Magazine article Journal of Commercial Lending

Dr. Penthothal, a Sleepy Bank, and Filing Proofs of Claim

Magazine article Journal of Commercial Lending

Dr. Penthothal, a Sleepy Bank, and Filing Proofs of Claim

Article excerpt

When a borrower files a bankruptcy petition, banks must promptly act to protect their interests in whatever assets may be available for distribution. This article details Local Bank's unfortunate experience with an anesthesiologist, Dr. Penthothal. It explains how a simple error in an otherwise routine matter resulted in Local Bank's loss of the opportunity to recover from the bankrupt's available assets.

Lending to Dr. Penthothal, a local anesthesiologist, had always been considered to be a relatively low-risk transaction. He moved to town shortly after completing his residency and built a very successful practice.

What his banks did not realize was that Dr. Penthothal, in a desperate effort to keep a speculative restaurant franchise afloat, had mortgaged everything he owned. And when there was nothing left to mortgage, he used his good name to borrow more.

None of the half dozen banks with which Dr. Penthothal did business suspected just how bad the situation was. In fact, at least two banks did not bother to get updated financial statements before they lent him more than $1 million unsecured.

On April 5, 1988, Dr. Penthothal filed a petition for Chapter 7 bankruptcy. The documents filed with the bankruptcy court included a schedule of Dr. Penthothal's debts, which listed his creditors and the amounts owed. Among the debts were five separate loans from one bank totaling $350,000. For this creditor, Local Bank, this posed a sizable loss. When compared, however, to $4 million owed to other banks, it did not look too bad. In addition, Dr. Penthothal's attorney assured the creditors that sufficient assets would be available to satisfy approximately 80% of the total debt.

Collecting on Assets

Local Bank's attorney confidently informed its president that collecting on Dr. Penthothal's assets was a routine matter. All that really needed to be done was for someone to complete the proofs of claims and forward them to the bank's attorney for filing with the Bankruptcy Court. The information provided by the Bankruptcy Court was self-explanatory, but if anyone had questions, he or she was instructed to call the attorneys. As set out in the bankruptcy documents, the bar date (last day) on which to file proofs of claims was September 1, 1988.

Local Bank and its Proofs of Claim

On May 24, 1988, Local Bank's installment loan department filed proofs of claims for loans totaling $33,000. These proofs of claims reflected amounts owed for outstanding installment debts. Nearly two years later, the claims for back taxes were finally satisfied, the secured claims were about to be resolved, and the remaining assets were to be distributed to the unsecured creditors, including Local Bank. The trustee notified each of the creditors of its estimated payout. Local Bank's estimated payout was less than $15,000. This did not seem right, so the bank's officers made an inquiry and discovered that no proofs of claims had been made for $317,000 of Dr. Penthothal's loans.

A Bad Assumption

What happened? The president of Local Bank had said he did not care who handled the matter--he just wanted the proofs of claims filed. Since most of Local Bank's bankruptcies involved installment loans, the notice of bankruptcy was delivered to that department. The installment loan department filed its own proofs of claims. It assumed that a copy of the same documents had been delivered to the other loan departments and that they filed their own proofs of claims. However, the other loan departments assumed that the installment loan department had filed their proofs of claims, too.

False Assurance

When the vice president in charge of the other departments inquired, he was assured that proofs of claims had been filed. No one had bothered to compare the proofs of claims against Dr. Penthothal's schedule of debts or the bank's records of Dr. Penthothal's debts. …

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