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Failure to Disclose Asset Excused in 10th Circuit Bankruptcy Appeal

By Myron A. Bloom

A recent decision issued by the 10th U.S. Circuit Court of Appeals Bankruptcy Panel, In re Riazuddin, provides an interesting case study involving the interplay among three often seen bankruptcy concepts - standards for reopening cases, judicial estoppel and standing.

First, the facts. Before the husband and his co-debtor wife filed their joint Chapter 7 case, Mrs. Riazuddin was injured while riding on an elevator maintained by Schindler Elevator Co. The Riazuddins retained a personal injury lawyer to prosecute their claim against Schindler, and the attorney put Schindler on notice of the claim. After issuance of the notice, and before suit was filed, the Riazuddins filed for Chapter 7 relief.

The debtors did not list the claim against Schindler on their Schedules and did not claim the proceeds of the claim as exempt. (Under applicable state law, the proceeds of such a claim could be exempted, to a maximum of $50,000.) While the Chapter 7 case was still open, the Riazuddis in fact filed suit against Schindler. They did not amend their schedules; the Chapter 7 trustee was not made aware of the suit, the debtors received their discharges, and the case was closed as a no-asset case.

Eventually, someone found out about the failure to list the claim as an asset. In this case it was Schindler, the defendant in the personal injury action. Schindler filed a motion to dismiss, claiming that the debtors had no standing to pursue the action, as the action was property of the bankruptcy estate, and that the former debtors were judicially estopped form bringing the action, based on their failure to disclose the action as an asset in the bankruptcy case. In response, the former debtors moved to reopen their bankruptcy case to amend their schedules, notified the Chapter 7 trustee, and sought abandonment of the claim. The Chapter 7 trustee also filed a motion to reopen, so that she could administer the claim for the benefit of creditors.

Schindler objected to both motions. It argued that the debtors' position in bringing a personal injury was inconsistent with the position taken in their bankruptcy schedules, that no such claim existed, and thus debtors' conduct was barred by principles of judicial estoppel. It also argued that the Chapter 7 trustee, as successor in interest to the debtors, was bound by the debtors' conduct. To these two objections, the debtors argued that they had disclosed the action to their bankruptcy counsel and had no intention of misleading the court, the trustee or creditors; and the Chapter 7 trustee argued that Schindler, not being a creditor, had no standing to oppose the motion.

The bankruptcy court, without allowing offered testimony from the debtors as to the reasons for omitting the claim, denied the motions to reopen, and held on the basis of judicial estoppel that the debtors were barred from prosecuting the action. Interestingly, the bankruptcy court did not specifically deal with the issue of standing, and at least implicitly concluded that the claim that had been omitted from the schedules was worthless to the estate. An appeal followed.

After concluding that the bankruptcy appellate panel had jurisdiction to review the bankruptcy court's order, it then discussed the standard of review (abuse of discretion for issues relating to reopening the closed case, application of the doctrine of judicial estoppel, and the decision to include or exclude evidence, noting, however, that "an abuse of discretion . . . may exist when a ruling is premised on an erroneous conclusion of law;" and de novo for the issue of standing). It then turned to the merits of the appeal.

The panel first dealt with Schindler's standing the oppose the motions to reopen. Rule 5010, Fed.R.Bankr.P., provides that a case may be reopened on motion of a debtor or other party in interest. The panel concluded that only those who had standing to reopen a case had standing to oppose a motion to reopen a case, since only those with a particular and direct stake in a case had standing. Here, Schindler had no such stake. Schindler's liability to the debtors (or to the Chapter 7 trustee) was not affected by the bankruptcy, and its mere assertion that its defense may be affected by the reopening was "insufficient to give it a direct interest in the [d]ebtors' bankruptcy case." Therefore, stated the panel, the bankruptcy court should have disallowed Schindler's opposition to the motions.

The panel next took up the issue of whether judicial estoppel should have applied to the debtors. The panel, following recent Supreme Court precedent, set forth a three-pronged test for determining whether judicial estoppel should apply: Is the party's later position clearly inconsistent with his earlier position; has the party succeeded in persuading a court to accept the earlier position, so as to create a perception that either the first or second court was misled; and will the party seeking to advance the inconsistent position obtain an unfair advantage or impose an unfair detriment on the opposing party if he were not estopped.

Judicial estoppel, stated the panel, is distinguishable from equitable estoppel, in that the party asserting equitable estoppel must demonstrate detrimental reliance; judicial estoppel is more concerned with, and designed to, protect the integrity of the court system and not any individual litigant.

In this case, while arguably the bankruptcy court was misled by "adopting" the debtors' position (that an asset did not exist) by entering a final decree, there was no permanent harmful effect since if the case were to be reopened, creditors will be notified and have an opportunity to file claims, and the Chapter 7 trustee will be able to administer the asset. In other words, even assuming the bankruptcy court was misled, the reopening of the case will remedy that fact. In addition, the debtors will not obtain an unfair advantage. With the exception of the possible exemption claim, the proceeds of the claim will be distributed to creditors. Finally, in no way will the debtors' and trustee's position impose an unfair detriment on Schindler - all Schindler loses is the windfall it hoped to receive by avoiding litigation.

Judicial estoppel, stated the panel, is an equitable doctrine. As such, a court can look beyond the three-pronged test adopted here to all equities of the case. Chief among them, stated the panel, is the interest of creditors. Here, refusal to reopen the case to administer the claim against Schindler ultimately harms creditors most of all. Though the goal of full disclosure is laudable, stated the panel, using judicial estoppel as a remedy without discretion "would land another blow on victims."(citing 7th Circuit authority). To have used it here, concluded the panel, was erroneous.

The panel next took up the issue of whether the bankruptcy court erred in concluding that judicial estoppel should have been extended to the Chapter 7 trustee. The panel found that the bankruptcy court did in fact commit reversible error by doing so. It stated that none of the factors to be evaluated in determining the applicability of judicial estoppel weighed in favor of such application. Indeed, the trustee was not responsible for any misperception. Though cases often recognize the general principle that the rights of a Chapter 7 trustee can rise no higher than those of the debtor, that axiom is limited to pre-petition defenses to causes of action that would have been applicable to a debtor if no bankruptcy had been filed.

Citing to 11th Circuit law, the panel recognized that here, when the bankruptcy case was filed, the claim against Schindler became an asset of the estate, and the trustee, not the debtors, became the real party in interest. The trustee never abandoned the claim, and never took an inconsistent position. Thus, the trustee cannot now be judicially estopped from pursuing it. To have held otherwise was error.

Finally, the panel focused on the bankruptcy court's refusal to allow the debtors to testify to the reasons for omitting the claim from the schedules. (As noted above, the claim was, according to current counsel, disclosed to their then-counsel. This point was made in counsel's remarks to the bankruptcy court, but not the subject of testimony.) The panel observed that judicial estoppel ought not to be applied if a party's prior position was based on inadvertence or mistake. The bankruptcy court, stated the panel, could not have properly evaluated the issue of unfair advantage without considering the debtors' state of mind; moreover, intent, which testimony would have illuminated, should be a factor in evaluating whether to impose the otherwise harsh result to creditors which would occur if estoppel applied. It was an abuse of discretion to not consider this evidence.

For all of the reasons set forth above, the decision of the bankruptcy court was reversed and remanded.

The panel seems to have gotten it right. Though its analysis of Schindler's standing to oppose the motion was not thorough, it would appear that any result other than reversal would severely punish creditors - those who had no hand in the debtors' omission, and the very people who, after all, are most often hurt the most in not only this, but in most, bankruptcy cases.

This article is reprinted with the permission from the March 2, 2007 issue of The Legal Intelligencer.  Copyright 2007 ALM Properties, Inc.  Further duplication without permission is prohibited.  All rights reserved.