Whether a Claim is Pre- or Post-Petition Is Critical But Often Far from Clear, as a Michigan Bankruptcy Court Decision Shows

By Peter D. DeChiara

pdechiara@cwsny.com

Posted May 2016

Whether a claim against a bankrupt employer arose before or after it petitioned for bankruptcy protection often makes a critical difference.  For example, pre-petition claims often receive pennies on the dollar under reorganization plans, while post-petition claims, which enjoy high priority status, are often paid in full.  While determining the pre- or post-petition status of a claim makes a huge difference, no easy test applies for making that determination, frequently requiring courts to make a judgment call based on the particular facts of the case.

The bankruptcy court overseeing the Detroit bankruptcy case recently had to make such a judgment call concerning a claim by a former employee of the city.  In re City of Detroit, Case No. 13-53846 (Bankr. E.D. Mich. April 19, 2016), the Bankruptcy Court for the Eastern District of Michigan found a fired police sergeant’s claim to be pre-petition and ordered her to dismiss her suit challenging her termination, even though at the time of the city’s bankruptcy filing the sergeant’s discharge had only been recommended and she was still on the city’s payroll.

In October 2012, Detroit’s police department suspended Tanya Hughes from active duty after she refused to follow department procedures in connection with a random drug test, but she continued after the suspension to receive her pay and benefits.  Later that year, a police trial board recommended her discharge from the police force but Hughes appealed that recommendation to arbitration.  Detroit filed for Chapter 9 bankruptcy in July 2013, well before the arbitration took place.  Detroit only cut off Hughes’ pay and benefits in December 2014, the day after an arbitrator affirmed the trial board’s recommendation.  In February 2015, Hughes sued the city in Michigan state court, claiming that by firing her the city had violated her civil rights.The city then filed a motion in the bankruptcy court demanding that Hughes be ordered to dismiss her lawsuit, arguing that her claim was pre-petition and was thus discharged under the terms of the city’s 2014 court-approved reorganization plan (which, in Chapter 9 cases, is called a plan of adjustment).

Bankruptcy judge Thomas Tucker began his analysis of Hughes’ claim by pointing out that Section 101(5)(A) of the Bankruptcy Code defines a “claim” as a “right to payment,” and expressly includes in the definition rights that are “contingent” and “unmatured.”  On the other hand, the judge noted, due process considerations limit how remote or contingent a right to payment can be and still be deemed a bankruptcy claim.  In surveying the relevant case law, the judge noted that the courts have tried different tests for determining when a bankruptcy claim arises.  He asserted that the most widely adopted test, which he referred to as the “fair contemplation” test, asks whether the possible claim was “within the fair contemplation of the creditor” at the time the debtor filed its bankruptcy petition.  Application of this open-ended test, the judge acknowledged, may require a judgment call, based on a number of case-specific factors, such as the debtor’s conduct, the parties’ pre-petition relationship, the parties’ knowledge, and the elements of the underlying claim.

Applying the “fair contemplation” test, the bankruptcy court found Hughes’ claim to be pre-petition.  Judge Tucker explained that Hughes knew before Detroit filed for bankruptcy that the police trial board had recommended her discharge.  The judge rejected her argument that at the time of the bankruptcy filing she had no claim because was still receiving her pay and benefits from the city.  He also rejected her argument that she had no claim at the time because she did not know whether the arbitrator would accept the trial board’s discharge recommendation.  “Ms. Hughes may not have known for certain that she would have an actionable claim against the City,” the court wrote, “but certainty is not the standard.  The standard is whether the contingent claim was within Ms. Hughes’s fair contemplation.”

While Judge Tucker’s conclusion was not unreasonable, the “fair contemplation” test leaves ample room for different possible outcomes, and the case could have gone the other way.  As of the date of Detroit’s bankruptcy filing, the police trial board had only recommended Hughes’ termination, leaving her on the payroll and financially unharmed, and thus arguably without a “right to payment” from the city.

That Judge Tucker in the same case found the wrongful termination claim of another employee to be post-petition only underscores the uncertainty of these claim determinations.  Cedric Cook, a former programming analyst for Detroit, was charged with workplace misconduct that allegedly occurred before the City filed for bankruptcy.  Although it was uncertain at the time the City would fire him, one could argue that the possibility was within Cook’s “fair contemplation,” especially given prior discipline he had received.  Yet, in Cook’s case, Judge Tucker deemed the possibility too remote to find that Cook had a pre-petition claim.

The Detroit case may have relevance to unions asserting bankruptcy claims that arise from an employer’s discharge of an employee.  But more broadly, the case serves as a reminder to unions and benefit funds asserting claims in employer bankruptcy cases how critical, yet potentially uncertain, a claim’s pre-versus post-petition status can be.