Chapter 7 and Chapter 13 Bankruptcy Codes Conflict

Debtor in Bankruptcy Must Disclose All Assets and Liabilities or Risk Severe Penalties#5 of 8 in Series — Previous Article #4: Judicial Estoppel Normally Used to Prevent Conflicting Litigation

In the vast majority of consumer cases, assets are easily identifiable and can be listed and valued on schedules A and B with limited investigation. However, one asset that may be both difficult to identify and value is the debtor’s interest in any causes of action that he or she may have against a creditor or other third party. In fact the debtor may not even realize that there is a potential claim, such as a creditor’s violation of the Fair Debt Collection Practices Act, or an action against a former employer for wrongful termination. The attorney’s failure to properly list an asset may bar the debtor from pursuing an action at a later time. Yet bad legal advice does not relieve the debtor of the consequences of the incorrect filing. In the case Cannon-Stokes v. Potter, 453 F.3d 446 (7th Cir. 2006)[2] Judge Easterbrook wrote “[a] lawyer is the client’s agent, and the client is bound by the consequences of advice that the client chooses to follow. Cannon-Stokes might as well say that she is free to ignore any contract that a lawyer advised her to sign with her fingers crossed behind her back. The lawyer’s role as agent is why the Supreme Court held in United States v. Boyle, 469 U.S. 241, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985), that a taxpayer could not avoid paying interest and penalties occasioned by his lawyer’s mishandling of the return. Just so here: a debtor in bankruptcy is bound by her own representations, no matter why they were made, at least until the debtor moves to amend the disclosures and pay the creditors their due (a step that, to repeat, Cannon-Stokes has not taken). The remedy for bad legal advice lies in malpractice litigation against the offending lawyer.”

Let’s sum this up: Upon filing a bankruptcy under sec. 541, everything in the world you own, or are entitled to receive, belongs to, and is under the control of, the bankruptcy court until the court abandons that property and gives it back to you. The job of a good attorney is to know what you are allowed to keep, and advise you on that.

However, that does not absolve the debtor from any responsibilities, as they could be penalized for following bad advise from their attorney and subject to fines, revocation of the bankruptcy, and/or criminal charges.

Judicial Estoppel Normally Used to Prevent Conflicting Litigation

Judicial estoppel “is an equitable concept providing that a party who prevails on one ground in a lawsuit may not in another lawsuit repudiate that ground.” United States v. Christian, 342 F.3d 744, 747 (7th Cir. 2003)[3]. This doctrine’s purpose is “‘to protect the integrity of the judicial process’ by preventing litigants from ‘deliberately changing positions according to the exigencies of the moment.’” Matthews v. Potter, 316 Fed. App’x 518, 522 (7th Cir. 2009)[4] (quoting New Hampshire v. Maine, 532 U.S. 742, 749-50 (2001)). Judicial estoppel may apply when: (1) the later position is clearly inconsistent with the earlier position; (2) the facts at issue are the same in both cases; (3) the party to be estopped convinced the first court to adopt its position; and (4) the party seeking to assert an inconsistent position would derive an unfair advantage or impose an unfair detriment on the opposing party if not estopped. Christian, 342 F.3d at 747. “Judicial estoppel is strong medicine, however, and it should not be used where it would work an injustice. . . . The rule looks toward cold manipulation and not an unthinking or confused blunder.” In re In re FV Steel & Wire Co., 349 B.R. 181, 185 (Bankr. E.D. Wis. 2006)[5].
Judicial Estoppel Applied in Bankruptcy When Debtor Belatedly Pursues Undisclosed Claim
The doctrine of judicial estoppel is normally invoked to prevent a party from asserting positions in successive judicial proceedings that are so “clearly inconsistent” that accepting the latter position would create the perception that at least one of the courts was deceived. Matthews, 316 Fed. App’x at 522. The doctrine frequently is invoked in connection with bankruptcy proceedings when a debtor has failed to disclose a claim, but then pursues the claim after the bankruptcy concludes. However, “[e]stoppel is an equitable concept, and its application is therefore within the court’s sound discretion…. It should not be used where it would work an injustice, such as where the former position was the product of inadvertence or mistake . . . or where there is only an appearance of inconsistency between the two positions but both may be reconciled.” In re Cassidy, 892 F.2d 637, 642 (7th Cir. 1990).[4].
Judicial Estoppel Motivates Full and Truthful Disclosures From Debtor Bankruptcy Filings

For example, in the Cannon-Stokes decision cited earlier in these materials, Traci Cannon-Stokes filed a Chapter 7 bankruptcy in which she attempted to discharge over $98,000.00 in debt while at the same time she was pursuing a $300,000.00 claim against her former employer, the United States Postal Service. The Seventh Circuit applied the doctrine of judicial estoppel and held that the debtor’s failure to list the potential asset in her bankruptcy would preclude her from pursuing the claim against the USPS. The Court held, “’By making [litigants] choose one position irrevocably, the doctrine of judicial estoppel raises the cost of lying.’ Chaveriat v. Williams Pipe Line Co., 11 F.3d 1420, 1428 (7th Cir.1993).[5]. A doctrine that induces debtors to be truthful in their bankruptcy filings will assist creditors in the long run (though it will do them no good in the particular case)—and it will assist most debtors too, for the few debtors who scam their creditors drive up interest rates and injure the more numerous honest borrowers. Judicial estoppel is designed to “prevent the perversion of the judicial process,” In re Cassidy, 892 F.2d 637, 641 (7th Cir.1990), a fair description of the result if we were to let Cannon-Stokes conceal, for her personal benefit, an asset that by her reckoning is three times the value of the debts she had discharged. It is impossible to believe that such a sizeable claim—one central to her daily activities at work—could have been overlooked when Cannon-Stokes was filling in the bankruptcy schedules. And if Cannon-Stokes were really making an honest attempt to pay her debts, then as soon as she realized that it had been omitted, she would have filed amended schedules and moved to reopen the bankruptcy, so that the creditors could benefit from any recovery. Cannon-Stokes never did that; she wants every penny of the judgment for herself.” Cannon-Stokes, 453 F.3d at 448.

Chapter 7 and Chapter 13 Bankruptcy Codes Conflict

Such a decision appears fairly straight-forward in the context of a Chapter 7 petition, but conflicting Code provisions in Chapter 13 cloud the waters in a Chapter 13 proceeding. Bankruptcy Code section 1306 [Property of the estate][1] states, “Property of the estate includes, in addition to the property specified in section 541 of this title — (1) all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first; and (2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first.

In the 7th Circuit, Judge Posner stated, “It’s true that the bankruptcy code say that all earnings of the debtor are property of the estate under 1306. But it also says confirmation of the plan vests all property of the estate to the debtor, unless the plan provides otherwise, which we think scotches any inference that Congress intended to render all Ch 13 debtors legally incompetent to manage any of their own property. We read the two sections, 1306 and 1327, to mean simply that while filing the petition for bankruptcy places all the property of the debtor in the control of the bankruptcy court, the plan upon confirmation returns so much property to the debtor’s control as is not necessary for the fulfillment of the plan.”

We interpret this to mean that if the court already has a confirmed plan in place, it is assumed that the debtor can manage these funds, and that assets not necessary for the fulfillment of the plan should be returned to the debtor.

Four Judicial Lines of Reasoning Regarding Bankruptcy Estate

Thus it appears clear that any after acquired property in Chapter 13 constitutes property of the estate. However, Bankruptcy Code section 1327(b) [Effect of confirmation] states, “Except as otherwise provided in the plan or the order confirming the plan, the confirmation of a plan vests all of the property of the estate in the debtor.” Thus once a case is confirmed all property of the estate vests in the debtor; so does the bankruptcy estate cease to exist? There are four main lines of reasoning from circuits across the country.
  1. Estate termination approach: All property of the estate vests in the debtor upon confirmation and that the estate terminates at that point. Under this approach, there is no property of the estate after confirmation, only property of the debtor. This approach takes a literally reading of Section 1327(b) in vesting all property regardless of when it was acquired in the debtor. It has been criticized because it fails to give effect to the language of section 1306(a), which specifically provides that all property acquired between commencement of the case and closing, conversion or dismissal is property of the estate. See Cal. Franchise Tax Bd. v. Jones (In re Jones), 420 B.R. 506, 514-515 (9th Cir. B.A.P. 2009). However, even under this approach, a debtor may have to amend schedules to add an after acquired asset even if it is not property of the estate. As discussed earlier undisclosed assets remain property of the estate and may not revest to the debtor.
  2. Estate Preservation Approach: All property of the estate at confirmation remains property of the estate until discharge, dismissal or conversion. This approach is criticized because it fails to address the language of section 1327(b), which specifically provides for the vesting of property of the estate in the debtor upon confirmation of the plan. See Security Bank of Marshaltown v. Neuman, 1 F.3d 687, 690-691 (8th Cir. 1993) which held that confirmation is not relevant to determining whether property is property of the estate. Instead the only relevant events are commencement of the case and dismissal, closing or conversion of the case. This approach has been criticized as it would render section 1327(b) meaningless when it clearly states that property of the estate vests in the debtor upon confirmation of the plan.
  3. Estate reconciliation approach: Estate property existing at confirmation vests in the debtor but subsequently acquired property becomes property of the estate. See In re Eldridge, 09-03589-8-SWH, 2013 WL 64756 (Bankr. E.D.N.C. Jan. 4, 2013): Residence vested in the debtor at confirmation and was not property of the estate; homeowners association did not need stay relief to pursue post-petition assessment under state law. The debtor was not required to pay association’s attorney fees for unnecessary stay relief motion. See also Crouser v. BAC Home Loans Servicing, L.P. (In re Crouser), 476 B.R. 340 (Bankr. S.D. Ga. Aug. 20, 2012): Vesting at confirmation did not prevent property acquired post-confirmation from coming into the estate. Damages for willful stay violation were property of the estate that must be turned over to trustee for distribution.
  4. Estate transformation approach: Chapter 13 plan confirmation returns all property of the bankruptcy estate to the Debtor that is not necessary for the fulfillment of the confirmed plan. This approach has been criticized because it also ignores the language of section 1306(a) which, by its terms, makes no distinction between “property necessary to complete the plan,” and any other property. See In re Waltower, No. 08-12864, 2012 WL 4758043 (Bankr. S.D. GA. Sept. 7 2012): Surrender of property to mortgagee through a confirmed plan and revesting property in debtors under §1327(b) removed property from the estate and automatic stay terminated; neighbor is entitled to §362(j) order confirming that the automatic stay does not protect debtors from a state court nuisance action when mortgagee did not foreclose or maintain property after surrender.
The estate transformation approach, which is what the 7th Circuit uses to make determinations, says the estate does continue to exist, but only to the extent of assets that are necessary for the completion of the plan.

Seventh Circuit Court Adopts Estate Transformation Approach

The Seventh Circuit adopted the “estate transformation approach” when it ruled on the case, Black v. United States Postal Serv. (In re Heath), 115 F.3d 521, 524 (7th Cir. 1997)[3]. Chief Judge Posner wrote the opinion and held “It is true that the Bankruptcy Code says that all the earnings of a Chapter 13 debtor are property of the estate. 11 U.S.C. § 1306(a)(2). But it also says that ‘confirmation of a plan vests all of the property of the estate in the debtor’ unless the plan provides otherwise, § 1327(b) (emphasis added), which we think scotches any inference that Congress intended to render all Chapter 13 debtors legally incompetent to manage any of their property. We read the two sections, 1306(a)(2) and 1327(b), to mean simply that while the filing of the petition for bankruptcy places all the property of the debtor in the control of the bankruptcy court, the plan upon confirmation returns so much of that property to the debtor’s control as is not necessary to the fulfillment of the plan.”

For example, let’s say the court states that the debtor has to pay back $5,000 to creditors because they have too much in assets, and the debtor puts together a plan that pays for a needed car, as well as pays $5,000 to their unsecured creditors, the estate exists to the extent that is necessary to collect that money to pay those debts back.

On the other hand, creditors cannot attempt to sue the debtor for a post-petition debt in an effort to garnish their wages or collect the debt. In this case, the bankruptcy attorney would be responsible to write to contact the creditor and state, “You cannot do that because the wages that they are earning are property of the estate because they are necessary for the fulfillment of the plan. After the bankruptcy is over, you can whatever the hell you want to do, but while the bankruptcy is going on, this is property of the estate and you can’t touch it.”

Next Article in Series: Cause of Action Assets Must Be Disclosed Whether Property of Estate or Debtor

Sources: [1] Cornell University Law School Legal Information Institute; [2] Justia; [3] OpenJurist; [4] CaseText; [5] CourtListener

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*Disclosure required by 11 U.S.C. § 528(a)(3): We, the law office of Tom Scott & Associates, P.C., are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.