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NORTHERN CALIFORNIA
ABTL REPORT

Volume 8 no. 1/Nov '98

Peter J. Benvenutti

On CREDITORS' RIGHTS

In bankruptcy, there's litigation, and then there's litigation, and there are major differences between the two. This apparent paradox can be explained by bankruptcy's distinction between adversary proceedings, which are functionally indistinguishable from traditional lawsuits under the Federal rules of Civil Procedure, and contested matters, which are much less formal and often involve neither discovery nor testimony. Misunderstanding the differences in purpose and procedure has doubtless contributed to the disdain that "real litigators" have been known to express on occasion toward their colleagues, like me, who make their living in the bankruptcy courts.
Bankruptcy is in concept a procedural system designed to allocate assets of a debtor among competing valid claims that, in the aggregate, exceed the amount or value of the assets available to satisfy them - a situation that is the very essence of insolvency. Of course, bankruptcy has other objectives too - including providing a "fresh start" for individuals who become overextended, and offering businesses a chance to reorganize in order to preserve jobs and maximize going concern value for creditors and stockholders, among others. But for purposes of understanding the differing approaches to dispute resolution, focusing on the "divide-the-pie" aspect of bankruptcy will suffice.
Economy and efficiency are logical features of a system which seeks to resolve disputes that arise in administering, liquidating and distributing insufficient assets among competing legitimate claimants. Otherwise, the very cost of resolving disputes could consume the value of the assets being administered. Accordingly, the Rules of Bankruptcy Procedure (the "Bankruptcy Rules") provide that most disputes regarding administrative aspects of a bankruptcy case - including the sale of assets and the allowance of creditors' claims - are subject to streamlined procedures usually resembling motion practice. They are called contested matters under Bankruptcy Rule 9014; are initiated by motion, objection or application; and typically use declarations instead of live testimony to supply any evidentiary foundation. By far most disputes in bankruptcy are contested matters.
In contrast, there are certain types of disputes in which the parties' interest in access to the full panoply of litigation procedures takes priority over the institutional bias toward efficiency. Examples include actions to recover money or property from a third (non-debtor) party; to determine the validity, priority or extent of a creditor's lien or other property interest; to determine whether an individual debtor will receive a discharge (either across the board or with respect to a particular debt); and a proceeding to obtain an injunction or other equitable relief. Under Bankruptcy Rule 7001, these (and other enumerated disputes) are denominated adversary proceedings; are initiated by complaint; and are subject to substantially all of the provisions of the FRCP. Unless settled or resolved by motion to dismiss, for summary judgment or some other dispositive motion permitted by the federal rules, these disputes are litigated in the bankruptcy court under substantially the same ground rules as any other lawsuit in federal court.
Here are some additional points to assist in understanding the distinction between adversary proceedings and contested matters:

The amount at stake does not determine how a dispute is classified. Contested matters can involve many millions of dollars; for example, a contested chapter 11 plan confirmation dispute, or a challenge to the sale of all the assets of a sizable business. Conversely, an adversary proceeding involving the dischargeability of credit card or other consumer debt is not subject to any jurisdictional minimum and might involve as little as a few hundred dollars (although usually economic reality constrains the litigation efforts and settlement demands of the parties).
Parties to a contested matter theoretically have recourse to all discovery procedures available under the Federal Rules. In practice, they actually take advantage of those procedures only rarely, since time constraints, economics or other practical factors discourage heavy discovery practice.
Although evidence at the hearing on a contested matter is usually presented by declaration, live testimony is permitted. Indeed, bankruptcy courts are very receptive to use of live testimony in any setting in which there is a factual dispute.
The bankruptcy court has discretion under Bankruptcy Rule 9014 to direct that any or all of the provisions of the FRCP applicable to adversary proceedings shall be applied to a particular contested matter. Hence, the court has flexibility to shape the procedural framework to fit the needs and magnitude of the dispute. Significant contested matters, such as objections to substantial claims or disputes over confirmation of a chapter 11 plan, often will involve discovery, formal pretrial, and other practice which far more closely resembles a bench trial than a motion.

Mr. Benvenutti is a partner in the firm of Heller Ehrman White & McAuliffe.