I recently wrote about what a “claim” is in New York bankruptcy. The term appears frequently in the Bankruptcy Code (often in regards to chapter 13 cases), but claims usually characterized as “allowed” or “not allowed” (“disallowed”). What’s the difference here?
Section 502 of the Bankruptcy Code specifies that a claim is “allowed” if a proof of claim is filed for it. (Click here to read about what a proof of claim is.) Once allowed, the creditor has a right to payment out of the bankruptcy estate’s assets (if there are any), depending on the priority level of its claim. The debtor, trustee, and other creditors, have the right to object to a proof of claim, but if they do not do so, then the claim is allowed.
Okay, so what happens if a proof of claim is not filed for a debt in the bankruptcy case or it’s disallowed for some other reason? Answer: It depends on the nature of the claim.
If the claim is for a lower-priority debt, then if the claim is not filed on time or is successfully objected to, then it is disallowed. This means that the creditor does not get to participate in any distribution. In most circumstances, a disallowed claim is automatically discharged at the end of the bankruptcy case. However, whether the claim is allowed or not bears no relationship to its dischargeability. In other words, if a claim was not dischargeable to begin with or the debtor did not take the steps to make it dischargeable, e.g. filing a necessary pre-bankruptcy adversary proceeding, then the claim will not be discharged. The creditor just won’t get anything from the bankruptcy estate. The best example of this is student-loan debt.
A creditor that doesn’t file a proof of claim does not necessarily give the debtor an advantage. For instance, a nondischargeable, disallowed claim will linger after bankruptcy, after the assets in the bankruptcy estate went to unsecured creditors whose claims would have been discharged even if they had been disallowed too. In these situations, the debtor should seriously consider filing a proof of claim on behalf of the creditor with the nondischargeable claim.
Next, a creditor with a disallowed, secured claim might see its lien on the debtor’s collateral survive the bankruptcy. The law is complicated on this matter, but under section 506 of the Bankruptcy Code, if the secured creditor does not file a proof of claim, then its lien survives bankruptcy. Although the law doesn’t spell out what happens if a secured creditor files a late proof of claim, bankruptcy courts have held that these will be allowed too. There are other exceptions that prevent liens on secured claims being voided because they are disallowed. Conversely, claims that are disallowed for other reasons, such as deficiencies in the proofs of claim themselves, will result in voided liens.
Debtors often rejoice at seeing a creditor’s claim disallowed, but that’s not always the end of the story for creditors—or even in debtors’ best interests. Whether a claim is allowed only affects what creditors can receive from the bankruptcy estate. If you’re concerned about the validity of a creditor’s claim, then consulting with an experienced New York bankruptcy lawyer can help you assess your options.
For answers to more questions about claims, bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.
