On October 25, 2013, the US Bankruptcy Court for the Northern District of Illinois, in In re Batista-Sanechez, ruled that a secured creditor that filed its proof of claim late would be permitted to retain its lien on the property underlying its claim. However, the Bankruptcy Court also ruled that the secured creditor lost its right to vote on and receive a distribution under the debtor's plan of reorganization. Therefore, the Court held that if the secured creditor was placed it own class, it would be deemed to have rejected the plan. Given this dissenting class, the plan could only be confirmed under the Bankruptcy Code's cramdown provisions.

In December 2012, Jesus Enrique Batista-Sanechez (Debtor) filed a petition for Chapter 11 bankruptcy. In January 2013, SunTrust Mortgage, Inc. (SunTrust) filed a motion for relief from the automatic stay. The Bankruptcy Court ordered the stay to remain in effect until the plan confirmation hearing. The claims bar date was set for March 11, 2013. SunTrust filed its proof of claim on April 17, 2013, which asserted a claim secured by a senior mortgage on the Debtor's real property.

The Debtor filed an objection to SunTrust's proof of claim, arguing that it should be disallowed because SunTrust filed its proof of claim after the bar date.

Conceding that it filed its proof of claim late, SunTrust argued that its proof of claim should not be disallowed because, among other things:

The Bankruptcy Court held that SunTrust's proof of claim would be disallowed, but that its lien would survive.

First, the Bankruptcy Court noted that SunTrust's arguments that its lien could not be avoided merely because of a late-filed claim were unrelated to whether its claim must be allowed. It also rejected the argument that disallowance of the claim would be an excessive punishment, citing Seventh Circuit authority that excessive punishment would be the extinguishment of the lien, not the disallowance of the claim (see In re Tarnow).

Second, the Bankruptcy Court held that SunTrust's motion for relief of stay was not an informal proof of claim. The Bankruptcy Court noted that within its jurisdiction (the Seventh Circuit), the informal proof of claim doctrine is very narrow. According to the Bankruptcy Court's previous decision in In re MarchFIRST, the doctrine only applies when a "creditor timely files a document that is meant as a proof of claim but is somehow defective or incomplete." In this case, the Bankruptcy Court could not apply the doctrine because SunTrust's motion to lift the stay was not meant to be a proof of claim, but a request to proceed outside of bankruptcy. Therefore, SunTrust's late-filed proof of claim was not rescued by an earlier informal proof of claim.

Third, the Bankruptcy Court ruled that extinguishing SunTrust's lien would require a nonsensical reading of section 506(d) of the Bankruptcy Code. Section 506(d) provides that to the extent a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void unless the claim is not allowed only due to the failure of the creditor to file a proof of claim. It is nonsensical to void a lien because a creditor filed a late proof of claim, but not if the creditor failed to file a proof of claim at all. The Court cited Fourth and Seventh Circuit precedents which held that filing a late proof of claim was not grounds for extinguishing valid liens (see In re Hamlett and In re Penrod). Therefore, the Bankruptcy Court permitted SunTrust to retain its lien.

Finally, the Bankruptcy Court held that under Federal Rule of Bankruptcy Procedure 3003(c)(2), SunTrust lost its right to vote on and receive a distribution under the plan due to its failure to file a timely proof of claim. Discussing the consequences of this on plan confirmation, the Court explained that under sections 1122 and 1123 of the Bankruptcy Code, SunTrust's claim must still be classified even though it was disallowed. The Court held that if SunTrust's claim was classified in its own class, this class could not vote and should be deemed to have rejected the plan. Given this dissenting class, the Court noted that the plan could only be confirmed under the Bankruptcy Code's cramdown provisions.

Secured creditors should not rely solely on their liens to protect their interests during bankruptcy. As this case demonstrates, while filing a proof of claim is not necessary to preserve a secured creditor's lien on its collateral, it is necessary to preserve its claim and its right to participate in the plan confirmation process.

For more information on filing a proof of claim, see Practice Note, Filing a Proof of Claim in a Chapter 11 Bankruptcy Case.