The Bottom Line:
The failure to timely file a proof of claim can have significant ramifications on a creditor’s right. Recently, the Seventh Circuit in In the Matter of Richard Louis Alexander, 2011 U.S. App. LEXIS 17110 (7th Cir. Aug. 16, 2011), held that a secured creditor who is only looking to proceed with a foreclosure action against the mortgaged property need not file a proof of claim to protect its rights to the collateral. As such, the failure to file a proof of claim was irrelevant to the secured creditor’s request for relief from the automatic stay to pursue a state court foreclosure action.
Kondaur Capital Corporation (“Kondaur”) and Prime Asset Fund II (“Prime”) were assignees of a promissory note and mortgage on specified property executed by Richard Alexander. When Alexander defaulted on his obligations, Kondaur and Prime initiated foreclosure proceedings. After Alexander filed for bankruptcy, Kondaur and Prime filed motions seeking relief from the automatic stay to resume their foreclosure proceedings. Kondaur and Prime asserted that relief from the stay was warranted because their interests were not adequately protected. Notably, Alexander had failed to make monthly debt payments, had no equity in the properties, and did not plan to pay real estate taxes or insurance according to his proposed bankruptcy budget. The debtor also argued that the secured creditors could not proceed with the foreclosure action because they failed to file proofs of claim in the bankruptcy cases. The bankruptcy court held that cause existed for stay relief and no proof of claim need be filed to pursue remedies against the collateral.
On appeal, the Seventh Circuit dismissed the notion that filing a proof of claim was required in order to seek stay relief to proceed with a foreclosure action against the mortgaged property:
“A secured creditor need not file a ‘proof of claim’ unless the creditor wishes to take part in the distribution of estate assets; here the creditors sought to separate the mortgaged property from the bankruptcy estate and vindicate their claims in foreclosure proceedings in state court, as the bankruptcy code permits. See 11 U.S.C. § 506(d)(2); In re Penrod, 50 F.3d 459, 461 (7th Cir. 1995) (‘A secured creditor can bypass his debtor's bankruptcy proceeding and enforce his lien in the usual way, which would normally be by bringing a foreclosure action in a state court. This is the principle that liens pass through the bankruptcy unaffected.’); In re Pence, 905 F.2d 1107, 1110 (7th Cir. 1990).”
Why the Case is interesting:
The decision underscores that a secured creditor’s in rem rights against collateral can “ride through” the bankruptcy and a proof of claim is not necessary to preserve rights against the collateral itself. While filing a proof of claim is usually prudent, there may be strategic reasons why a creditor may wish to avoid doing so and, at least for secured creditors, the issue surrounds whether to preserve any deficiency or other unsecured claims.