Let's Be Careful Out There: The Danger of Omitting Assets

Filing bankruptcy is serious business.    The mere act of filing a petition creates an automatic stay effective against all entities.    Liens can be modified, taxes can be paid out and debts can be discharged.   The price of admission for getting all these benefits is full disclosure.   Unfortunately some debtors either don't understand these obligations or think they can selectively disclose only the assets they want to list.   The consequences for omitting assets can be severe as illustrated by two recent opinions from the Fifth Circuit and a press release from the Acting U.S. Attorney for the Southern District of Illinois.

Judicial Estoppel

Judicial estoppel is a way for courts to make lawsuits go away.   Technically, it is about preventing people from taking inconsistent positions in litigation.   However, in bankruptcy, it is a way for defendants to get out of being sued based on the plaintiff's mistakes.   Two recent cases from the Fifth Circuit illustrate the dangers of this doctrine.

In Allen v. C & H Distributors, LLC, , No. 15-30330, 2015 U.S. App. LEXIS 22567 (5th Cir. 12/23/15), the debtors filed a chapter 13 petition and confirmed a plan.   One month after the plan was confirmed, one of the debtors was injured in a workplace accident.  One year later, she filed suit.  However, she did not amend her schedules to disclose either the claim or the lawsuit.    Four years later, after the plan had been amended several times, the Bankruptcy Court closed the chapter 13 case because the debtors failed to complete a financial management course.   Shortly thereafter, the defendant filed a motion for summary judgment based on judicial estoppel.    The defendant claimed that it had just learned of the bankruptcy because the plaintiffs/debtors had failed to mention the bankruptcy in response to interrogatories.    

The district court granted the motion and the Fifth Circuit affirmed.    The Fifth Circuit found that the debtors had taken inconsistent positions since they did not tell the bankruptcy court about the lawsuit while simultaneously pursuing it in district court.    The court found that the bankruptcy court accepted the debtors' position because it did not require the debtors to modify their plan to account for the lawsuit.   Finally, the court found that the failure to disclose was not inadvertent.   The court rejected the debtors' argument that they had no motive to conceal the asset since they did not receive a discharge in their chapter 13 case.   The Fifth Circuit held that what was important was the debtors' intent at the time they failed to disclose it, not at the point that they didn't get a benefit.

Thus, the debtors lost their lawsuit and did not receive a discharge, a bad result all around.   The court did provide that if the debtors' case was reopened and converted to chapter 7, the chapter 7 trustee would be allowed to intervene.   

The Allen case illustrates the unique nature of chapter 13.   It is not enough to file accurate schedules at the beginning of the case.   It is necessary to continually update those schedules as new assets are acquired.    

In United States ex rel. Long v. GSDMIdea City, LLC, 798 F.3d 265 (5th Cir. 2015), the debtors also lost their claim,  In November 2008, the debtors filed a chapter 13 petition.   A few months later, they confirmed a chapter 13 plan which provided for payment of 100% of unsecured claims, albeit without interest.  Nearly three years later in 2011, the debtor filed a False Claims Act case against his employer, GSDMIdea City.   In October 2013, the debtors completed their chapter 13 plan.   They discharged about $4,500 in unsecured claims, apparently because these creditors failed to file claims.   Just before trial, GSDMIdea City learned of the bankruptcy and moved to dismiss the case.   The District Court gave the Chapter 13 trustee seven days to intervene, which the trustee declined to do.   It then dismissed the case.

The Fifth Circuit affirmed the dismissal.  It found that the failure to disclose was not inadvertent.  Even though the debtors had completed a plan providing for a 100% payout, they did not pay all of their creditors and did not pay interest.   This was a harsh result.   If the debtors had disclosed the lawsuit, the creditors that did not file claims still would not have been paid.   If the trustee had required the debtors to amend their plan to provide for payment of post-petition interest, it would have been at the federal judgment rate and would have been minimal.   

What these cases show is that judicial estoppel will be strictly enforced against debtors.   The courts seem to be more concerned with policing the integrity of debtor's disclosures than protecting creditors.  In both cases, the failure to disclose did not harm creditors.   In Allen, the fact that the case was closed without entry of a discharge meant that the creditors could have still pursued the debtors and garnished the lawsuit proceeds.   However, because the lawsuit was dismissed, creditors lost this asset (although it allowed a subsequent trustee to pursue the claim).    In Long, the defendant escaped liability because the debtors failed to pay a nominal amount of interest to their creditors.   

Criminal Prosecution

As bad as losing a lawsuit is, losing your freedom is worse.   On February 2, 2016, the Acting U.S. Attorney for the Southern District of Illinois announced three prosecutions for bankruptcy fraud.   In two of the cases, the debtors filed chapter 13 but failed to disclose workers compensation claims which were later settled for $28,129.55 and $17,000 respectively.   Additionally, one debtor was indicted for refusing to provide copies of his tax returns to the trustee and another was indicted for failure to turn over a tax refund in the amount of $2,478.

According to the Statement issued by the Acting U.S. Attorney:

"Our federal bankruptcy laws allow people who have overwhelming debt to obtain a fresh start," Acting United States Attorney Porter explained. "Before their debts are eliminated, however, individuals who file bankruptcy are asked to be truthful about their assets and other matters that affect the bankruptcy case. When people conceal their assets and otherwise lie in bankruptcy proceedings, they are cheating their creditors and subverting the bankruptcy process. People who engage in this type of activity can expect to be prosecuted by my office no less than those persons who would use force to steal."

In both of these cases, the debtors face criminal prosecution for failing to disclose relatively small amounts of money.    The amounts that the debtors allegedly kept were modest when compared to being fingerprinted, photographed, publicly shamed and potentially going to jail for a felony.

There was a third case involving perjury and falsifying records which was more complicated.

Will the New Schedules Help?

Some debtors will intentionally try to game the system and hang on to more assets than they should.   However, the schedules are really complicated and it is quite possible to make an inadvertent mistake.  The judicial estoppel cases relate to failure to disclose claims which later resulted in litigation.    Under the old schedules, the question on Schedule B asked about:

Other contingent and unliquiated claims of every nature, including tax refunds, counterclaims of the debtor, and rights to setoff claims.

It probably required a lawyer to translate this into English as "is there anyone you want to sue"?

The new schedules which went into effect on December 1, 2015 may help to address this problem.    Here are some of the categories debtors are required to list:

28. Tax refunds owed to you

30. Other amounts someone owes you Examples: Unpaid wages, disability insurance payments, disability benefits, sick pay, vacation pay, workers’ compensation, Social Security benefits; unpaid loans you made to someone else

 33. Claims against third parties, whether or not you have filed a lawsuit or made a demand for payment Examples: Accidents, employment disputes, insurance claims, or rights to sue

With the new plain English forms, debtors will be more likely to understand their disclosure obligations (assuming that they actually read the forms).   The bad news is that debtors who omit assets will have a harder time saying I didn't understand.