In chapter 13, creditors – not just the debtor – may sometimes lose out if the debtor had concealed the existence of a personal injury claim and the defendant invokes judicial estoppel to bar prosecution of the lawsuit, according to a decision by Bankruptcy Judge Meredith S. Grabill of New Orleans.
The opinion limits the applicability of Reed v. City of Arlington, 650 F.3d 571 (5th Cir. 2011), to chapter 7 cases with similar facts. In Reed, the en banc Fifth Circuit ruled that chapter 7 trustees and creditors must not be punished for the misdeeds of debtors.
The decision by Judge Grabill raises a familiar question: Do bankruptcy courts have a reservoir of equitable power to create a necessary remedy when none exists in the plain language of the statute?
A Perfect Case for Judicial Estoppel
In the case before Judge Grabill, the debtor had pushed all the buttons for the invocation of judicial estoppel.
Nine months before bankruptcy, the debtor filed a personal injury action in state court. In the schedules and statement of affairs accompanying her chapter 13 petition, she did not disclose the suit. She also did not disclose the suit at her Section 341 meeting when asked if she was suing anyone.
The debtor confirmed a chapter 13 plan to pay her creditors less than 5%.
At a deposition in the personal injury suit two months after confirmation, the debtor prevaricated when asked if she had been in bankruptcy. When confronted with the petition, she admitted having seen the papers but didn’t recall reading them. Eventually, her counsel admitted at a later hearing in bankruptcy court that she had not been truthful in her deposition testimony.
The defendant in the personal injury suit filed a complaint in bankruptcy court for a declaration that judicial estoppel barred the debtor from pursuing the personal injury claim.
The Proper Remedy
In her January 15 opinion, Judge Grabill had no difficulty establishing that the elements of judicial estoppel were present. The question was remedy. The debtor’s lawyer recommended that she follow Reed and permit the chapter 13 trustee to pursue the suit on behalf of creditors.
Let’s focus on the facts in Reed:
The debtor, a firefighter, had won a $1 million judgment. While the defendant was appealing, the debtor filed a chapter 7 petition. The debtor did not disclose the lawsuit or the judgment in his schedules.
After the debtor’s discharge, the defendant learned about the bankruptcy and moved to invoke judicial estoppel. The elements of judicial estoppel were present, but the district judge didn’t want the defendant to have a windfall.
The district court crafted a remedy where the chapter 7 trustee would pursue collection of the judgment and distribute proceeds to creditors, with none for the debtor. The defendant would have a refund if there were an excess.
The Fifth Circuit affirmed en banc, holding that a defendant in a lawsuit cannot assert judicial estoppel to inflict harm on a bankruptcy trustee and innocent creditors based on a debtor’s misconduct.
Does Reed always apply in chapter 13? That was the question for Judge Grabill.
Futility and a Chapter 13 Trustee’s Limited Powers
The Reed debtor was in chapter 7, where the trustee has statutory power to collect assets of the estate. Chapter 13 is different.
The powers of a trustee in chapter 13 under Section 1302 do not include the right in Section 704(a)(1) to collect estate assets. Similarly, Section 1303 excludes the chapter 13 trustee from using or selling estate property under Section 363. Powers under Section 363 are vested exclusively in the chapter 13 debtor.
Judge Grabill therefore concluded that “the remedy crafted by the district court [in Reed] would have required a chapter 13 trustee to act beyond the authority given her by Congress in §§ 1302 and 1303 of the Bankruptcy Code.”
There was yet another factual distinction and a practical problem. The debtor in Reed already had a judgment. The personal suit in Judge Grabill’s case was in its infancy.
If the debtor were barred from collecting and the incentive for participating were removed, Judge Grabill “reasonably” estimated that the suit, “at that point, [was] worthless to the estate’s creditors.” She therefore concluded that crafting a remedy to preserve the suit for creditors was “essentially futile.”
Judge Grabill considered an alternative suggested by other cases: convert the chapter 13 case to chapter 7, where the trustee could pursue the suit. Aside from futility without the debtor’s cooperation, she had other concerns.
Judge Grabill declined to convert the case, saying that “conversion to chapter 7 would impose harsher consequences upon [the debtor] that are not justified at this time (i.e., the liquidation of all non-exempt assets and the relinquishment of control over her assets).”
Judge Grabill entered judgment barring the debtor from pursuing or receiving any recovery in the suit. However, she declared that the claim would remain an estate asset never to vest in the debtor, to be pursued by a trustee if the case were later converted to chapter 7.
Questions
Perhaps the personal injury defendant is not out of the woods.
Judge Grabill has been carrying a motion to dismiss the chapter 13 case for the debtor’s failure to make plan payments. After adjournments allowing the debtor to cure arrears, the motion comes to court again on March 11.
Perhaps Judge Grabill sensed that the chapter 13 case was heading for dismissal or conversion, potentially allowing a chapter 7 trustee to pursue the claim.
Even if the case were to remain in chapter 13, creditors might have another avenue for recovery.
How about amending the plan to provide that the debtor will not receive a discharge unless she diligently assists in prosecution of the suit, with a recovery earmarked only for creditors?
Alternatives were not before the court, and the court is not required to take on the role of a litigant to raise issues not presented by the parties.
In chapter 13, creditors – not just the debtor – may sometimes lose out if the debtor had concealed the existence of a personal injury claim and the defendant invokes judicial estoppel to bar prosecution of the lawsuit, according to a decision by Bankruptcy Judge Meredith S. Grabill of New Orleans.
The opinion limits the applicability of Reed v. City of Arlington, 650 F.3d 571 (5th Cir. 2011), to chapter 7 cases with similar facts. In Reed, the en banc Fifth Circuit ruled that chapter 7 trustees and creditors must not be punished for the misdeeds of debtors.
The decision by Judge Grabill raises a familiar question: Do bankruptcy courts have a reservoir of equitable power to create a necessary remedy when none exists in the plain language of the statute?
A Perfect Case for Judicial Estoppel
In the case before Judge Grabill, the debtor had pushed all the buttons for the invocation of judicial estoppel.
Nine months before bankruptcy, the debtor filed a personal injury action in state court. In the schedules and statement of affairs accompanying her chapter 13 petition, she did not disclose the suit. She also did not disclose the suit at her Section 341 meeting when asked if she was suing anyone.
The debtor confirmed a chapter 13 plan to pay her creditors less than 5%.