One of the first things we advise all of our clients about filing bankruptcy is the requirement that a debtor disclose all required information. Whether filing a Chapter 7 Bankruptcy, Chapter 11 Bankruptcy or Chapter 13 Bankruptcy, the Bankruptcy Petition is a statement made subject to the federal penalties for perjury. However, even more importantly, the Bankruptcy Code is replete with requirements that disclosure equals protection. A recent case from the Eleventh Circuit highlights the potential peril of failing to disclose a disputed claim when filing for bankruptcy protection.
Slater sued U.S. Steel for discrimination and retaliation for her complaints of discrimination under provisions of Title VII, 42 U.S.C. § 2000e et seq, and 42 U.S.C. § 1981. The federal district court denied portions of U.S. Steel’s Motion to dismiss on summary judgment.
About a month after the ruling, Slater filed a Chapter 7 bankruptcy petition. In the Petition, Slater failed to disclose the pending claim against U.S. Steel. She had two (2) opportunities to do so. In Schedule B-Personal Property, a debtor is required to disclose “contingent and unliquidated claims.” In the Statement of Financial Affairs, a debtor must identify any “suits and administrative proceedings to which the debtor is or was a party within one year immediately preceding the filing of this bankruptcy case”. In both cases, she again answered “none.”
The bankruptcy trustee, unaware of Slater’s claim against U.S. Steel, issued a Report of No Distribution finding there was no property available for distribution from the estate over and above that exempted by law.
The next day, U.S. Steel, seeing opportunity, sought to dismiss Slater’s federal claims based on Slater’s failure to disclose the claim in her bankruptcy petition. Slater amended her Petition to reflect the claim and subsequently converted to a Chapter 13 case. Slater failed to make all required payments and her Chapter 13 case was ultimately dismissed without Slater receiving a discharge.
Slater’s claims against U.S. Steel were also dismissed. The Court was not moved by Slater’s argument that her failure to disclose was “inadvertent” nor her immediate amendments which disclosed them. The Court found that Slater “intended to make a mockery of the judicial system” and dismissed her claims.
Applicable Bankruptcy Law
When a debtor files a Chapter 7 petition, his assets, subject to certain exemptions, are immediately transferred to a bankruptcy estate. 11 U.S.C. § 541(a)(1). 11 U.S.C. § 727 provides that a Chapter 7 debtor may denied a discharge for failing to list an asset in the bankruptcy petition.
The logical reason for these provisions of the Code is simple and straightforward. Creditors who have claims against the debtor have a right to know whether the debtor has any assets against which a claim by them can be made. “Chapter 7 allows a debtor to make a clean break from his financial past, but at a steep price: prompt liquidation of the debtor’s assets.” Harris v. Viegelahn, 135 S. Ct. 1829, 1835 (2015).
Doctrine of Judicial Estoppel
The provisions of the Bankruptcy Code become relevant in bankruptcy cases under the the doctrine of judicial estoppel. “The equitable doctrine of judicial estoppel is intended to protect courts against parties who seek to manipulate the judicial process by changing their legal positions to suit the exigencies of the moment.” Slater v. United States Steel Corp. at 1176-1177. Where a party makes a legal argument in a proceeding, a Court may bar – or estop – that party from taking an inconsistent advantage by pursuing an incompatible theory.
U.S. Steel argued that Slater was estopped from, on one hand, failing to disclose her claim in the bankruptcy petition, and continuing to pursue it after it was not disclosed. The District Court’s language belied its belief that Slater’s omission was a purposeful effort to “defraud creditors” and that her subsequent amendment was “waiting until after being caught… is too little, too late.”
The Appellate Court Reverses
The Slater odyssey was not yet complete. After an Appellate Panel of the 11th Circuit Court of Appeals affirmed the dismissal of the claims, Slater sought review of an en banc panel of the Appellate Court.
The Court, seemingly aware of the harsh nature of the language in prior rulings, took a more balanced and nuanced approach. The Appellate Court reversed the dismissal of the case and remanded the matter to the en banc panel to determine whether the district court abused its discretion in applying judicial estoppel.
The Appellate Court began with a review and emphasis of the remedial intent of the Chapter 7 and Chapter 13 provisions of the Bankruptcy Code. Citing Grogan v. Garner, 498 U.S. 279, 286-87 (1991), the Court found that “hard-and-fast” rules about nondisclosure are antithetical to the spirit and statutory language of the Code. The Court noted Congress’ adoption of Bankruptcy Rule 1009 which permits a debtor to amend a schedule or statement “as a matter of course at any time before the case is closed.” Fed. R. Bankr. R. P. 1009(a).
Instead, the Court found that application of judicial estoppel, as applied to a debtor’s failure to disclose a claim in a bankruptcy petition, should be reviewed under a totality of the circumstances. The Court overruled any prior inference that a debtor’s nondisclosure was, by its very nature, an intent to make a mockery of the judicial system. Instead, the Court instructed District Courts to consider all of the circumstances when reviewing a claim of judicial estoppel. “The court should look to factors such as the plaintiff’s level of sophistication, his explanation for the omission, whether he subsequently corrected the disclosures, and any action taken by the bankruptcy court concerning the nondisclosure.” Slater at 1176.
Slater presents a cautionary tale about the risk associated with omitted assets and claims. For a debtor filing a bankruptcy case, it provides the range of opinions that Courts may have about “inadvertent” omissions and the importance of a “due diligence inquiry” into the facts and information provided in the bankruptcy petition. For bankruptcy attorneys, the case presents clear evidence of the duration and cost of litigation that such “inadvertent” omissions may cause to their clients and their firms. And for those who prosecute claims for recovery, it evidences the importance of conferring with your clients about any prior bankruptcy filings and the necessity that any such filings be reviewed with an experienced bankruptcy attorney.