Bankruptcy Judge Jennie D. Latta of the United States Bankruptcy Court, Western District of Tennessee, Western Division recently held that an individual chapter 7 debtor lacks standing as a party in interest to object to proofs of claim filed against the individual’s bankruptcy estate.
In the matter, In re Jack W. Harang, Case No. 18-24543, the debtor commenced a chapter 7 case, listing liabilities well in excess of assets. A creditor and the creditor’s law firm filed proofs of claim for over $1,000,000 based on a judgment entered against the debtor in separate litigation. In addition to these claims, the United States Treasury filed a proof of claim for over $1,000,000, a portion of which was entitled to priority.
The debtor filed objections to the claims asserted by the creditor and law firm. At a pretrial conference, the creditor and law firm raised the question of whether the debtor had standing to object to proofs of claim. The Trustee indicated that since there would likely be no assets available for distribution given the filed claims, it would not be prudent to initiate claims objections.
The Court began its analysis at Section 502(a) of the Bankruptcy Code to determine who has standing to object to a proof of claim. Section 502(a) provides that “a claim or interest, proof of which is filed under section 501 of this title, is deemed allowed, unless a party in interest … objects.” 11 U.S.C. § 502(a). While the term “party in interest” is not defined in the Bankruptcy Code, Courts generally understand it to mean that the party has a pecuniary interest in the outcome of the controversy. Judge Latta indicated that “in most cases, the chapter 7 trustee has standing to object to proofs of claim and the debtor does not.” In some cases where the Chapter 7 debtor’s filed claims are less than scheduled, the debtor’s pecuniary interest in reducing amounts paid to administrative and non-dischargeable claims is clear, as he may then expect funds to be returned. In an alternate scenario, if the debtor has only dischargeable debts, then reducing the amounts paid to any one claim means that more creditors can be satisfied by estate funds without the sale of personal property. The Court emphasized that in many cases there are insufficient assets in the chapter 7 estate to pay creditor claims, leaving no funds for the debtor that would grant a pecuniary interest in the outcome of a claim objection.
Despite this general rule, Judge Latta cited two exceptions where a chapter 7 debtor may have standing to object to a proof of claim: (1) where assets are more than sufficient to pay all administrative expenses and creditors in full, or (2) where the claim involved may not be discharged. In addition to these exceptions, Judge Lotta indicated that some courts in New York and Michigan, have expanded the second exception to allow debtors to object to a claim for administrative expenses if any of the claims against the estate are non-dischargeable. The reasoning for this exception is that reducing the amount of administrative expenses to be paid from estate funds would result in a higher distribution to creditors, thereby reducing the debtors’ liabilities on non-dischargeable claims. In these courts, the debtor objected to the trustee’s claim for fees or expenses. Judge Lotta held that it would not be reasonable to expect that a Trustee would object to their own fee application, therefore the debtor would be the only person with a pecuniary interest in such a controversy.
While the Court of Appeals for the Sixth Circuit had not addressed the narrow issue before, Judge Latta looked to the unpublished decision, Khan v. Regions Bank (In re Khan), 544 Fed. Appx. 617 (6th Cir. 2013), where the court addressed the question of standing in order to determine whether a debtor was a party in interest under Section 502(a). The bankruptcy court had held that the debtor had no reasonable possibility of receiving a surplus once all claims were paid and thus was not a “party in interest” under Section 502(a). The debtor in Khan then appealed the bankruptcy court’s decision to the district court, which dismissed the appeal based on the debtor’s lack of appellate standing under the “person aggrieved standard.” Although the question of whether a debtor with non-dischargeable debts can object to a proof of claim was not before the court, the Court of Appeals explained that in order to be considered a “person aggrieved,” the petitioner must demonstrate a financial stake in the order, or, that the person is “directly and adversely affected pecuniarily by the order.” Khan, 544 Fed. Appx. at 619.
Because of the Sixth Circuit’s emphasis that the “person aggrieved standard” required a direct pecuniary interest in the outcome of an appeal, Judge Latta held that the bankruptcy court should adopt similar standards for similar issues. The Court did not want to institute different standards for similar issues where, for example, a debtor might face one standard to establish standing to object to a proof of claim and another standard to appeal the bankruptcy court’s order denying standing. Judge Latta believed if the question were to come before the Court of Appeals, the Court would apply the “person aggrieved standard” to determine whether a debtor has standing to object to a claim when his only interest is potentially increasing payment to other creditors and reducing his liability on non-dischargeable claims. While this is a pecuniary interest, it would be remote rather than a direct interest and would allow a debtor to object to claims whenever there is even one non-dischargeable claim. Granting such broad and remote interest as debtor’s standing to object to claims could disrupt the orderly administration of bankruptcy cases constructed under the Code.
The debtor in In re Jack W. Harang conceded the remoteness of his interest in the disputed claims and did not directly respond to creditor objections about standing. The Court held that the debtor’s objection regarding the basis for the claims would have been raised by the Trustee if had the Trustee decided to litigate the claim objections. For these reasons, Judge Latta overruled the debtor’s objections, and did not allow the debtor to independently review the claims of the creditor and law firm.
As more individuals look to bankruptcy to remedy effects resulting from the Covid-19 pandemic, both debtors and creditors need to understand the rights afforded to them under the Bankruptcy Code, including standing to object to claims. Given the split of legal authority, parties should seek experienced bankruptcy counsel to determine whether non-dischargeable debt gives an individual chapter 7 debtor standing to object to creditor claims.