INFORMAL PROOFS OF CLAIM

PCFS Financial v. Spragin (In re Nowak), 2008 WL 1924974 (B.A.P. 6th Cir. 2008). The debtors executed a mortgage in favor of PCFS on their residence. Three years later when they filed bankruptcy, the trustee filed a complaint to avoid the lien of PCFS on the basis that the mortgage was not executed in accordance with the laws of the State of Ohio. The Bankruptcy Court entered an order avoiding the lien, and PCFS appealed to the B.A.P., which certified to the Ohio Supreme Court a question concerning the constitutionality of former Ohio Revised Code § 5301.234, a statute which purported to preserve mortgages notwithstanding certain irregularities. After the Ohio Supreme Court issued its opinion concluding that the statute was unconstitutional, the B.A.P. affirmed the Bankruptcy Court’s decision avoiding PCFS’s lien.

While the adversary proceeding was pending, the trustee filed a notice of intent to sell and a motion to avoid lien, claim, or encumbrance, whereby she proposed the sale, free and clear of PCFS’s lien, of the debtors’ residence on the basis that PCFS’s lien was in bona fide dispute. PCFS objected. Additionally, PCFS filed a motion for relief from stay and abandonment. The Bankruptcy Court overruled PCFS’s objection to the trustee’s sale motion, and PCFS withdrew its stay relief motion. While the adversary proceeding was on appeal, the trustee filed an amended sale notice, and PCFS did not object.

Upon the filing by the trustee of her final report, PCFS filed an objection and motion to allow informal proof of claim, requesting that the Court consider collectively as an informal proof of claim its previously filed motion for relief from stay pleadings and its filings in the adversary proceeding. The Bankruptcy Court overruled PCFS’s objection and denied its motion.

In reviewing whether an informal proof of claim existed, the B.A.P. applied the five-factor Sixth Circuit test as set forth in In re N.J. Waterman & Assocs., Inc.¸ 227 F.3d 604 (6th Cir. 2000). In order to constitute an informal proof of claim, this test states that: (1) the proof of claim must be in writing; (2) the writing must contain a demand by the creditor on the debtor’s estate; (3) the writing must express an intent to hold the debtor liable for the debt; and (4) the proof of claim must be filed with the Bankruptcy Court. Only if the filing meets all these criteria, then may the court consider whether, as a fifth element, it would be equitable to allow the amendment of the informal proof of claim. Thus, the first four factors are indicative of the proposed claim’s validity, and the fifth factor answers the question whether the amendment should be allowed once the informal proof of claim is determined to be valid.

On appeal, the B.A.P. found that the objection filed by PCFS to the trustee’s proposed sale, its motion for relief from stay pleadings, and its defense of the adversary proceeding all evidenced a representation that the debtors were indebted to it and that PCFS was seeking to hold the debtors’ estate liable for the debt. The objection estimated the current balance on the promissory note and the stay relief motion set forth the exact outstanding balance, the same as if PCFS were filing a proof of claim. PCFS had attached a copy of its promissory note from the debtors to its objection to the trustee’s proposed sale and to its motion for relief from stay. Thus, all the information that PCFS would have been required to include in a formal proof of claim had been set forth in the stay relief motion and other documents.

However, the B.A.P. found that deference must be given to a bankruptcy court’s judgment regarding whether the allowance of an informal proof of claim would be equitable. In concluding that the allowance of PCFS’s informal claim would be inequitable, the Bankruptcy Court considered PCFS’s lack of explanation for its failure to timely file a proof of claim. The Court also took into account that, contrary to other creditors who had only three months notice to file proofs of claim, PCFS had over four years to file its claim, from the time the trustee first filed the complaint to avoid PCFS’s lien to 30 days after the judgment in the adversary proceeding as affirmed by the B.A.P. became final. Additionally, but for PCFS’s claim, other creditors, who timely followed the rules, would receive payment in full plus interest. However, if PCFS’s claim were allowed, the Bankruptcy Court found that these creditors would receive less than a third of their claims, without interest, while PCFS would receive the bulk of the distribution. Thus, the B.A.P. concluded that the Bankruptcy Court’s rejection of this outcome had not been unreasonable and was not an abuse of discretion. The B.A.P. affirmed the Bankruptcy Court’s decision, and therefore, PCFS’s informal proof of claim was not allowed.