Unscheduled, undisclosed property is treated altogether differently when a case was dismissed compared to what happens if the case was closed, as the Ninth Circuit Bankruptcy Appellate Panel explained in an April 2 opinion.
If the case was administered and closed, undisclosed or unscheduled property remains in the estate, perhaps indefinitely. On the other hand, if the case was dismissed, all property reverts to the debtor, including undisclosed property.
The debtor’s standing is also different after dismissal. Because all property revested in the debtor, the debtor can pursue undisclosed property after dismissal. If the case was administered and closed, the debtor would not have standing to collect undisclosed property.
The Undisclosed Malpractice Claim
Two individuals owned a corporate debtor that owned apartment buildings. The owners conferred with bankruptcy lawyers about the efficacy of filing a chapter 11 petition for the corporation. The lawyers advised against a filing in chapter 11 and recommended filing a chapter 7 petition instead.
The owners consulted another bankruptcy lawyer, who put the debtor corporation into chapter 11, but not before the lender had installed a receiver in state court. The owners did not put themselves into bankruptcy.
In the chapter 11 case, the debtor did not schedule malpractice claims as an asset.
The bankruptcy court approved a sale of the corporation’s property, but the estate was administratively insolvent. The debtor corporation filed a motion to dismiss the chapter 11 case under Section 1112(b)(1). When no one objected, the bankruptcy court granted the dismissal motion.
Using the district’s standard form, the order dismissed the case and closed it, “but only for administrative purposes.”
The Malpractice Suit
After dismissal, the owners and the debtor corporation sued the lawyers they first consulted, claiming malpractice for not recommending a chapter 11 filing before the receiver was installed.
In state court, both sides agreed that the malpractice claim was a prepetition asset. They disagreed about whether the claim was owned by the bankruptcy estate or the debtor corporation.
Not sure who owned the claim, the judge in state court asked the parties to reopen the bankruptcy, schedule the malpractice claim, and have the bankruptcy court decide who owned the claim.
The debtor corporation filed a motion asking Bankruptcy Judge Peter C. McKittrick of Portland, Ore., to reopen the chapter 11 case. He reopened the case, but “for administrative purposes only, including but not limited to filing amended schedules.” He said it was impossible to reopen the dismissed chapter 11 case under Section 350(b) because it has not been closed under Section 350(a).
The case reopened, and the debtor amended the schedules to list the malpractice claim as an asset.
The Appeal Dismissed in the BAP
The malpractice defendants appealed the order to the BAP that reopened the chapter 11 case.
Writing for the BAP, Bankruptcy Judge Julia W. Brand dismissed the appeal because the malpractice defendants lacked standing.
Judge Brand noted that the malpractice defendants were not creditors of the debtor corporation. Reopening the chapter 11 case, she said, did not diminish their property, impose any burdens on them, or detrimentally affect their rights. Reopening the case would require the firm to defend the suit in state court but did not preclude them from asserting any defenses.
Consequently, the law firm was not a “person aggrieved” and therefore had no standing to appeal.
The Discussion of Dismissal vs. Closing under Section 350
The significance of the opinion lies in the BAP’s discussion of the distinction between closing a case after dismissal and closing a case under Section 350(a) after the case has been “fully administered.”
If the case has been “fully administered,” Section 350(a) requires the court to close the case.
Judge Brand pointed out that the chapter 11 case had been administratively closed after dismissal. It was not a statutory closing mandated by Section 350(a) after the case has been fully administered.
Judge Brand noted that no one had moved to vacate dismissal. She said that administrative reopening did not vacate the dismissal, reinstate the case, create a bankruptcy estate to administer, or trigger the automatic stay.
Had the case been administered and closed under Section 350(a), all scheduled property would have been “abandoned to the debtor” under Section 554(c). If there had been an administration and closure, Bankruptcy Judge Christopher M. Klein said in a concurring opinion that “unscheduled property is neither abandoned nor administered and remains property of the estate, essentially forever,” citing Section 554(c) & (d).
However, the case had not been administered and closed. It had been dismissed, making Sections 350 and 554 inapplicable. On the other hand, Section 349 was applicable.
After dismissal, Section 349(b)(3) “revests the property of the estate in the entity in which such property was vested immediately before the commencement of the case under this title.”
In the case of dismissal, Judge Brand characterized the section as saying that “all of the estate property revested in them at that time under § 349(b)(3), ‘regardless of whether the property was scheduled,’” citing Menk v. LaPaglia (In re Menk), 241 B.R. 896, 912 (B.A.P. 9th Cir. 1999). [Emphasis in original.]
Consequently, Judge Brand said, the malpractice claim “is now owned by” the debtor corporation. “In short, the [debtor corporation is] the proper plaintiff,” she said.
Judge Klein’s Concurrence
Judge Klein wrote a concurring opinion to “foster informed communication with state courts” about the distinction between closing and dismissing a case and the consequences for property of the estate.
As guidance for state courts when there has been an administered and closed case followed by the debtor’s prosecution of an unscheduled asset, Judge Klein said that judicial estoppel is not the issue. Rather, the debtor lacks standing to prosecute a claim that belongs to the estate. The trustee is the real party in interest, and the debtor lacks standing.
When a dismissed case is administratively reopened, Judge Klein said that “an unscheduled cause of action could not be property of the estate,” because nothing was left in the estate. He went on to say that “amending the schedules would have no legal effect.” He surmised that the bankruptcy judge allowed the debtor to amend the schedules “apparently as an accommodation to the state court’s requirement that schedules be amended so there would be no doubt about the state court’s authority.”
Judge Klein ended his concurrence with a hint about what might happen next in state court. He said that the BAP expressed no view “regarding what, if anything, the Oregon state court should do in consequence of the omission from the schedules of the prepetition cause of action.”
In other words, Judge Klein was hinting that judicial estoppel might bar the owners and the debtor corporation from prosecuting claims they had not scheduled in the bankruptcy case.
Other Observations
What happens next in state court?
Judicial estoppel could be a problem for the owners and the debtor, but better-reasoned opinions are saying that judicial estoppel does not preclude a trustee from liquidating an unscheduled asset.
Let’s assume, however, that the suit proceeds in state court and judicial estoppel doesn’t knock out the owners and the debtor. Also assume that the plaintiffs obtain a judgment against the malpractice defendants.
The malpractice claim had not been abandoned in chapter 11, so ownership did not vest permanently in the debtor.
The U.S. Trustee or a creditor could have the bankruptcy court revoke dismissal, convert to chapter 7 or appoint a chapter 11 trustee, and take the judgment into the estate. Or, the U.S. Trustee or a creditor could revoke dismissal sooner and take over prosecution of the suit if the state court was on the verge of dismissing based on judicial estoppel.
From the BAP’s opinion, it is unclear whether further proceedings in bankruptcy court would serve any purpose because the debtor said that no remaining unsecured creditors existed.
Unscheduled, undisclosed property is treated altogether differently when a case was dismissed compared to what happens if the case was closed, as the Ninth Circuit Bankruptcy Appellate Panel explained in an April 2 opinion.
If the case was administered and closed, undisclosed or unscheduled property remains in the estate, perhaps indefinitely. On the other hand, if the case was dismissed, all property reverts to the debtor, including undisclosed property.
The debtor’s standing is also different after dismissal. Because all property revested in the debtor, the debtor can pursue undisclosed property after dismissal. If the case was administered and closed, the debtor would not have standing to collect undisclosed property.
The Undisclosed Malpractice Claim
Two individuals owned a corporate debtor that owned apartment buildings. The owners conferred with bankruptcy lawyers about the efficacy of filing a chapter 11 petition for the corporation. The lawyers advised against a filing in chapter 11 and recommended filing a chapter 7 petition instead.
The owners consulted another bankruptcy lawyer, who put the debtor corporation into chapter 11, but not before the lender had installed a receiver in state court. The owners did not put themselves into bankruptcy.
In the chapter 11 case, the debtor did not schedule malpractice claims as an asset.
The bankruptcy court approved a sale of the corporation’s property, but the estate was administratively insolvent. The debtor corporation filed a motion to dismiss the chapter 11 case under Section 1112(b)(1). When no one objected, the bankruptcy court granted the dismissal motion.
Using the district’s standard form, the order dismissed the case and closed it, “but only for administrative purposes.”