One Bite at the Apple: Section 502(e)(1)(B) and the Disallowance of Redundant, Contingent Claims
Section 502(e)(1)(B) of the Bankruptcy Code allows debtors to seek disallowance of certain types of contingent claims to avoid being twice liable on a single obligation. It has the added benefits of facilitating debtors’ efficient exit from bankruptcy and ensuring that unsecured creditors are paid in a timely fashion. Debtors commonly seek Section 502(e)(1)(B) relief for claims involving environmental remediations or tort lawsuits, for example personal injury actions. They might also seek such relief in instances where they are guarantors on a debt or where contractual arrangements render them co-liable on an obligation.
Specifically, Section 502(e)(1)(B) provides that a court “shall disallow any claim for reimbursement or contribution of an entity that is liable with the debtor on or has secured the claim of a creditor, to the extent that . . . such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance of such claim for reimbursement or contribution.” 11 U.S.C. § 502(e)(1)(B). While the Bankruptcy Code does not define many of these terms, In re Lyondell Chem. Co., 442 B.R. 236, 243 (Bankr. S.D.N.Y. 2011), courts interpreting the section consider:
- Whether the claim in question is for reimbursement, contribution, or indemnification;
- Whether the claimant is co-liable with the debtor on the claim of a third party, for example by way of a guaranty; and
- Whether the claim remains contingent at the time that claims are allowed or disallowed.
Id.; In re Chemtura Corp., 436 B.R. 286, 292-93 (Bankr. S.D.N.Y. 2010); In re Caribbean Petroleum Corp., Case No. 10-12553 (KG), 2012 WL 1899322, at *3 (Bankr. D. Del. May 24, 2012) (finding that a claim for indemnification is “functionally the same as [a] claim for reimbursement or contribution”); Denke v. PNC Bank, N.A. (In re Denke), 524 B.R. 644, 655 (Bankr. E.D. Va. 2015) (citing 4 Collier on Bankruptcy ¶ 502.06[d] (16th ed. 2014) for the proposition that Section 502(e)(1)(B) “is applicable to a debt owed by the debtor to a creditor which has been guaranteed by a third party”).
The goal of Section 502(e)(1)(B) is to prevent “redundant recoveries on identical claims against insolvent estates in violation of the fundamental [Bankruptcy] Code policy fostering equitable distribution among all creditors of the same class.” In re Caribbean Petroleum Corp., 2012 WL 1899322, at *2. Section 502(e)(1)(B) also enables debtors to move forward with distributions to unsecured creditors without forcing them to establish a reserve for contingent claims which might take years to litigate or settle. Id. (citing In re Wedtech Corp., 85 B.R. 285, 290 (Bankr. S.D.N.Y. 1988)).
Courts interpret co-liability under Section 502(e)(1)(B) broadly. The inquiry involves whether a debtor could be co-liable with a third party on an underlying claim, not whether a debtor is “automatically” liable. In re Chemtura Corp., 436 B.R. at 295 (citing In re Amatex Corp., 110 B.R. 168, 171 (Bankr. E.D. Pa. 1990) (“Congress clearly meant to include all situations wherein indemnitors or contributors could be liable with the debtor within the scope of § 502(e)(1)(B).”)); In re Caribbean Petroleum Corp., 2012 WL 1899322, at *2 (“coliability encompasses all possibilities for shared liability, whether judicially, contractually or statutorily created”)(citations omitted). In instances where a debtor is allegedly co-liable with a third party pursuant to a statutory authority, courts must consider the statute underlying the alleged liability. See In re Lyondell Chem. Co., 442 B.R. at 244.
A contingent claim, by definition, is “a claim which has not yet accrued and which is dependent upon some future event that may never happen.” In re Denke, 524 B.R. at 655. Courts construe claims for reimbursement or contribution to remain contingent until a co-liable third party has both incurred liability and actually made payments in satisfaction thereof. In re Caribbean Petroleum Corp., 2012 WL 1899322, at *3 (citing In re APCO Liquidating Trust, 370 B.R. 625, 631 (Bankr. D. Del. 2007); In re Pinnacle Brands, Inc., 259 B.R. 46, 55 (Bankr. D. Del. 2001); Aetna Cas. and Sur. Co. v. Georgia Tubing Co., 93 Civ. 3659 (LAP), 1995 WL 429018, at *2 (S.D.N.Y. July 20, 2005); In re Global Indus. Tech., Inc., 327 B.R. 230, 233 (Bankr. W.D. Pa. 2005)). The determination as to whether a claim is contingent is made at the time of allowance or disallowance. Id.
Some courts even propose that Section 502(e)(1)(B) applies where the party with the claim underlying the contribution claim has not filed a proof of claim, i.e. when the possibility that a debtor would be forced to pay twice on the claim has already been eliminated. In re Chemtura Corp., 436 B.R. at 294. Those courts reason that a co-liable third party would not be prejudiced by the disallowance of its contribution claim under these circumstances in light of the fact that Section 501(b) and Rule 3005(a) of the Federal Rules of Bankruptcy Procedure provide such a co-liable third party thirty (30) days to file a surrogate proof of claim on behalf on a non-filing claimant from the passage of the bar date. Id. at 294-95.
In sum, Section 502(e)(1)(B) offers important protections to debtors and unsecured creditors. As such, debtors and potential debtors should be alert to situations in which they are guarantors on debts or in which they are potentially co-liable on claims and should advise their bankruptcy counsel of creditors who they anticipate may file claims for reimbursement, contribution, or indemnification resulting from such co-liabilities. Bankruptcy counsel, in turn, should scrutinize claims and work closely with their clients to determine whether to move for disallowance in light of Section 502(e)(1)(B). Such vigilance both protects debtors from making duplicative payments and increases returns and expedites the distribution process for all unsecured creditors.
As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.
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