Secured Creditors Must File Timely Proofs of Claims to be Paid: Seventh Circuit

The Seventh Circuit¹ just issued an opinion holding that if secured creditors wish to participate in Chapter 13 bankruptcy plan distributions, they must not only file a secured proof of claim, but also file it in a timely manner.² Up until now, it was widely held that the proof of claims deadline only applied to unsecured claims.³

This is especially important in the Northern District of Illinois because the practice has been that if a secured creditor was provided for in the plan with monthly payments from the Chapter 13 trustee, that creditor did not need to file a claim to get paid.

Now, if a secured creditor does not file a claim by the deadline, not only will that creditor not be paid for the duration of the plan, a debtor or the trustee may object to the claim and have it disallowed. Most importantly, secured creditors who fail to timely file a proof of claim would not be entitled to relief from stay for default in payments. 

This will not have any effect on the lien as the lien will survive the bankruptcy.  But, what will the value of your collateral be at the end of a five year plan?  Secured creditors with vehicle claims will be most affected because the collateral is sure to depreciate over five years, and the recovery of the vehicle at the end of the plan will almost certainly not be sufficient to meet the balance on the debt.

How will this affect mortgage claims?  If the claim is to be paid by the trustee, the mortgage proof of claim must be filed timely or that mortgage will not be paid for the duration of the plan. What would be the effect of disallowance of a mortgage proof of claim?  Would the debt be discharged and leave the creditor with only the property to satisfy its claim?  If a mortgage claim is treated as long-term debt, would the disallowance of the claim have no affect on the debtor’s liability to pay the note?

What if the plan provides that the debtor is to pay the secured creditor directly?  Must a claim be filed in order to receive payments directly from the debtor and not the trustee?

These are answers that courts will have to answer in the future.  In fact, courts nationwide will be answering them if the U.S. Judicial Conference’s Advisory Committee’s proposed rules are adopted by the Supreme Court.  Those rules would specifically provide that both secured and unsecured creditors must file timely proofs of claims to be paid, but if a secured creditor failed to file claim, its lien would survive the bankruptcy.  The Seventh Circuit is merely adopting by case law a probable amendment to the Bankruptcy Rules.

Obviously, the only acceptable practice for secured creditors in the Seventh Circuit is to start filing timely secured claims immediately to ensure payment in Chapter 13 bankruptcies.  This applies to all cases where the claims deadline has not passed. 

If the case is not in the Seventh Circuit, it would be wise to establish procedures now to file secured claims within the claims deadline now, in advance of the amendment to the Federal Bankruptcy Rules.