Contributed by Abigail Lerner
As if the various statements, schedules, and reports that debtors are compelled to file with a bankruptcy court containing information about the debtor’s assets and liabilities aren’t enough of a reminder that disclosure and transparency are of utmost importance to the bankruptcy process, a recent decision by the United States Court of Appeals for the Fifth Circuit reinforces this notion. In In re Allen, the court held that individual debtors asserting a personal injury suit were judicially estopped from bringing their action because they never disclosed the existence of the lawsuit to the bankruptcy court.
In In re Allen, the debtors filed a chapter 13 bankruptcy case in July 2009 and confirmed their chapter 13 plan in September of the same year. The debtors then amended their plan multiple times, with the last amendment occurring in January 2013. In April 2014, the bankruptcy court closed the chapter 13 case without granting the debtors a discharge because of their failure to file certain required documentation.
In October 2010, after confirmation of the debtors’ original chapter 13 plan but before filing any of their plan amendments, the debtors commenced a personal injury suit against various entities in federal district court. The suit alleged that one year earlier, in October 2009, one of the debtors was injured at work when the stool she was sitting on broke apart.
In September 2014, the defendants moved for summary judgment, arguing that they only first learned of the debtors’ chapter 13 case in late August 2014 and contending that the suit was barred by judicial estoppel because the debtors failed to disclose the suit to the bankruptcy court. The debtors moved to strike the summary judgment motion, contending that at least one of the defendants knew of the bankruptcy case as early as March 2012. The district court granted the defendants’ motion for summary judgment, finding that judicial estoppel barred the debtors from pursuing their personal injury claim, and dismissed the claims with prejudice. However, the dismissal was without prejudice to the rights of a chapter 7 trustee to pursue the claims if the debtors’ bankruptcy case was reopened and converted to a chapter 7 case. The debtors appealed the judgment.
In reviewing the lower court’s decision, the Fifth Circuit first considered the purpose of the doctrine of judicial estoppel – “ ‘to protect the integrity of the judicial process,’ by ‘prevent[ing] parties from playing fast and loose with the courts to suit the exigencies of self interest.’” In re Coastal Plains, Inc., 179 F.3d at 205 (quoting Brandon v. Interfirst Corp., 858 F.2d 266, 268 (5th Cir. 1988)). The court then identified the three elements of judicial estoppel: (1) The party against whom it is sought has asserted a legal position that is plainly inconsistent with a prior position; (2) a court accepted the prior position; and (3) the party did not act inadvertently.
Pursuant to sections 521(a)(1) and 1306(a)(1) of the Bankruptcy Code, a chapter 13 debtor has a continuing obligation to disclose claims that arise, or assets that are acquired, after the commencement of a bankruptcy case, regardless of whether the debtor confirmed its plan. That is because the chapter 13 debtor’s property of the estate includes all assets acquired by the debtor postpetition until the chapter 13 case is closed, dismissed, or converted to a case under another chapter of the Bankruptcy Code. Therefore, once the personal injury claim arose, the Allen debtors had a duty to disclose its existence to the bankruptcy court and their creditors.
In addressing the first element, the court acknowledged that the debtors never disclosed the existence of their personal injury suit to the bankruptcy court. Because the debtors failed to do so, they impliedly represented that they had no such claim. By now asserting the claim, the debtors were taking a legal position inconsistent with the prior one, satisfying the first element of judicial estoppel.
Next, as to judicial acceptance, the bankruptcy court confirmed the debtors’ chapter 13 plan and plan modifications on the assumption that the debtors’ schedules were accurate and that the debtors had truthfully disclosed all of their assets. The accurate and continuous disclosure of assets by a chapter 13 debtor – even after confirmation – is essential to the chapter 13 process. By concealing the existence of the claim, the debtors withheld property that should have been available for creditor distribution. The Fifth Circuit concluded, therefore, that the bankruptcy court accepted the prior position of the debtors by omitting any reference to the personal injury claim in the modified plan. That is, had the court known about the claim, potential recoveries flowing therefrom would have been included in the assets available to creditors. Finally, as to inadvertence, the court explained that where a debtor has no motive to conceal its assets, the debtor’s failure to disclose the assets could be found to be inadvertent. Here, however, the court found that concealing the claim would have allowed the debtors to “reap a windfall had they been able to recover on the undisclosed claim without having disclosed it to the creditors” because, as noted above, absent disclosure, the debtors could have retained any proceeds of the suit instead of distributing them to the debtors’ creditors. The debtors’ motivation for concealment, the court stated, was self-evident because of this potential financial benefit the debtors stood to gain from their non-disclosure. According to the court, the debtors could not show that their failure to disclose the suit was inadvertent.
Because the three elements of judicial estoppel were satisfied, the court ruled that the district court did not abuse its discretion by dismissing the debtors’ claims and by allowing the bankruptcy trustee to pursue the personal injury claim in place of the debtors. The Fifth Circuit, however, clarified that the district court could reopen the debtors’ case and substitute a chapter 7 trustee for the debtors so long as the trustee decided to pursue the claim within a reasonable period of time.
This case should serve as a reminder that attorneys must always highlight to their clients the importance of disclosure in a bankruptcy case and especially stress that the obligation to disclose is continuous. As In re Allen teaches us, it is for the bankruptcy court – not the debtor – to decide which assets should be available to satisfy creditors. The debtors in In re Allen learned this the hard way.