Bankruptcy Litigation Committee

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Second Circuit Imparts Some Tender Loving Care on Reconsideration of Settled Claims

Deadlines may lead to unwelcome results, but they prompt parties to act and they produce finality. Taylor v. Freeland & Kronz, 503 U.S. 638 (1992)

It is well settled that bankruptcy courts, as courts of equity, have the power in many circumstances to reconsider previous orders. Some of these “motions for reconsideration” are made pursuant to 11 U.S.C. §502(j), which states, “[a] claim that has been allowed or disallowed may be reconsidered for cause” on the grounds of mistake of law or fact. Motions for reconsideration are governed in bankruptcy cases by Federal Rule of Bankruptcy Procedure 9024, which incorporates—with certain exceptions—Rule 60 of the Federal Rules of Civil Procedure (FRCP). One exception is that a motion for reconsideration of an order allowing or disallowing a claim against the estate, which is entered “without a contest,” is not subject to the one-year limitation set forth in FRCP 60(c).
The Second Circuit Court of Appeals recently clarified the law and incentivized settlement agreements among parties in bankruptcy cases by holding that an objection to a claim automatically deems that claim contested, rendering applicable the time-limits of FRCP 60(c) to motions for reconsideration of claims. Jackson v. Tender Loving Care Liquidation Trust (In re Tender Loving Care Health Services Inc.), 562 F.3d 158 (2d Cir. 2009).

TLC's Bankruptcy Case
Prior to filing for chapter 11 relief in 2002, Tender Loving Care Health Care Services Inc. (TLC) issued a promissory note agreeing to pay Roger Pleasant $1.58 million plus interest by Sept. 1, 2010. The promissory note gave Mr. Pleasant the option to call the entire amount outstanding in the event of a missed payment. TLC missed a payment and subsequently filed for bankruptcy protection. Pursuant to the promissory note, Mr. Pleasant filed a $1.97 million proof of claim in the debtor’s bankruptcy proceeding.

TLC filed an objection to the claim, contending that the proper amount owed to Mr. Pleasant was $1.43 million, not the $1.97 million reflected in the proof of claim. TLC and Mr. Pleasant subsequently entered into settlement negotiations, and both parties agreed on a value of $1.78 million. TLC factored the claim of $1.78 million into their plan of reorganization.

The claim was finalized in December 2004 when the U.S. Bankruptcy Court for the Eastern District of New York confirmed TLC’s plan. Among other things, the plan also created the TLC Liquidation Trust to be the successor-in-interest to the debtors. The trustee determined the payment of $1.78 million to be excessive because the amount included postpetition interest, running afoul of §502(b)(2) of the Bankruptcy Code. Consequently, in June 2006, the trustee paid Mr. Pleasant $1.68 million, reflecting the trustee’s calculation of the correct amount owed on the claim. One month later, Mr. Pleasant filed a motion to compel payment of the difference. The trustee filed a cross-motion for reconsideration under Rule 9024 and reduction of the value of the claim.

The bankruptcy court decided to reconsider the claim, determining that the trustee properly paid Mr. Pleasant. The bankruptcy court held that “it is indisputable that this claim is materially and erroneously overstated” because the claim included unmatured postpetition interest on an unsecured pre-petition claim.

The bankruptcy court further held that the trustee's motion for reconsideration was timely because Rule 9024 contains an exception to the one-year statute of limitation for claims that are entered “without a contest.” The court acknowledged that the debtors filed an objection. However, the court held that the claim was “without a contest” since the debtors and Mr. Pleasant entered into a settlement agreement before the bankruptcy court entered an order with respect to the objection, triggering the Rule 9024 exception as mandated by FRCP 60(c). The district court affirmed.

The Second Circuit’s Decision
The Second Circuit Court of Appeals reversed in a per curiam decision, concluding that the objection filed by the debtor deemed the claim “contested,” and therefore applied the one-year time limit to the Motion for Reconsideration. The court examined the reasoning behind Rule 9014, which governs “contested matters.” Rule 9014 provides that "[i]n a contested matter…relief shall be requested by motion, and reasonable notice and opportunity for hearing shall be afforded the party against whom relief is sought. No response is required under this rule unless the court directs otherwise.” (Emphasis added by the court.) The court then noted the Advisory Committee Notes to Rule 3007, which provide that a contested matter initiated by an objection to a claim is governed by Rule 9014. These two rules together led the court to conclude that “[t]he critical factor in our Rule 9024 analysis is that the claimant filed a proof of claim and the Debtors filed an objection to it,” which triggered the contest and, in turn, triggered the tolling of the FRCP 60(c) time limit for reconsideration of claims.

Finally, the court cited the oft-quoted Supreme Court ruling of Taylor v. Freeland & Kronz, that in bankruptcy cases, “[d]eadlines may lead to unwelcome results, but they prompt parties to act and they produce finality.” 503 U.S. 638 (1992).

Implications
In addition to clarifying the law, the Second Circuit intended to promote settlement agreements with this ruling. Settlement agreements between debtors and creditors are crucial in any bankruptcy proceeding. Affirming the lower courts’ decision would have reached back three years to unravel a consensual settlement agreement. The Second Circuit noted that failure to apply the one-year time limit would “create a significant disincentive to parties settling disputed claims because such settlements could be challenged well beyond a year later.”

Since claim objections act as a catalyst for the filing party to enter into settlement agreements, many settlements occur only after the debtor files an objection to the claim. Thus, this decision will have broad applicability in bankruptcy cases by promoting settlement agreements and removing stale challenges to the finality of those agreements in bankruptcy cases.