to the proceeds of the debtor's liability insurance to satisfy any settlement or judgment. Debtors' attorneys often agree to these stipulations because continuation of the personal injury action will have no adverse affect on the debtor's assets.

Disputed Personal Injury Claims

The allowance and disallowance of claims in a bankruptcy case are somewhat unusual. In a Chapter 11 case, a debtor files a schedule of claims listing each claimant and the amount that the debtor contends is owed the claimant. Unless the debtor schedules a claim as disputed, contingent, or unliquidated, a creditor does not need to file a proof of claim if the creditors agree to the amount and classification of the claim.(14) The claim will be allowed in the amount scheduled even if the claimant never files a proof of claim.

This procedure works well for trade claims, because often the amount owed is undisputed. Personal injury claims, however, invariably are listed as contingent and disputed. So the claimant must file a proof of claim. The debtor also will file an objection to a proof of claim filed by the claimant, so that the claim will not be deemed allowed.

Objections to most claims are litigated as contested proceedings in the bankruptcy court.(15) But the court has no jurisdiction to adjudicate personal injury tort and wrongful death claims.(16) These must be litigated either in the district court where the bankruptcy claim is pending or, more commonly, in the state or federal court where the personal injury action was filed.(17)

Post-Petition Products Claims

You may represent a client who suffered injuries after the filing of a Chapter 11 petition but before confirmation of a plan of reorganization or liquidation. In this case the client's claim may be treated differently than if it had occurred before the petition was filed. Under the Bankruptcy Code's priority scheme, general unsecured claims are paid after all other claims except for claims for fines or punitive damage claims.(18)

Claims arising from the conduct of the debtor's business post-petition are treated as first priority claims.(19) These include not only post-petition wages, salaries, and trade claims but also tort claims caused by the debtor's post-petition operations.(20)

These claims have priority over general unsecured claims. Also, the automatic stay does not bar a plaintiff from filing an action against the debtor even while the bankruptcy case is pending. The automatic stay bars starting or continuing an action "that was or could have been commenced before the commencement of the case under this title."(21) Therefore, the stay has no effect on an injury that occurs post-petition.(22)

A debtor in possession may be sued without leave of court about its conduct of the business.(23) The action may be brought in the district court for the district in which an action could have been brought in state or federal court had there been no bankruptcy filing.(24)

That a person was injured post-petition by a product the debtor made does not mean the claimant is automatically entitled to have the claim treated as an administrative priority claim rather than an unsecured one. Courts typically require that a party asserting an administrative priority claim must establish that the claim arose from a transaction with the debtor in possession and benefited that debtor.(25)

Courts have been willing to hold that payment of a post-petition personal injury claim is an "actual and necessary" expense, so that it can be held to be a transaction that "benefited" the debtor in possession.(26) But it may be difficult to establish that the injury involved a transaction with this debtor if the product that caused the injury was made pre-petition. One court has held that in such a situation it will not be possible to determine whether the claim is an administrative or a general unsecured claim until after the underlying action is tried and the ground of liability established.(27)

If the basis for liability is solely pre-petition negligence or a pre-petition manufacturing or design defect, the claim will be a general unsecured claim. But if the basis for liability was a breach of a duty to warn, a duty that continued up to the time of the injury, the claim will be entitled to administrative priority.(28)

Plan of Reorganization

In a Chapter 11 case, the timing, amount, and manner of payment of products claims will be determined by the terms of the reorganization or liquidation plan the bankruptcy court confirms. Most plans provide no special treatment for personal injury claims. They will be in the same class as other general unsecured claims. But where the debtor has many products claims and a self-insured retention that must be satisfied before the insurer becomes obligated to pay claims, a plan often will provide separate treatment for personal injury claims.

Plans of reorganization or liquidation usually are the result of extensive negotiations between the debtor and creditor constituencies. It is important that products claimants express their views on the plan even though this may be difficult.

Although the United States Trustee will have appointed an official committee of unsecured creditors,(29) the committee may be composed of trade creditors whose interests differ from those of personal injury claimants. For example, trade creditors may be more interested in keeping the debtor alive to have a continuing customer than in receiving maximum dollars on their claims.

If there are many personal injury claims, a group of claimants may request that the court order the U.S. trustee to appoint a separate committee of personal injury claimants.(30) The committee would be entitled to retain counsel whose fees would be paid by the bankruptcy estate.(31)

If a committee is appointed, it can play a valuable role in protecting the rights of these claimants. It is important that the plan be structured to encourage swift and fair settlement or litigation.

This can be difficult. For example, it is not unusual for a plan to provide that a products liability claimant will have a general unsecured claim either (1) up to the limit of a per occurrence self-insured retention (that is, the deductible that the company must pay on each claim) or (2) as a pro rata share of a claim in the amount of an aggregate self-insured retention for a policy year. Once the self-insured retention has been satisfied, the claimant can be paid.

The effect of such a provision, which is unavoidable in some cases, is that a claimant will have some part of the claim satisfied in "bankruptcy dollars." This amount could be as low as a few pennies on the dollar or as high as twenty-five or fifty cents on the dollar. The rest would be satisfied in "real dollars" through insurance proceeds. It is difficult to reach settlements where claimants will not know until all claims in a policy year have been settled what part, if any, of the claim will be paid in real dollars.

In some cases the insurers will have been a part of the plan negotiation process and have agreed to the plan. If they have not been involved, however, there is the risk that the insurer will insist that the self-insured retention can only be satisfied in real dollars--not bankruptcy dollars. Products liability claimants and their lawyers should have input on these issues so that they are adequately addressed in the plan.

The plan will be accompanied by a disclosure statement. This statement gives information about the debtor and the plan that a typical claimant needs to make an informed decision on accepting or rejecting the plan.(32) Unfortunately, many disclosure statements are difficult to understand. You should review the plan's treatment of personal injury claims to determine what steps you must take to liquidate your client's claim.

Some plans simply permit the claimants to resume litigation of the underlying action to liquidate the amount of the claim. Other plans may contain mandatory mediation provisions. In any event, know the steps you need to take to liquidate your client's claim if the plan is confirmed.

Voting and Payment

Creditors are entitled to vote on a plan. Voting is done by class. In order for a class of claims to accept a plan, the plan must be accepted by creditors that hold at least two-thirds in amount and more than one-half in number of allowed claims that have accepted or rejected the plan.(33) Abstaining from voting has no impact on whether the plan will be accepted or rejected. Before deciding, you should review the plan and disclosure statement with an eye to its workability in liquidating personal injury claims, in addition to what percentage payment your client will receive.

All unsecured creditors will receive the same percentage payment on their claims. The payment will either be a fixed percentage of each claim, or simply a pro rata amount of funds remaining after payment of secured claims and priority claims. The debtor does not have the flexibility under the Bankruptcy Code to treat personal injury claimants more favorably than other unsecured creditors are treated.

All unsecured creditors will be required to take some discount on their claims, often a severe discount. Where a personal injury claim is covered in part by liability insurance, the discount will be taken only on the uninsured part of the claim.

The bankruptcy process should not be one from which nonbankruptcy practitioners hide, but one whose basics they should seek to understand. A basic knowledge of the claims process, the function of the automatic stay, the categorization of claims, and the confirmation process will provide the tools to best maximize your client's recovery against a defendant in bankruptcy.

Notes

(1)In re Pettibone Corp., 156 B.R. 220, 229 (Bankr. N.D. Ill. 1993).

(2)11 U.S.C. [sections]362(a) (1988).

(3)Official Form No. 9 in BANKRUPTCY CODE, RULES & OFFICIAL FORMS 836-843 (1994).

(4)See, e.g., In re Pettibone Corp., 156 B.R. 220, 228.

(5)FED. R. BANKR. P. 3002(c).

(6)Official Form No. 10 in BANKRUPTCY CODE, supra note 3, at 846.

(7)11 U.S.C. [sections]502(a).

(8)FED. R. BANKR. P. 3007.

(9)See FED. R. BANKR. P. 9006(b)(1); Pioneer Inv. Serv. Co. v. Brunswick Assocs. L.P., 113 S. Ct. 1489, 1491-92 (1993).

(10)Ellis v. Consolidated Diesel Elec. Corp., 894 F.2d 371, 372 (10th Cir. 1990); Phoenix Bond & Indem. Co. v. Shamblin (In re Shamblin), 878 F.2d 324, 327 (9th Cir. 1989); Smith v. First Am. Bank, N.A, (In re Smith) 876 F.2d 524, 526 (6th Cir. 1989).

(11)Fortier v. Dona Anna Plaza Partners, 747 F.2d 1324, 1330 (9th Cir. 1984); Wedgeworth v. Fibreboard Corp., 706 F.2d 541, 544 (5th Cir. 1983); Pitts v. Unarco Indus., 698 F.2d 313, 314 (7th Cir.), cert. denied, 464 U.S. 1003 (1983).

(12)11 U.S.C. [sections]362(d).

(13)See, e.g., Holtkamp v. Littlefield (In re Holtkamp), 669 F.2d 505, 508-09 (7th Cir. 1982). Cf. Owaski v. Jet Fla. Sys., Inc. (In re Jet Fla. Sys., Inc.), 883 F.2d 970, 976 (11th Cir. 1989) (injunction against pursuing discharged claims post-confirmation modified to permit plaintiff to seek determination of debtor's liability so as to seek recovery from debtor's liability insurer).

(14)FED. R. BANKR. P. 3003(c)(2).

(15)FED. R. BANKR. P. 9014.

(16)28 U.S.C. [sections]157(b)(5) (1988).

(17)See Citibank, N.A. v. White Motor Corp. (In re White Motor Credit), 761 F.2d 270, 274 (6th Cir. 1985).

(18)11 U.S.C. [sections]507, 726.

(19)11 U.S.C. [sections]503(b)(1), 507(a)(1).

(20)Reading Co. v. Brown, 391 U.S. 471 (1968).

(21)11 U.S.C. [sections]362(a)(1).

(22)See Pettibone Corp. v. Ramirez (In re Pettibone Corp.), 90 B.R. 918, 930 (Bankr. N.D. Ill. 1988).

(23)28 U.S.C. [sections]959(a).

(24)28 U.S.C. [sections]1409(e).

(25)In re Jartran, Inc., 732 F.2d 584, 586-87 (7th Cir. 1984).

(26)See Reading Co., 391 U.S. 471, 485.

(27)Pettibone Corp., 90 B.R. 918, 934.

(28)Id. at 933.

(29)11 U.S.C. [sections]1102(a)(1).

(30)11 U.S.C. [sections](a)(2).

(31)11 U.S.C. [sections]1103(a).

(32)11 U.S.C. [sections]1125(a).

(33)11 U.S.C. [sections]1126(c).