Bankruptcy Fraud—Tactics for the Effective Use of a Plaintiff’s Bankruptcy Filing in Defending Civil Claims

By Nicholas D. Bowers, Esq.*

As most any seasoned claim handler can attest, it is not uncommon to come across a civil plaintiff who has pursued or is actively pursuing a petition for bankruptcy in the federal courts, separate and apart from his or her civil claim. As is set forth in detail below, these bankruptcy filings can be utilized by carriers and their insureds to great effect in defending civil actions.

Under 11 U.S.C. §§541(a)(1) of the United States Bankruptcy Code, upon the filing of a bankruptcy petition, all of a debtor’s assets become property of the [bankruptcy] estate. “Property of the estate” is broadly defined in the Code as “all legal or equitable interests of the debtor in property as of the commencement of the case.” The Bankruptcy Code requires a debtor to disclose all of his assets and liabilities, including causes of action, regardless of the value of the claim or likelihood of success. See, Oneida Motor Freight, Inc. v. United Jersey Bank, 848 F.2d 414, 419 (3^rd Cir. 1988).

The duty to disclose applies to pre-petition claims, i.e., claims that arose prior to the date of the bankruptcy filing. See, 11 U.S.C. § 521(1) (“The debtor shall file… a schedule of assets and liabilities… and a statement of the debtor’s financial affairs… .”); Collier on Bankruptcy, 15^th Edition Rev. §521.06[3][a] (“Possible causes of action belonging to the debtor should be listed, even if the likelihood of success is unknown”). See also, Oneida Motor Freight, 848 F.2d at 416-17 (3^rd Cir. 1988). The disclosure obligation continues throughout the pendency of the bankruptcy proceeding and requires the debtor to amend the schedules, as necessary, to ensure the accuracy and reliability of the disclosed information. Okan’s Foods v. Windsor Assocs., L.P. (In re: Okan’s Foods), 217 B.R. 739, 752 (Bkrtcy. E.D. Pa. 1998).

A debtor is required to list all assets and liabilities in order to provide the Bankruptcy Court, the trustee and the creditors of the estate information regarding the debtor’s financial condition so that the debtor’s claims and liabilities can be adjusted, administered and distributed in accordance with the Code. When a debtor fails to list assets, the bankruptcy process is stymied because neither the trustee nor the Bankruptcy Court can administer such hidden property. It becomes impossible to determine whether it has value and should be distributed for the benefit of the estate’s creditors or is of inconsequential value and should be abandoned back to the debtor.

Given the importance of a full disclosure in bankruptcy, a debtor is barred from retaining title to, or seeking to recover, undisclosed assets that were never abandoned in the bankruptcy case. The Code provides that, “[u]nless the court orders otherwise, property of the estate that is not abandoned . . . and that is not administered in the case remains property of the estate.” 11 U.S.C. §554(d). By way of additional explanation, 11 U.S.C. §554(c) states, “[u]nless the court orders otherwise, any property scheduled under section 521(a)(1) of this title not otherwise administered at the time of the closing of a case is abandoned to the debtor….” Thus, where the property (asset) is not disclosed and, thus, not scheduled under section 521(a)(1), it cannot be subsequently abandoned under section 554(c) and, therefore, remains part of the bankruptcy estate after discharge. See, 11 U.S.C. §554(d). Accordingly, title to the non-disclosed property remains with the bankruptcy trustee and does not transfer back (via abandonment) to the debtor. See, First National Bank v. Lasater, 196 U.S. 115 (1905); Krank v. Utica Mutual Insurance Co., 109 B.R. 668, 669 (Bkrtcy. E.D. Pa. 1990).

Stated plainly, where a plaintiff files for bankruptcy protection and does not disclose a civil cause of action that arose prior to bankruptcy discharge, the plaintiff becomes barred from pursuing the civil action following termination of the bankruptcy case (discharge). The practical effect of this operation of law is significant. Specifically, it provides an opportunity to dispose of a claim based on the plaintiff’s fraudulent conduct in a collateral bankruptcy proceeding. The claim could be worth $10,000 or $10 million – the plaintiff loses his or her right to pursue the civil action, regardless of its merit or potential value.

Several tactics are recommended in order to ensure that an opportunity to dispose of a claim, as described above, is not missed or overlooked. In investigating a claim, take a recorded statement and ask the plaintiff whether he has ever filed for bankruptcy protection and, if so, when. This line of questioning should also be pursued at the time of deposition. Further, all answers in this regard are verifiable via review of the applicable bankruptcy petition filing, docket and discharge order (each of which are public records and are available at a reasonable cost). In the event it is determined that a plaintiff failed to disclose an actual or potential civil claim in a bankruptcy filing resulting in a discharge subsequent to the civil date of loss, the plaintiff’s civil claim should be denied and defended on this basis.

*Nick is an associate in our Philadelphia, Pennsylvania, office. He can be contacted at 215.575.2742 or ndbowers@mdwcg.com.

Defense Digest, Vol. 19, No. 4, December 2013

Defense Digest is prepared by Marshall Dennehey Warner Coleman & Goggin to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. Copyright © 2013 Marshall Dennehey Warner Coleman & Goggin, all rights reserved. This article may not be reprinted without the express written permission of our firm.