Oct. 18 --A bankruptcy court did not abuse its discretion by finding a debtor estopped because there is a continuing duty to disclose post-petition causes of action in a Chapter 13 proceeding, the U.S. Court of Appeals for the Fifth Circuit held Oct. 4 ( Flugence v. Axis Surplus Ins. Co. (In re Flugence), 2013 BL 275313 5th Cir., No. 13-30073, 10/4/13).
Reversing the judgment of the district court and reinstating the judgment of the bankruptcy court, Judge Jerry E. Smith concluded that the debtor had a continuing duty to disclose that she was pursuing a personal injury claim post-confirmation.
Although there is some uncertainty as to whether a debtor must disclose assets post-confirmation, that possible conflict is irrelevant here, the court said. In this case, the court noted, the plan explicitly stated that the estate's assets would not revest in the debtor until discharge.
The court disagreed with the personal injury defendants' reading of Reed v. City of Arlington, , 650 F.3d 571 (5th Cir. 2011) (en banc)(23 BBLR 1034, 8/25/11), because nothing in that case requires that recovery be limited strictly to the amount owed creditors. According to the appeals court, Reed requires only that, after a claim is prosecuted and the creditors and fees have been paid, any remaining recovery must be returned to the personal injury defendants.
Debtor Cheryl Ann Flugence filed for Chapter 13 protection in 2004, and a plan was confirmed. In March 2007, she was injured in a car accident, and hired an attorney one month later. Subsequently, in July 2007, an amended Chapter 13 plan was confirmed.
In March 2008, the debtor sued the appellants Axis Surplus Insurance Co., Great West Casualty Co., and A & R Transport Inc., for personal injury from the accident. In November 2008, she was discharged of all her remaining debt.
The debtor never disclosed to the bankruptcy court between March 2007 and July 2007 (when the amended plan was confirmed), or between July 2007 and November 2008 (when her debts were discharged), that she had been in an accident and might prosecute a personal injury claim. Once the personal injury defendants discovered the non-disclosure, they asked the bankruptcy court to reopen the case and sought to have the debtor judicially estopped from pursuing the undisclosed claim.
The bankruptcy court determined that the debtor was estopped from pursuing the claim on her own behalf, but her bankruptcy trustee was not estopped and could pursue the claim for the benefit of the debtor's creditors in accordance with Reed.
The bankruptcy court also found the law on disclosure well settled in that Chapter 13 debtors have a continuing obligation to disclose post-petition causes of action.
On appeal, the district court reversed with respect to estopping the debtor, and affirmed in all other aspects. According to the district court, the bankruptcy court abused its discretion by estopping the debtor because she “did not have a potential cause of action prior to her initial application for bankruptcy protection in 2005.” In addition, the court found that she relied on her attorney's advice as to whether she must disclose her potential cause of action to the bankruptcy court, and there was a “flux in the law at the time regarding a debtor's duty to disclose post-confirmation” in Chapter 13 proceedings.
On appeal to the Fifth Circuit, the personal injury defendants contended that the bankruptcy court did not abuse its discretion in declaring the debtor estopped. According to the personal injury defendants, both the bankruptcy and district courts erred in holding that Reed allows a trustee to pursue an estopped debtor's claim without limits on the extent on the extent of possible recovery. They argued that their exposure to liability should be limited to the amount of the debtor's outstanding debt to creditors, which was about $44,000.
The debtor, however, contended that her cause of action accrued after the initial confirmation and that her non-disclosure was inadvertent because she did not know that she had to disclose. She also argued that it was unclear whether she had to disclose because of a conflict in two Bankruptcy Code provisions that have “troubled courts,” including the Fifth Circuit.
Judicial estoppel has three elements, the appeals court said: “(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.” The bankruptcy court found all three elements in this case, and did not abuse its discretion, the court said.
According to the appeals court, Chapter 13 debtors have a continuing obligation to disclose post-petition causes of action. The court acknowledged that there is some uncertainty, however, as to whether a debtor must disclose assets post-confirmation, citing Bankruptcy Code Sections 1306(a)(1) and 1327(b). Section 1306(a)(1), the court said, suggests that post-confirmation causes of action are “property of the estate,” and Section 1327(b) suggests that such property is “vested” in the debtor.
That conflict, the court said, is irrelevant here. Section 1327(b) vests property in the debtor unless otherwise specified by the confirmation plan. In this case, the court said, the plan explicitly stated that the estate's assets would not revest in the debtor until discharge.
At oral argument, the debtor's attorney stated that there is still ambiguity because the order says property of the estate shall revest after discharge, but it is unclear whether the cause of action ever was property of the estate. Even so, the decisions have settled that debtors have a duty to disclose to the bankruptcy court notwithstanding uncertainty, the court said. Because the debtor had an affirmative duty to disclose her personal injury claim to the bankruptcy court and did not do so, she impliedly represented that she had no such claim, the court said. If the bankruptcy court had been aware of the claim, it may have altered the plan, the court said. Thus, the first two elements of judicial estoppel apply, the court said.
The court next looked to whether the debtor acted inadvertently. To establish inadvertence, the court explained, the debtor may prove either that she did not know of the inconsistent position or that she had no motive to conceal it from the court. According to the court, the controlling inquiry is the “knowing of facts giving rise to inconsistent positions…. [A] lack of awareness of a statutory disclosure duty for  legal claims is not relevant.”
The debtor knew of the facts underlying her personal injury claim, the court said. The bankruptcy court also found that she had a motive to conceal because her claim, if disclosed, would be available to the creditors, the court said. The fact she did not know that bankruptcy law required disclosures is irrelevant, the court said.
The court rejected the personal injury defendants' argument that the bankruptcy court erred in interpreting Reed to allow the trustee to pursue the debtor's personal injury claim without limitation. Reed, the court said, holds generally that, “where a debtor is individually estopped from pursuing an undisclosed claim, 'absent unusual circumstances, an innocent trustee can pursue [the claim] for the benefit of creditors.'” According to the court, if the personal injury defendants were entitled to the sort of limitation they seek, then such declarations would tend to “thwart one of the core principles of the bankruptcy system--obtaining a maximum and equitable distribution for creditors.”
Judicial estoppel is an equitable doctrine, the court said, and using it to land another blow on the victims of bankruptcy fraud is not an equitable application, the court said. According to the court, providing the personal injury defendants with the windfall they seek is neither necessary nor desirable.
Thus, where a debtor is judicially estopped from pursuing a claim she failed to disclose to the bankruptcy court, the trustee, consistent with Reed, may pursue the claim without any limitation not otherwise imposed by law, the court said.
Judges James L. Dennis and Stephen A. Higginson joined the opinion.
To contact the reporter on this story: Diane Davis in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Jay Horowitz at email@example.com
To view additional stories from Bloomberg Law® request a demo now