Disclose It or Lose It: Defending Unscheduled Claims Brought by a Former Debtor
For many creditors, a bankruptcy case seems like a financial black hole – lots of money goes in but very little comes out. Often, the only communication that a creditor receives from a chapter 11 debtor (or a chapter 7 trustee) is a demand for payment associated with an allegedly preferential transfer.
Accordingly, there is particular anger by the creditor when years after the bankruptcy case concludes, the debtor sues the creditor in a nonbankruptcy forum based upon a pre-bankruptcy claim. The creditor discovers that although he was listed on the bankruptcy schedules as a creditor, the debtor failed to list the fact that the debtor possessed a counterclaim against the creditor. Frustrated, the creditor questions whether it possesses any defenses to the litigation based upon the debtor’s failure to fully and accurately disclose this counterclaim on the bankruptcy schedules.
Fortunately for creditors, recent cases demonstrate that the creditor/defendant may be able to raise the doctrines of judicial estoppel and/or standing as a defense and bar to the debtor’s nonbankruptcy litigation.
The Bankruptcy Code Requires Full Disclosure of Assets
A basic premise of bankruptcy law is that a debtor is required to make full disclosure of his assets and liabilities in a bankruptcy case. The obvious reason for this requirement is to ensure that full and candid disclosures are made to the trustee, the court and the debtor’s creditors. Section 521 of the Bankruptcy Code codifies this disclosure requirement. Section 541 of the Bankruptcy Code further defines what assets become property of the bankruptcy estate. Under section 541 “all legal or equitable interests of the debtor in property as of the commencement of the case” becomes property of the bankruptcy estate. Accordingly, the debtor must list in its bankruptcy schedules all “contingent and liquidated claims of every nature, … counterclaims of the debtor, and rights to setoff claims.” The reach of section 541 is extensive in that the section encompasses “every conceivable interest of the debtor, future, non-possessory, contingent, speculative and derivative.” For chapter 11 debtors, additional disclosure requirements are imposed in connection with the approval of a plan of reorganization.
Inadvertence or ignorance of the law does not justify a failure to list a known actual or potential claim on the bankruptcy schedules. Indeed, the importance of the disclosure rules is highlighted by the fact that a debtor who knowingly and fraudulently conceals asset information not only faces repercussions in civil litigation, but even puts himself at risk of being criminally prosecuted.
Based on the aforementioned broad and stringent disclosure requirements of sections 521 and 541, it is not surprising that all claims of the debtor are considered to be property of the estate regardless of whether the debtor discloses those claims on the bankruptcy schedules.
Judicial Estoppel as a Potential Bar
Bankruptcy schedules are filed under oath and the debtor’s failure to list a claim may enable a defendant to seek dismissal of a subsequently filed action based on the doctrine of judicial estoppel. This “obscure legal doctrine” is intended to protect the integrity of the judicial process and uphold the sanctity of the oath. Judicial estoppel prevents parties from playing “fast and loose with the courts to suit the exigencies of self interest.” Specifically, the doctrine is intended to prevent a party from taking one position under oath in a proceeding and then take an inconsistent position in a subsequent proceeding.
A debtor’s failure to disclose the claim in the bankruptcy schedules may be deemed as an admission by the debtor that no claim exists. Therefore, the filing of a complaint in a nonbankruptcy forum may be construed as a position that is inconsistent with the debtor’s admission contained on the bankruptcy schedules. Ultimately, the question of whether the doctrine of judicial estoppel will bar the litigation depends on how strictly a given jurisdiction chooses to interpret and apply the doctrine.
Standing as a Potential Bar
In addition, a defendant in a subsequently filed action may assert that the nonbankruptcy litigation is barred under the doctrine of standing. Specifically, the defendant will argue that the debtor lacks standing to bring suit and, therefore, the court lacks subject matter jurisdiction.
When a claim becomes property of the bankruptcy estate under section 541, the debtor is divested of standing to pursue the claim. Only the bankruptcy trustee has standing to pursue claims that are considered to be property of the bankruptcy estate.
At the close of the bankruptcy case, the trustee often automatically abandons his interest in the balance of the property of the estate pursuant to section 554(c) of the Bankruptcy Code. Under this scenario, a debtor would automatically regain standing to pursue the claim in a subsequent, nonbankruptcy proceeding.
However, section 554(c) only applies when a debtor properly discloses a claim on the bankruptcy schedules before the conclusion of the bankruptcy case. Where a debtor fails to list the asset in the bankruptcy schedules, the trustee never becomes aware of the asset and, thus, is denied an opportunity to pursue the claim. To allow a debtor to pursue the claim post-bankruptcy would produce an inequitable result whereby the debtor would be rewarded for his omission, while the bankruptcy creditors would suffer. Accordingly, when a debtor fails to list an asset in the bankruptcy schedules, the claim does not automatically revert back to the debtor at the conclusion of the bankruptcy case; rather the claim remains property of the estate and is not abandoned by the trustee pursuant to section 554(d).
Thus, when the debtor attempts to pursue an unscheduled claim in subsequent, nonbankruptcy litigation, the court should conclude that the debtor lacks standing to raise the claim. Based on the finding that the debtor lacks standing, many jurisdictions will dismiss the nonbankruptcy action in its entirety. Other jurisdictions, however, will take a less stringent approach by opting not to dismiss the lawsuit, but instead to refer the issue to the bankruptcy court for adjudication on the question of whether the asset should remain property of the estate or whether the asset should be abandoned to the debtor; these latter jurisdictions allow the debtor the opportunity to attempt to cure the standing defect.
When faced with a claim from a former debtor, the first question that the defendant should ask is: “Was this claim completely and accurately disclosed in the debtor’s prior bankruptcy case?” If the defendant discovers that the debtor’s disclosure was incomplete or inaccurate, the defendant should investigate whether the relevant jurisdiction’s legal precedent supports dismissal under either the doctrine of judicial estoppel or standing.
1. Oneida Motor Freight, Inc. v. New Jersey Bank, 848 F.2d 414, 417 (3rd Cir. 1988) (“A long-standing tenet of bankruptcy law requires one seeking benefits under its terms to satisfy a companion duty to schedule, for the benefit of creditors, all his interests and property rights.”).
2. 11 U.S.C. §521(1) (“The debtor shall – (1) file a list of creditors, and unless the court orders otherwise, a schedule of assets and liabilities, a schedule of current income and current expenditures, and a statement of the debtor’s financial affairs …”).
3. 11 U.S.C. §541 (“Property of the Estate: “(a) The commencement of a case under Section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held: (1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case.”).
4. Official Bankruptcy Form 6, Schedule B, ¶20.
5. Brown, William Houston, Debtors’ Counsel Beware: Use of the Doctrine of Judicial Estoppel in Nonbankruptcy Forums, 75 Am. Bankr. L.J. 197, 198, 200 (2001); In re Coastal Plains, 179 F.3d 197, 208 (5th Cir. 1999)(“The duty of disclosure in a bankruptcy case is a continuing one, and a debtor is required to disclose all potential causes of action. The debtor need not know all the facts or even the legal basis for the cause of action; rather, if the debtor has enough information ... prior to confirmation to suggest that it may have a possible cause of action, then that is a ‘known’ cause of action such that it must be disclosed.” “Any claim with potential must be disclosed, even if it is ‘contingent, dependent, or conditional.’”) (citations omitted); Dailey v. Smith, 292 Ill.App.3d 22, 24, 684 N.E.2d 991, 993 (1st Dist. 1997).
6. 11 U.S.C. §1125 (Relating to chapter 11 bankruptcies: “Postpetition disclosure and solicitation. (a) In this section – (1) “adequate information” means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor ... that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the plan ... .”); Southmark Corp. v. Troter, Smith & Jacobs, 212 Ga.App. 454, 456, 442 S.Ed.2d 265, 267 (Ga. 1994) (noting that chapter 11 is particularly stringent in its disclosure requirement).
7. In re Coastal Plains, 179 F.3d at 205-206 (“Coastal’s claimed ‘inadvertence’ is not the type that precludes judicial estoppel against plaintiffs, as Coastal’s successors, from asserting in the instant litigation the previously nondisclosed claims; Coastal both knew of the facts giving rise to its inconsistent positions, and had a motive to conceal the claims.”)
8. 18 U.S.C. §152 (“Concealment of assets; false oaths and claims; bribery. A person who – (1) knowingly and fraudulently conceals from a custodian, trustee, marshal, or other officer of the court charged with the control or custody of property, or, in connection with a case under title 11, from creditors or the United States Trustee, any property belonging to the estate of a debtor; … shall be fined under this title, imprisoned not more than five years, or both.”).
9. Dailey, 292 Ill.App.3d at 25, 684 N.E.2d at 993 (“The preceding principles apply regardless of whether the bankruptcy petitioner has scheduled the property or assets.”).
10. In re Coastal Plains, 179 F.3d at 205-206 (“The rationale for ... decisions [invoking judicial estoppel to prevent a party who failed to disclose a claim in bankruptcy proceedings from asserting that claim after emerging from bankruptcy] is that the integrity of the bankruptcy system depends on full and honest disclosure by debtors of all of their assets. The courts will not permit a debtor to obtain relief from the bankruptcy court by representing that no claims exist and then subsequently to assert those claims for his own benefit in a separate proceeding. The interests of both the creditors, who plan their actions in the bankruptcy proceeding on the basis of information supplied in the disclosure statements, and the bankruptcy court, which must decide whether to approve the plan of reorganization on the same basis, are impaired when the disclosure is incomplete.”) (citations omitted).
11. 18 Ill. Law & Prac. Estoppel §29 (2003); Brown, supra, note 5, at 198, 200; In re Coastal Plains, 179 F.3d at 205-206 (“Because the doctrine is intended to protect the judicial system, rather than the litigants, detrimental reliance by the opponent of the party against whom the doctrine is applied is not necessary …. The doctrine is generally applied where “intentional self-contradiction is being used as a means of obtaining unfair advantage in a forum provided for suitors seeking justice.”) (citations omitted); Reynolds v. Comm’r, 861 F.2d 469, 472-73 (6th Cir. 1988) (“Courts have used a variety of metaphors to describe the doctrine, characterizing it as a rule against playing fast and loose with the courts, blowing hot and cold as the occasion demands, or having one’s cake and eating it too. Emerson’s dictum that a foolish consistency is the hobgoblin of little minds cuts no ice in this context.”).
12. Brown, supra, note 5, at 200; Southmark, 212 Ga.App. at 455, 442 S.Ed.2d at 267 (“Thus, the ‘essential function and justification of judicial estoppel is to prevent the use of intentional self-contradiction as a means of obtaining unfair advantage in a forum provided for suitors seeking justice.’ The primary purpose of the doctrine is not to protect the litigants, but to protect the integrity of the judiciary. The doctrine does not require reliance or prejudice before a party may invoke it.”) (citations omitted); but see Eubanks v. CBSK Financial Group, Inc., No. 02-5902 (6th Cir. October 1, 2004) (judicial estoppel was not appropriate basis for dismissal of action when omission of claim in previous bankruptcy was inadvertent and there was no evidence that plaintiff had any fraudulent intentions towards bankruptcy court).
13. Brown, supra, note 5, at 205.
14. See Brown, supra, note 5, at Appendix and Dodd, Brian A., Civil Procedure Intent and the Application of Judicial Estoppel: Equitable Shield or Judicial Heartbreak, 22 Am. J. Trial Advoc. 481 (1998) for a variety of legal opinions from multiple jurisdictions.
15. White Colony Diner v. City of Waterbury, 2000 WL 1873061, *1-*2 (Conn.Super. 2000)(unpublished opinion); Ernst v. Hertzmark, 1993 WL 21244, *2, 8 Conn. L. Rptr. 251 (Conn.Super. 1993) (unpublished opinion); Dailey, 292 Ill.App.3d at 24, 684 N.E.2d at 993 (“The filing of a bankruptcy petition is an assertion of the jurisdiction of the bankruptcy court over all the assets and property of the alleged bankrupt.”); Wright v. Abbot Capital Corp., 79 Ill. App.3d 986, 990, 398 N.E.2d 1147, 1149-1150 (1st Dist. 1979) (“The filing of a petition in bankruptcy, whether voluntary or involuntary, is an assertion of the jurisdiction of the bankruptcy court over all the property and assets of the alleged bankrupt with a view to the determination of his status and the settlement and distribution of his estate in the event an adjudication results…”) (citation omitted).
16. Wright, 79 Ill. App.3d at 990, 398 N.E.2d at 1149-1150 (“Furthermore, the fact that certain assets were unscheduled has no bearing on the divestiture of plaintiff’s title to those assets.”) (citation omitted).
17. Dailey, 292 Ill.App.3d at 25-26, 684 N.E.2d at 993-994; Wright, 79 Ill. App.3d at 990, 398 N.E.2d at 1149-1150 (“[Upon] adjudication, the assets of the bankrupt are regarded as in custodia legis as of the time of the filing of the petition; and, as of such date, the bankruptcy court becomes vested with exclusive jurisdiction over all property of the bankrupt which may be considered a part of his estate, or all property in which the bankrupt has or may claim an interest, or all property in the actual or constructive possession of the bankrupt in which he claims an interest.”).
18. 11 U.S.C. §554(c) (“Abandonment of property of the estate …. (c) Unless the court orders otherwise, any property scheduled under section 521(1) of this title not otherwise administered at the time of the closing of a case is abandoned to the debtor and administered for purposes of section 350 of this title.”).
19. 11 U.S.C.§554(c); Bureau v. Gendron, 783 A.2d 643, 646 (Me. 2001).
20. 11 U.S.C.§554(c).
21. Moore v. Slonim, 426 F.Supp. 524, 527 (D.Conn. 1977).
22. Moore, 426 F.Supp. at 527-528 (“It cannot be that a bankrupt, by omitting to schedule and withholding from his trustee all knowledge of certain property, can, after his estate in bankruptcy has been finally closed up, immediately thereafter assert title to the property on the ground that the trustee had never taken any action in respect to it. If the claim was of value ... it was something to which the creditors were entitled, and this bankrupt could not, by withholding knowledge of its existence, obtain a release from his debts, and still assert title to the property.”) (citations omitted); Ernst, 1993 WL 21244 at *4 (“When the bankrupt fails to list the assets, he denies the trustee an opportunity to pursue the claims.”).
23. 11 U.S.C. §554(d) (“Abandonment of property of the estate … (d) Unless the court orders otherwise, property of the estate that is not abandoned under this section and that is not administered in the case remains property of the estate.”); Lowry v. KTI Waste Services, Inc., 794 A.2d 80, 81-82 (Me. 2002); Moore, 426 F.Supp. at 527 (“Because plaintiff did not list this chose of action as an asset of the estate, he cannot claim an abandonment by the trustee.”) (citations omitted); Bureau, 783 A.2d at 646; White Colony Diner, 2000 WL 1873061 at *3; Dailey, 292 Ill.App.3d at 26, 684 N.E.2d at 994.
24. Moore, 426 F.Supp. at 528; Dailey, 292 Ill.App.3d at 24, 684 N.E.2d at 993; Bureau, 783 A.2d at 2001; Lowry, 794 A.2d at 82; Wright, 79 Ill. App.3d at 990, 398 N.E.2d at 1150; White Colony Diner, 2000 WL 1873061 at *4; Ernst, 1993 WL 21244 at *4; Kuriakuz v. Community Nat’l Bank of Pontiac, 107 Mich.App. 72, 77, 308 N.W.2d 658, 660 (Mich. App. 1981).
25. Moore, 426 F.Supp. at 528 (granting motion to dismiss); Dailey, 292 Ill.App.3d at 24, 684 N.E.2d at 993 (granting motion for judgment notwithstanding the verdict); Bureau, 783 A.2d at 2001 (granting summary judgment); Lowry, 794 A.2d at 82; Wright, 79 Ill. App.3d at 990, 398 N.E.2d at 1150 (granting motion to dismiss) (“In conclusion, we submit that a bankrupt who voluntarily omits to schedule an asset may not thereafter assert any claim thereto.”).
26. White Colony Diner, 2000 WL 1873061 at *4; Ernst, 1993 WL 21244 at *4; Kuriakuz, 107 Mich.App. at 77, 308 N.W.2d at 660.