American Reserve Corp., Matter of

• Decision Date: 18 February 1988
• Docket Number: No. 87-1768,87-1768
• Citation: 840 F.2d 487
• Parties: , 18 Collier Bankr.Cas.2d 501, 10 Fed.R.Serv.3d 868, 17 Bankr.Ct.Dec. 504, Bankr. L. Rep. P 72,205 In the Matter of AMERICAN RESERVE CORPORATION, Debtor. Appeal of Clear and Doris Elaine HUDDLESTON.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 487

840 F.2d 487

56 USLW 2497, 18 Collier Bankr.Cas.2d 501,

10 Fed.R.Serv.3d 868,

17 Bankr.Ct.Dec. 504, Bankr. L. Rep. P 72,205

In the Matter of AMERICAN RESERVE CORPORATION, Debtor.

Appeal of Clear and Doris Elaine HUDDLESTON.

No. 87-1768.

United States Court of Appeals, Seventh Circuit.

Argued Dec. 11, 1987.

Decided Feb. 18, 1988.

John G. Jacobs, Plotkin & Jacobs, Ltd., Chicago, Ill., Richard A. Kirby, Washington, D.C., for appellant.

Leslie D. Locke, Ross & Hardies, Chicago, Ill., for appellee.

Before POSNER and EASTERBROOK, Circuit Judges, and GRANT, Senior District Judge. ^*

EASTERBROOK, Circuit Judge.

This interlocutory appeal under 28 U.S.C. Sec. 1292(b) presents the question whether a person may file a proof of claim as representative of others similarly situated in a bankruptcy case. The bankruptcy judge answered yes, the district judge no. 71 B.R. 32 (N.D.Ill.1987). We conclude that class actions may exist within as well as outside bankruptcy, and so reverse the district court's order.

Clear and Doris Elaine Huddleston filed a class action in 1979 in state court contending that Reserve Insurance Co. had defrauded its policyholders by issuing policies between 1977 and 1979 against reserves it knew to be insufficient. Reserve Insurance was declared insolvent that year by the Illinois Director of Insurance. In 1980, before the state court decided whether to certify the class, American Reserve Corporation, a holding company whose assets include all of the stock of Reserve Insurance, filed a bankruptcy petition, which everyone assumes automatically stayed, see 11 U.S.C. Sec. 362, the state suit against Reserve Insurance. ¹ The Huddlestons then filed a proof of claim in American Reserve's bankruptcy on behalf of themselves as well as all members of the class of people who purchased policies between 1977 and 1979. The Huddlestons and other policyholders undoubtedly have "claims", because the 1978 overhaul of the Code greatly enlarged the definition of a claim:

"[C]laim" means--(A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured ...

11 U.S.C. Sec. 101(4). American Reserve's trustee contested the representative claim, maintaining that each policyholder had to file separately. The district court agreed.

We start with the Bankruptcy Rules. Bankruptcy Rule 7023 provides: "Rule 23 F.R.Civ.P. applies in adversary proceedings." Bankruptcy Rule 9014, which applies to "a contested matter in a case ... not otherwise governed by these rules" states that "[t]he court may at any stage in a particular matter direct that one or more of the other rules in Part VII shall apply." Rule 9014 thus allows bankruptcy judges to apply Rule 7023--and thereby Fed.R.Civ.P. 23, the class action rule--to "any stage" in contested matters. Filing a proof of claim is a "stage". All disputes in bankruptcy are either adversary proceedings or contested matters, see Daniel R. Cowans, 1 Bankruptcy Law and Practice 189 (1986), so Rule 23 may apply throughout a bankruptcy case at the bankruptcy judge's discretion. Rule 23 provides for filing by a representative, not just prosecution by a representative of claims already pending. So the right to file a proof of claim on behalf of a class seems secure, at least if the bankruptcy judge elects to incorporate Rule 23 via Rule 7023 via Rule 9014, as the judge did in this case. Yet every court that has discussed the question at any length, other than the bankruptcy judge in this case, has come to the opposite conclusion. See In re Standard Metals Corp., 817 F.2d 625, 630-32 (10th Cir.1987), vacated in part on rehearing and decided on other grounds under the name Sheftelman v. Standard Metals Corp., 839 F.2d 1383 (1987); In re Johns-Manville Corp., 53 B.R. 346, 350-54 (Bkr.S.D.N.Y.1985); In re Baldwin-United Corp., 52 B.R. 146 (Bkr.S.D.Ohio 1985); In re Computer Devices, Inc., 51 B.R. 471 (Bkr.D.Mass.1985). Each relied on 11 U.S.C. Sec. 501 and a series of arguments that lead it to conclude that class actions are unnecessary in bankruptcy courts. We take up these arguments before discussing Sec. 501.

The principal function of bankruptcy law is to determine and implement in a single collective proceeding the entitlements of all concerned. Butner v. United States, 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979); Boston & Maine Corp. v. Chicago Pacific Corp., 785 F.2d 562, 565 (7th Cir.1986); Thomas H. Jackson, The Logic and Limits of Bankruptcy Law 7-33 (1986); Douglas G. Baird, Loss Distribution, Forum Shopping, and Bankruptcy, 54 U.Chi.L.Rev. 815 (1987); H.R.Rep. No. 95-595, 95th Cong., 2d Sess. 10 (1978), U.S.Code Cong. & Admin.News 1978, 5963, 5971-72. When there is not enough to go around, the bankruptcy judge must establish priorities and apportion assets among creditors with the same priority, but the starting point is legal entitlements that exist outside of bankruptcy. If American Reserve is liable for fraud, the victims are entitled to recovery--according to their entitlements under substantive law--just as the firm's landlords and vendors of typewriters are entitled to recovery.

Class actions have procedural and substantive advantages. Procedurally, the class action concentrates litigation in a single forum, where it may be resolved more readily than a series of suits could be. See American Pipe & Construction Co. v. Utah, 414 U.S. 538, 553-54, 94 S.Ct. 756, 766, 38 L.Ed.2d 713 (1974). The bankruptcy forum, as a mandatory collective proceeding, serves this purpose without the overlay of the class action. Substantively, the class action permits the aggregation and litigation of many small claims that otherwise would lie dormant. At least in principle, the class action provides compensation that cannot be achieved in any other way; although the costs of litigation may consume much of the benefit, the device still serves a deterrent function by ensuring that wrongdoers bear the costs of their activities. Deposit Guaranty National Bank v. Roper, 445 U.S. 326, 338-39, 100 S.Ct. 1166, 1173-74, 63 L.Ed.2d 427 (1980). See Kenneth W. Dam, Class Actions: Efficiency, Compensation, Deterrence, and Conflict of Interest, 4 J.Legal Studies 47 (1975); Roger Bernstein, Judicial Economy and Class Actions, 7 J.Legal Studies 349 (1978).

The compensatory function is as important inside bankruptcy as outside. Under Sec. 101(4)(A) there may be many "claims" of uncertain value, and holders of contingent claims--such as the policyholders--may not recognize their entitlement to file unless some champion appears. ² The representative (presumably) has done substantial investigation to identify and shape the claim. Even though there is no fee to file claims in bankruptcy, the opportunity costs of the time needed to investigate and decide whether to file may be substantial, especially because Bankruptcy Rule 9011(a) (a parallel to Fed.R.Civ.P. 11) requires every claimant to investigate the facts and do necessary legal research before filing. The combination of contingent claims (which many people may not identify as something they are entitled to pursue) and the effort needed to decide whether to pursue an identified claim means that for many small claims, it is class actions or nothing.

Outside of bankruptcy, class actions aggregate claims and permit both compensation and deterrence that are otherwise impossible. The same debts should be pursued inside bankruptcy--for other creditors have no right to the higher share of the debtor's assets they can achieve by excluding rival creditors at the threshold. ³ The class proof of claim may be essential to discover what the bankrupt's entire debts are, and therefore who should be paid what. Presumptively, too, representational litigation is available in federal courts. Califano v. Yamasaki, 442 U.S. 682, 700, 99 S.Ct. 2545, 2557, 61 L.Ed.2d 176 (1979) (only a "clear expression of congressional intent" terminates the ability to file representative actions under Rule 23). There is nothing unusual about representative litigation in bankruptcy cases. Quite the contrary, some of the earliest class suits were the creditors' bills that preceded the 1898 Code. ⁴ One creditor filed suit as a representative of all others of the same class; the proceeds were divided among all creditors who later appeared. E.g., Handley v. Stutz, 137 U.S. 366, 11 S.Ct. 117, 34 L.Ed. 706 (1890); Richmond v. Irons, 121 U.S. 27, 44, 66, 7 S.Ct. 788, 795, 806, 30 L.Ed. 864 (1887); Johnson v. Waters, 111 U.S. 640, 673-74, 4 S.Ct. 619, 637, 28 L.Ed. 547 (1884). These creditors' bills had the features of the modern class action: a single plaintiff, an inquiry into the plaintiff's capacity to act as agent for others similarly situated, and uncertainty until the end of the case who would appear to claim payment (and therefore how much was available for those who did appear). The creditors' bill was a representational suit, not an invitation to joinder.

Plaintiffs and their champions at the bar hold the benefits of class litigation in higher esteem than do courts. The efficiency benefits of consolidation to one side--because bankruptcy achieves them without the need for class suits--class actions are a headache for judges. They are suits that would not exist if each injured person had to litigate separately. And what suits! Each starts off with complex problems about commonality of claims and adequate representation, followed by notice, opt-out, and other procedural issues unique to class actions, on top of which the substance of the case may be very difficult. Class actions consume judicial time, putting off adjudication for other deserving litigants; they impose steep costs on defendants, even those in the right. The systemic costs of class litigation should not be borne lightly.

More, an action with modest stakes per claimant--the kind of claim...