Under chapter 11 of the United States Code (the Bankruptcy Code), claimants in a bankruptcy must file proofs of claim to participate in a reorganization and obtain any consideration from the estate. See Bankruptcy Rule 3003(c). Because the Bankruptcy Code contains no explicit provision authorizing the filing of a class proof of claim, whether a proof of claim could be filed on behalf of a class of individuals was a hotly disputed question up until the late 1980s, when the Seventh Circuit issued the landmark decision of In re American Reserve Co., 840 F.2d 487 (7th Cir. 1988) (Easterbrook, J.). As of the late 1980s, the majority of courts to consider the question did not allow class proofs of claim. See In re Standard Metals, 817 F.2d 625 (10th Cir. 1987), vacated and rev'd on other grounds sub nom. Sheftelman v. Standard Metals Corp., 839 F.2d 1383 (1987), cert. dismissed,488 U.S. 881, 109 S. Ct. 201, 102 L. Ed. 2d 171 (1988); In re Allegheny Int'l, Inc., 94 B.R. 877 (Bankr. W.D. Pa. 1988); In re Great W. Cities, Inc., 88 B.R. 109, 112 (Bankr. N.D. Tex. 1988); In re Vestra Indus., Inc., 82 B.R. 21, 22 (Bankr. S.C. 1987); In re Elec. Theatre Restaurants Corp., 57 B.R. 147 (Bankr. N.D. Ohio 1986); In re Cont'l Airlines Corp., 64 B.R. 874, 880 (Bankr. S.D. Tex. 1986); In re Computer Devices, Inc., 51 B.R. 471 (Bankr. D. Mass. 1985); In re Johns-Manville Corp., 53 B.R. 346 (Bankr. S.D.N.Y. 1985); In re Baldwin-United Corp., 52 B.R. 146, 147 (Bankr. S.D. Ohio 1985); In re Shulman Transp. Enters., Inc., 21 B.R. 548 (Bankr. S.D.N.Y. 1982), aff'd, 33 B.R. 383 (S.D.N.Y. 1983), aff'd,744 F.2d 293 (2d Cir. 1984); In re Soc'y of the Divine Savior, 15 Fed. R. Serv. 2d 294 (E.D. Wis. 1971). See also Secs. & Exch. Comm'n v. Aberdeen Secs. Co., 480 F.2d 1121, 1128 (3d Cir.), cert. denied, 414 U.S. 1111, 94 S. Ct. 841, 38 L. Ed. 2d 738 (1973) (affirming refusal to treat individual claims as part of a class action in a proceeding under old Bankruptcy Act and Securities Investor Protection Act of 1970, 15 U.S.C.A. §§ 78 et seq.); In re Stirling Homex Corp., 579 F.2d 206, 209 n.5 (2d Cir. 1978), cert. denied sub nom. Jezarian v. Raichle, 439 U.S. 1074, 99 S. Ct. 847, 59 L. Ed. 2d 40 (1979) (noting but not reaching district court's disallowance of bankruptcy claims to the extent made on behalf of class of claimants); In re Grocerland Coop., Inc., 32 B.R. 427 (Bankr. N.D. Ill. 1983) (dicta); In re Cartridge Television, Inc., 535 F.2d 1388 (2d Cir. 1976) (mooting bankruptcy court's ruling against class claim); In re U.S. Truck Co., Inc., 89 B.R. 618, 623 n.3 (E.D. Mich. 1988) (dicta); In re The Woodmoor Corp., 4 B.R. 186 (Bankr. D. Colo. 1980) (dicta).
Aside from the Bankruptcy Code's lack of express authorization allowing class proofs of claim, the other main reason why historically courts found that class proofs of claim should not be allowed is because the class procedures afforded by Rule 23 are already mimicked by the bankruptcy claim filing process. See In re Am. Reserve Corp., 840 F.2d at 490 (discussing whether class device should be applicable in bankruptcy proceedings as bankruptcy achieves benefits of consolidation of claims "without the need for class suits—class actions are a headache for judges"). The Seventh Circuit found that class proofs of claim were not per se invalid. In the wake of this decision, courts now routinely accept that proofs of claim can be filed on behalf of a class of individuals.
But there remain numerous and substantial hurdles to asserting a class claim in bankruptcy. The largest hurdle is that recognition of a class proof of claim is not automatic—the bankruptcy court has broad discretion to decide whether to allow the claim to proceed as a class claim. Generally, in determining whether to permit class treatment, a bankruptcy court will determine that
(1) the class claimant has moved to extend application of Rule 23 of the Federal Rules of Civil Procedure
(2) the benefits to be gained from the use of a class claim device are consistent with goals of bankruptcy such that the bankruptcy court should allow the application of Rule 23, and, if so,
(3) the claims sought to be certified fulfill the requirements of Rule 23.See In re Mortg. & Realty Trust, 125 B.R. 575, 580 (Bankr. C.D. Cal. 1991); In re CommonPoint Mortg. Co., 283 B.R. 469, 479 (Bankr. W.D. Mich. 2002); In re Tarragon Corp., No. 09-10555 DHS, 2010 WL 3842409, at *3 (Bankr. D.N.J. Sept. 24, 2010); In re Blockbuster Inc., 441 B.R. 239, 241 (Bankr. S.D.N.Y. 2011); In re Motors Liquid. Co., No. 09-50026(REG), 2011 WL 284933, at *4 (Bankr. S.D.N.Y. Jan. 28, 2011); In re Circuit City Stores, Inc., No. 08-35653, 2010 WL 2208014, at *7 (Bankr. E.D. Va. May. 28, 2010).
This article is a road map to plaintiffs' counsel and debtor's counsel to help them navigate the potential pitfalls and technical hurdles that arise when litigating class actions in bankruptcy.
Moving for Application of Rule 23 under Bankruptcy Rule 9014
A plaintiff who seeks to bring a class proof of claim must comply with the applicable procedural requirements. See, e.g., In re Am. Reserve Corp., 840 F.2d at 494 (noting applicability of Bankruptcy Rule 9014 and its procedural requirements); see In re Ephedra Prods. Liab. Litig., 329 B.R. 1, 6–7 (S.D.N.Y. 2005) (same). These procedural requirements are not complicated, but are often overlooked. As discussed in further detail below, because a claim "cannot be allowed as a class claim until the bankruptcy court directs that Rule 23 apply," the putative class representative must file a motion with the bankruptcy court requesting the application of Rule 23 pursuant to Bankruptcy Rule 9014. In re Woodward & Lothrop Holdings, Inc., 205 B.R. 365, 370 (Bankr. S.D.N.Y. 1997). As discussed below, class counsel should file this motion as soon as possible because if it is filed later in the bankruptcy process, the bankruptcy court may be less inclined to allow the class claim due to the risk of delay to the reorganization process and prejudice to the debtors and other creditors. Id. at 368, 370 ("Rule 23 does not say who must make a timely motion, but the duty ordinarily falls on the proponent of the class action.").
In addition, a purported agent (like class counsel or class representative) should consider filing a verified statement of multiple creditor representation pursuant to Bankruptcy Rule 2019. See Fed. R. Bankr. P. 2019. While failure to file a statement under Rule 2019 is unlikely to be fatal to a class claim, it may be necessary in some jurisdictions. In general, bankruptcy courts are loath to pour out class claims due to failure to comply with "hyper-technical" bankruptcy rule requirements. See, e.g., In re Charter Co., 876 F.2d 866, 873 (11th Cir. 1989) (holding failure to file Bankruptcy Rule 2019 statement was irrelevant because "[i]f class certification is appropriate, compliance with the class action procedures would satisfy the rule's objectives nunc pro tunc; and, on the other hand, if the bankruptcy judge exercises his discretion not to apply Rule 23, the question of compliance with 2019 is moot"); In re Craft, 321 B.R. 189, 198 (Bankr. N.D. Tex. 2005) ("[A] court decision certifying a class, in and of itself, satisfies the requirements of Rule 2019."); but see Reid v. White Motor Corp., 886 F.2d 1462, 1471 (6th Cir. 1989), cert. denied, 494 U.S. 1080 (1990) ("Failure to comply with Rule 2019 is cause for denial of the proof of claim."); In re Baldwin-United Corp., 52 B.R. at 148 (ruling that claimants' failure to comply with Rule 2019(a) barred their ability to file class proof of claim); In re GAC Corp., 681 F.2d 1295, 1299 (11th Cir. 1982) (affirming disallowance of class proof of claim filed on behalf of debtor's debenture holders where, among other things, proposed class representative failed to comply with the predecessor of Rule 2019).
The Court's Discretion to Apply Rule 23
There is no absolute right to file a class proof of claim under the Bankruptcy Code. See In re Bally Total Fitness of Greater N.Y., Inc., 402 B.R. 616, 619 (Bankr. S.D.N.Y.), aff’d, 411 B.R. 142 (S.D.N.Y. 2009); In re Sacred Heart Hosp., 177 B.R. 16, 22 (Bankr. E.D. Pa. 1995) (noting that class action device may be utilized in appropriate contexts, but should be used sparingly). Instead, application of Bankruptcy Rule 7023 (which provides that Rule 23 applies in adversary proceedings) to class proofs of claim lies within the sound discretion of the court. Part VII of the Bankruptcy Rules, which includes Bankruptcy Rule 7023 (the Bankruptcy Rule that incorporates Rule 23 of the Federal Rules of Civil Procedure), only applies to adversary proceedings. See Fed. R. Bankr. P. 7001. Bankruptcy Rule 9014 adopts certain of the rules from Part VII for application in contested matters. But Bankruptcy Rule 7023 is not among them. See Fed. R. Bankr. P. 9014. Thus, plaintiffs seeking the application of Bankruptcy Rule 7023 (and, by implication, Rule 23) to a class proof of claim are required to move under Bankruptcy Rule 9014 for a court to apply the rules in Part VII. See Fed. R. Bankr. P. 9014; accord In re Woodward, 205 B.R. at 369 (stating that "[f]or a Class Claim to proceed . . . the bankruptcy court must direct Rule 23 to apply"). See, e.g., Reid, 886 F.2d at 1470; In re Charter Co., 876 F.2d at 876 (holding that proof of claim filed on behalf of class of claimants is valid, but that "does not mean that the appellants may proceed, without more, to represent a class in their bankruptcy action. Under the bankruptcy posture of this case, Bankruptcy Rule 7023 and class action procedures are applied at the discretion of the bankruptcy judge."). In exercising that discretion, the bankruptcy court first decides under Bankruptcy Rule 9014 whether or not to apply Rule 23 to the purported class claim; if and only if the court decides to apply Rule 23 does it then determine whether the requirements of Rule 23 are satisfied.In re Ephedra Prods. Liab. Litig., 329 B.R. at 5.
When determining whether to apply Bankruptcy Rule 7023, courts focus on whether the benefits to be gained from the use of a class claim device are consistent with goals of bankruptcy. In making that determination, courts have considered a variety of factors, including, inter alia,
- whether claimants are in "compliance with the Bankruptcy procedures regulating the filing of class proofs of claim in a bankruptcy case" (See, e.g., In re Thomson McKinnon Secs Inc., 133 B.R. 39, 41 (Bankr. S.D.N.Y. 1991) (disallowing class proof of claim where named plaintiff failed to file Bankruptcy Rule 9014 motion requesting that Rule 7023 apply).
- whether the debtor intends to liquidate,see id. at 41 (noting that context of liquidating chapter 11 plan supports rejection of class proofs of claim)
- whether or not a purported class was previously certified (See, e.g., In re Bally Total Fitness, 402 B.R. at 620 (refusing to allow class proof of claim where class was not certified prepetition); In re Sacred Heart Hosp., 177 B.R. at 23 (classes certified prepetition are "best candidates" for class proof of claim).). A number of other courts have held that class proofs of claim may be inappropriate where a class was not certified pre-petition in a non-bankruptcy forum. See, e.g., In re Trebol Motors Distrib. Corp., 220 B.R. 500, 502 (B.A.P. 1st Cir. 1998); In re Ret. Builders, Inc., 96 B.R. 390, 391 (Bankr. S.D. Fla. 1988); In re Ephedra Prods. Liab. Litig., 329 B.R. at 5. However, the authors are not aware of any case within the Second Circuit in which a class proof of claim was allowed when the class was not certified prepetition.
- whether the class action has been filed and allowed to proceed as a class action in a non-bankruptcy forum for a considerable time prepetition (In re Sacred Heart Hosp., 177 B.R. at 22.
- whether the class claim device will result in "increased efficiency, compensation to injured parties, and deterrence of future wrongdoing by the debtor" (See In re Woodward, 205 B.R. at 376 (internal citations omitted); accord In re Thomson, 133 B.R. at 40 (“Manifestly, the bankruptcy court’s control of the debtor's affairs might make class certification unnecessary.").
- whether the entertainment of class claims would subject the administration of the bankruptcy case to undue delay (See, e.g., In re Ephedra Prods. Liab. Litig., 329 B.R. at 5 ("[A] court sitting in bankruptcy may decline to apply Rule 23 if doing so would . . . 'gum up the works' of distributing the estate.").
- whether or not adequate notice of the bar date was afforded to potential class members (See In re Jamesway Corp., No. 95 B 44821 (JLG), 1997 WL 327105, at *10 (Bankr. S.D.N.Y. June 12, 1997) (refusing to certify class where adequate notice of bar date was afforded to potential class members, and thus to certify class would be "unwarranted, unfair, and possibly violate the due process rights of other creditors") (internal quotations omitted).
The application of these factors by courts may differ across the circuits. For instance, there are some courts, notably in the Third Circuit, that seem to be more inclined to apply Rule 23. See, e.g., In re United Cos. Fin. Corp., 277 B.R. 596, 601 (Bankr. D. Del. 2002); In re Kaiser Grp. Int'l, Inc.,278 B.R. 58, 63–64 (Bankr. D. Del. 2002). These cases are in the minority and have been criticized by other courts. See In re Craft, 321 B.R. at 192 (criticizing Kaiser Group Int'l, Inc.). If the bankruptcy court denies application of Rule 7023 in an exercise of its discretion, the result will be that class claims will be denied and expunged. In re Thomson, 133 B.R. at 40–41.
The factor of whether or not a purported class was previously certified closely relates to the factor regarding whether the entertainment of class claims would subject the administration of the bankruptcy case to undue delay because a large certification battle could be costly to the estate and potentially delay confirmation of a plan and distributions to creditors. As a result, in some jurisdictions, such as the Second Circuit, this factor can be nearly dispositive. There are no published cases in the Second Circuit allowing class treatment for a proof of claim where the class was not certified pre-petition and the propriety of certification was in dispute. But in some other jurisdictions, courts are willing to permit class treatment where the class was not certified pre-petition. See, e.g., In re Mortg. & Realty Trust, 125 B.R. at 578 (permitting class claim where class was certified post-petition by district court); In re Kaiser Group Int'l, Inc., 278 B.R. at 64 (permitting class claim where class was not certified pre-petition). Further, decertification of a class or a denial of a pre-petition motion for class certification is grounds for denial of the application of Rule 23.See In re Blockbuster Inc., 441 B.R. at 242.
The question of whether the entertainment of class claims would subject the administration of the bankruptcy case to undue delay is possibly the most important, as delay of the administration of the bankruptcy estate stands to prejudice the debtor and other creditors. As stated in the In re Ephedra Productions Litigation decision, "a court sitting in bankruptcy may decline to apply Rule 23 if doing so would . . . 'gum up the works' of distributing the estate." In re Ephedra Prods. Liab. Litig., 329 B.R. at 5. In this regard, class counsel should not wait to file a motion under Bankruptcy Rule 9014 for application of Rule 23 until the debtor objects to the class claim, as doing so late in the bankruptcy proceedings or on the eve of plan confirmation may heighten the risk of prejudice to the debtor and other creditors and, thus, denial of the class claim. See In re Musicland Holding Corp., 362 B.R. 644, 654 (Bankr. S.D.N.Y. 2007) (citing In re Computer Learning Ctrs., Inc., 344 B.R. 79 (Bankr. E.D. Va. 2006)) (holding that motion to apply Rule 23 "should be filed as soon as practicable" and should be denied if it comes so late as to prejudice any party). There is some authority for the proposition that a class claimant need not assert a motion under Bankruptcy Rule 9014 for application of Rule 23 until the debtor objects to the claim. See In re Charter Co., 876 F.2d at 874. But this authority is at odds with the plain language of Rule 23, and has been roundly rejected by many courts. Fed. R. Civ. P. 23(c)(1)(A) (class certification decision should be made "at an early practicable time"); see In re Ephedra Prods. Liab. Litig., 329 B.R. at 7 (disagreeing and distinguishing In re Charter Co., and holding claimants had right to move for class certification from moment debtors' chapter 11 petition was filed); see also In re Musicland Holding Corp., 362 B.R. at 652 (where claimants moved for certification before debtor filed claim objection, court noted that claimants "could have made the motion sooner," and "[a]lthough the delay does not automatically disqualify the class claim, it bears on the exercise of the discretion whether to apply Rule 23"); In re Thomson, 133 B.R. at 40 (disallowing class claim for failure to file motion under Bankruptcy Rule 9014 because "the costs and delay associated with class actions are not compatible with liquidation cases where the need for expeditious administration of assets is paramount so that all creditors, including those not within the class, may receive a distribution as soon as possible").
With respect to defending class claims from a debtor's perspective, a good defense starts with a good offense. Adequate notice of the bar date (i.e., the claimants' deadline to file claims against the debtor's estate) is of the utmost importance. A bankruptcy court will be less inclined to disallow a class claim if doing so means that hundreds or thousands of individuals stand to be barred from asserting claims against the estate because they failed to file proofs of claim on their individual behalf; as a result, if there is a question as to whether notice of the bar date was adequate to these individuals, the bankruptcy court may require additional notice to be issued and extend the deadline to file individual claims. One of the principal goals of the Bankruptcy Code is to ensure that creditors of equal rank receive equal treatment in the distribution of a debtor's assets. Therefore, the Bankruptcy Code and Bankruptcy Rules require creditors to file proofs of claim before a bar date. See 11 U.S.C. § 502(b)(9); Fed. R. Bankr. P. 3003(c)(3). Regardless of how worthy their claims may be, claimants who fail to file before an applicable bar date "shall not be treated as a creditor with respect to such claim for the purposes of voting and distribution." Fed. R. Bankr. P. 3003(c)(2). But if the notice program is found to be adequate, there is authority holding that members of a putative class that was not certified prepetition cannot rely on the filing of a class claim to reserve their rights, and must file claims on their individual behalf. See In re Jamesway Corp., 1997 WL 327105, at *10 (denying motion for class certification of class claim where "[n]o class was pre-certified such that purported class members who did not choose to file a proof of claim should or could have had any reasonable expectation that they need not comply with the Bar Date Order").
In determining whether a class proof of claim should be allowed, courts consider whether adequate notice of the bar date was afforded to potential class members. See In re Jamesway Corp., 1997 WL 327105, at *8 ("The proper inquiry is whether [the debtor] acted reasonably in selecting means likely to inform persons affected by the Bar Date and these chapter 11 proceedings. . . ."). As with any good notice program, actual notice of the bar date should be as broad as reasonably practicable, and at a minimum include class counsel in pending class actions and class members whose identities and addresses are known or easily ascertainable by the debtor. In re Amdura Corp., 170 B.R. 445 (D. Colo. 1994) (stockholders' actual identities were known and addresses were "easily ascertainable" and could be obtained from class representatives); In re Am. Reserve Corp., 840 F.2d at 491 (stating that trial court judge "might consider" directing additional notice and invite individual proofs of claim as opposed to allowing class proof of claim where debtor insurance company could "identify its own policyholders without difficulty" to mail individuals notice). If the identities and addresses of class members are not known, notice by publication will likely be upheld as adequate. See Mullane v. Cent. Hanover Bank & Trust Co., 339 U.S 306, 317 (1950) (holding notice by publication is constitutional in the case of unknown persons, "however great the odds that publication will never reach the eyes of such unknown parties"). Further, while certain circumstances may warrant notice to foreigners, such as in the event putative class members likely reside outside the United States or the debtor was engaged in worldwide operations, there is authority holding that foreigners are not entitled to bar date notice. See Vancouver Women’s Health Collective Soc'y v. A.H. Robins Co., 820 F.2d 1359, 1363 (4th Cir. 1987) (affirming denial of motion to extend or abolish bar date for foreign claimants because "[t]he Constitution does not extend its guarantees to nonresident aliens living outside the United States").
Application of Rule 23
Even if the bankruptcy court decides to apply Rule 23, the court will then have to decide whether the class meets the appropriate certification requirements under Rule 23. This means that the class must meet (i) all four requirements of subsection (a) of Rule 23, see Moore v. PaineWebber, Inc., 306 F.3d 1247, 1252 (2d Cir. 2002); see also In re Woodward, 205 B.R. at 371; (ii) one of the requirements of Rule 23(b), see, e.g., In re Drexel Burnham Lambert Group, Inc., 960 F.2d 285, 290 (2d Cir. 1992) (evaluating certification under Rule 23(b)(3)); and (iii) any other "inherent" requirements under Rule 23, such as that the proposed class must be identifiable or ascertainable,see In re Methyl Tertiary Butyl Ether Prods. Liab. Litig., 209 F.R.D. 323, 336–37 (S.D.N.Y. 2002); Dunnigan v. Metro. Life Ins. Co., 214 F.R.D. 125, 135 (S.D.N.Y. 2003).
Notably, certification for classes seeking injunctive relief pursuant to Rule 23(b)(2) may be denied as moot when the debtor is not currently operating a business or is liquidating. See In re Ephedra Prods. Liab. Litig., 329 B.R. at 9 n.5 ("Insofar as the class claims seek injunctive relief against Twinlabs under Rule 23(b)(2), they are moot now that Twinlabs has gone out of business and existence."). Further, the availability of the so-called limited fund class action device under Rule 23(b)(1)(B) has been severely curtailed by the Supreme Court's decision in Ortiz v. Fireboard, 527 U.S. 815 (1999), and any party seeking to certify a limited fund class action in the bankruptcy context should be familiar with this case (in Ortiz, the Supreme Court adopted a narrow, historically based model for limited fund class actions under Rule 23(b)(1)(B) and rejected a $1.545 billion settlement arising out of asbestos litigation; the Supreme Court's reasons for rejecting the settlement establish the minimum requirements that a Rule 23(b)(1)(B) class action settlement must meet). There is no prohibition against utilizing limited fund settlement procedures in the bankruptcy setting. There has been a volume of articles and case law addressing whether limited fund settlement procedures are available in the bankruptcy context under the rationale that bankruptcy procedures should be sufficient to address any claims that might otherwise be addressed by the limited fund class action rule. See, e.g., In re Simon II, 982 F.2d 721, 735–36 (2d Cir. 1992). But the Supreme Court has apparently attempted to settle the matter by going out of its way to note that "there is no inherent conflict between a limited fund class action under Rule 23(b)(1)(B) and the Bankruptcy Code." See Ortiz, 527 U.S. at 860 n.34; see also Leonard Gerson, "Use of a 'Limited Fund' Class Action in a Bankruptcy," Am. Bankr. Inst. J., June 2009, at 48. Moreover, while limited, there is some precedent for allowing limited fund class action settlements in bankruptcy settings. See, e.g., In re Drexel Burnham Lambert Group, Inc., 960 F.3d at 292.
Another consideration is the status of class-related discovery. Almost all class actions filed pre-petition will be stayed immediately upon the commencement of the bankruptcy proceedings as a result of the automatic stay. As a result, the parties might be required to brief Rule 23 issues without the benefit of full discovery. Accordingly, the parties may wish to ask the bankruptcy court to permit discovery before the bankruptcy court rules on Rule 23 issues.
How courts address class claims in bankruptcy is ever-evolving. While a generation ago most courts wholly rejected the idea of class claims outright, nowadays most courts will recognize that class claims may be permissible in certain, although limited, contexts. There are still substantial hurdles to asserting a class claim in bankruptcy, including that the bankruptcy court has discretion as to whether to permit class treatment. In making this determination, the impact of class treatment on other creditors and the debtors' estates will be paramount.