Fifth Circuit Stretches Equitable Notions to Bend Plain Language

A nonprecedential opinion from the Fifth Circuit raises the perennial question: When (if ever) may the court ignore the plain language of the Bankruptcy Code to achieve an equitable result for creditors?

The debtor confirmed a chapter 13 plan in 2009. He was injured in an accident in 2010 and filed suit in 2011. He never disclosed the personal injury claim to the court, the chapter 13 trustee or creditors. The debtor completed payments under his plan and received a discharge in 2014, while the undisclosed lawsuit was still pending.

The defendant in the lawsuit reopened the chapter 13 case in 2017 and filed an adversary proceeding for a declaration that the debtor was judicially estopped from pursuing the undisclosed personal injury claim.

The bankruptcy court found that the elements of judicial estoppel had been established but declined to impose the doctrine for equitable reasons.

As a remedy, the bankruptcy court allowed the debtor to pursue the personal injury claim but required the debtor to turn recoveries over to the chapter 13 trustee for distribution to unsecured creditors, with interest if claims were paid in full. 

On cross motions by the debtor and the defendant, the Fifth Circuit granted permission for a direct appeal.

In a nonprecedential, per curiam opinion on January 8, the Fifth Circuit upheld the bankruptcy court. The panel consisted of Chief Circuit Judge Priscilla R. Owen and Circuit Judges Jacques L. Wiener, Jr. and James L. Dennis.

In principle, the remedy crafted by the bankruptcy court was consistent with Fifth Circuit authority. See Reed v. City of Arlington, 650 F.3d 571 (5th Cir. 2011) (en banc). In Reed, the appeals court estopped the debtor from pursuing an undisclosed claim for himself, but permitted the trustee to prosecute the claim for the benefit of creditors.

The January 8 opinion said that “the bankruptcy court took an alternate route to the same final outcome” by declining to apply judicial estoppel to the debtor while ordering him to turn over any recovery to the trustee. Were it to reverse, the appeals court said it would have remanded for the bankruptcy court to apply judicial estoppel to the debtor while allowing the trustee to pursue the claim for creditors.

The “ultimate outcome” was the same, the circuit court said.

Ruling that the bankruptcy judge had not abused his discretion, the appeals court said that judicial estoppel is an equitable doctrine to be applied “‘flexibly’” to achieve “‘substantial justice,’” quoting Reed. Id. at 574.

Observations

The Fifth Circuit opinion did not discuss Sections 1329(a) or 1322(d)(1).

Section 1329(a) provides that a chapter 13 plan may be modified to increase payments “[a]t any time after confirmation but before completion of payments under the plan . . . .”

The debtor’s plan called for a total fixed amount of some $42,500 to be paid to the trustee through payroll deductions. Most of the payments, about $30,000, were earmarked to pay the debtor’s auto loan. Unsecured creditors were slated to receive about $3,700.

The plan prohibited the debtor from pursuing nonexempt personal injury claims without court authorization. A violation, the plan said, could result in dismissal, conversion to chapter 7, or criminal prosecution.

In sum, the plan did not seem to provide for the distribution of additional estate property that might arise after confirmation. To distribute a recovery from the personal injury suit would seem to require a plan amendment.

But long after completion of plan payments, Section 1329(a) would not seem to permit a plan amendment directing recoveries to unsecured creditors. What is there to do?

Simply allowing the debtor to retain a lawsuit recovery doesn’t sound right. Indeed, if that were the only possible result, the court surely would invoke judicial estoppel to bar the debtor from realizing a windfall resulting from his nondisclosure.

Even so, letting the defendant off the hook also doesn’t sound right, either. Avoiding a windfall for the defendant was the motivating factor in Reed. Similarly, Reed was motivated by equitable concerns for creditors given that the lawsuit was an estate asset that should enhance their recoveries.

There is yet another statutory hurdle. Given the level of the debtor’s income, Section 1322(d)(1) provides that “the plan may not provide for payments over a period that is longer than 5 years.”

In the case on appeal, the personal injury claim was not resolved within five years. Even if the plan had been amended on a timely basis to direct recoveries to creditors, could creditors receive payments after five years?

Strictly applying the statutory language, there do not seem to be grounds for directing recoveries to creditors in the case on appeal. But should creditors lose out if a debtor or trustee cannot complete prosecution of a lawsuit within five years?

Strictly applying the statute and judicial estoppel would let the defendant off the hook while giving nothing to the creditors and the debtor, but is that right?

In sum, the case is a stark example of the collision between the plain meaning doctrine and whatever reservoir of equitable powers remain in the bankruptcy court. Perhaps situations such as this are reason for the Supreme Court to stop taking away the equitable powers of bankruptcy courts.