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Debtor's exemption surcharged for failure to list an asset: Seres

In re Seres; WDNY Bk 08-12185; Ford Credit v. Seres & Wallach; AP 09-01289 (Judge Bucki; Decision dated October 1, 2010). If a debtor fails to list an ongoing personal injury lawsuit on his bankruptcy petition, or report it to the trustee at the 341 hearing, that debtor's personal injury exemption will be surcharged for the trustee's costs and expenses caused by the failure to disclose, so says Judge Bucki. I would predict that Rochester Judge Ninfo, rather than surcharging the exemption, would have denied it outright, in a similar situation.

In 2001, the debtor was involved in a car accident in Lackawana NY. Two years later, he filed a personal injury lawsuit against the other driver. In 2004, Ford Tilting Credit Trust was added as a defendant in the lawsuit Apparently Ford Credit was the actual owner of the vehicle. It must have been a lease; in New York, car owners are liable for accidents caused by drivers of their car. Since then New York law has changed regarding liability of businesses that lease cars.

The debtor filed a Chapter 7 bankruptcy petition May 19, 2008 (as an aside, this debtor had obtained a discharge in a prior bankruptcy in March of 2000, very slightly more than eight years earlier.) The debtor failed to list the lawsuit anywhere on the schedules. On the Statement of Financial Affairs, question 4, the debtor listed being a defendant in three lawsuits, but not that he was plaintiff in the Ford credit case. On his schedules of assets, the lawsuit was not listed and the debtor answered "none" under question 21 (contingent claims of any kind) and 35 (any other personal property.)

The debtor testified under oath at a trustee (341) hearing on June 26, 2008. The trustee asked the debtor "have you fully listed all your assets and liabilities to the best of your knowledge?" and the debtor replied "yes." The trustee specifically asked "do you have any personal injury claims", and the debtor answered "no."

The debtor received a bankruptcy discharge on September 18, 2008, and the case was closed a month later. Under Bankruptcy Code Section 554 (c), all assets that have been listed on the bankruptcy schedules and not administered by the trustee are deemed abandoned back to the debtor. In other words, if an asset is listed on the schedules and the trustee doesn't sell it, the debtor becomes the owner of that asset again when the case is closed. But here, the personal injury lawsuit was never scheduled, so as a legal matter the trustee remained owner of the asset even after the bankruptcy case was closed.

In March of 2009, Ford Credit moved in state court to dismiss the personal injury lawsuit, on the grounds that the plaintiff (the bankruptcy debtor) was no longer the owner of the claim (because the bankruptcy trustee was the owner) and, therefore, the plaintiff no longer had the standing to continue the lawsuit. The trustee apparently was made aware of this situation and applied to the bankruptcy court on May 13, 2009 to reopen the bankruptcy case. In state court, the Ford Credit motion was granted and the 2003 personal injury lawsuit was dismissed June 9, 2009. The trustee filed a new state court personal injury lawsuit July 10, 2009

Ford Credit then filed a bankruptcy lawsuit (adversary proceeding) in December of 2009, asking the bankruptcy court to declare that the debtor (and, for some reason, the trustee) was "judicially estopped" from pursuing the personal injury action. The claim was that having failed to disclose the claim on his schedules or at the trustee hearing, the debtor should not be entitled to pursue it further. I am not quite sure how this was suppose to apply to the trustee as well.

In any case, the trustee filed a motion July 14, 2010, asking the bankruptcy court to approve a settlement of the personal injury lawsuit for $75,000. The debtor filed a letter August 11 claiming the settlement as wholly inadequate, that the claim was worth $3,750,000. A month later the debtor's attorney filed a doctor's report stating that the debtor was totally disabled by this accident.

Meanwhile, the debtor finally amended his schedules to include the accident claim on August 16, 2010, valuing the asset bat $3,750,000. The debtor also claimed a $7,500 personal injury exemption. The trustee filed a motion objecting to the exemption on August 19. The debtor's reply to that motion, filed August 30, stated that he was on medications at the time he filed his bankruptcy and was not thinking clearly. He also stated that the lawsuit "had been dragging on for so long that I really didn't feel I'd ever see any funds and I had just put the whole thing out of my mind."

In his October 1 decision, Judge Bucki approved the $75,000 settlement, based on the recommendation of the trustee's personal injury attorney's recommendation (the same attorneys as had represented the debtor in the action.) The judge also concluded that the debtor was not entitled to object to the settlement, that he was "estopped" from objection due to his own failure to list the asset. The bankruptcy trustee was required to go through the trouble and expense of filing a new state court lawsuit - and face objections from Ford Credit - due to the debtor's failure to list the asset. "Thus we find necessary elements of estoppel: a willful misrepresentation upon which the trustee would rely to the detriment of the bankruptcy estate."

The judge also hammered the debtor on his exemption claim. The debtor had taken two opposing viewpoints concerning this lawsuit. On the one hand, the debtor claims that it was so inconsequential that it just slipped his mind when he filed bankruptcy and testified at the trustee hearing. On the other hand, the debtor claims the lawsuit was so monumental that the trustee's $75,000 settlement was wholly inadequate.

The judge did not disallow the exemption claim outright. "Because the trustee relied upon the debtors non-disclosure of a personal injury claim, estoppel precludes the debtor's objection to the trustee's proposed settlement. The late claim of an exemption presents a different issue, however. Having made no distribution to creditors, the trustee has suggested no detrimental reliance from the absence of any exemption claim." Because Bankruptcy Rules allow a debtor to amend schedules at any time, "[i]mplicitly, the debtor may remedy his bad faith in any initial failure to file comprehensive schedules."

However, the failure to list the asset has likely caused the trustee additional costs and expenses. "Because creditors should not suffer the losses that result from a violation of disclosure obligations under 11 U.S.C. §521(a), the court will surcharge the debtor's exemption for the reasonable value of any cost to the estate." The trustee filed a motion October 21 asking for $3,608.50 in attorney fees and expenses be surcharged to the debtor's exemption claim.

As an aside, I believe the dismissal of the original state court proceeding, due to the failure of the debtor to schedule the asset in the bankruptcy, could have been catastrophic for the bankruptcy trustee. When the trustee filed the new state court lawsuit July 10, 2009, it was way past the three year statute of limitations for this 2001 car accident.

I do not know if the statute of limitations was raised in this new action; the judge's decision and other papers filed in the bankruptcy case do not mention a statute of limitations defense. I also do not know why the trustee was not simply substituted as plaintiff in the state court action, as it had already been filed before the bankruptcy and the debtor had standing to sue when the state court case was filed. Where we see these statute of limitation problems more frequently is where the lawsuit is filed after the bankruptcy is closed. There are plenty of New York cases where the statute of limitations has been successfully raised where:

1) A lawsuit claim (personal injury or contract claim) was not scheduled in bankruptcy
2) The bankruptcy case closed
3) The debtor files a state court lawsuit
4) The debtor's state court case dismissed due to lack of standing to sue,
5) The trustee made aware of the claim well after the statute of limitations had run and,
6) Therefore, the trustee is time-barred from filing a new lawsuit.

In at least one case where I was trustee I got around the problem by abandoning the claim back to the debtor, in exchange for a security interest in the claim. When an asset is abandoned back to the debtor, the abandonment is effective as of the petition date (or 'nunc pro tunc" in lawyer-speak.) Thus, the debtor retroactively was empowered to have standing to prosecute the state court action; the debtor's original lawsuit could continue without worrying about statute of limitation problems, and the creditors still received the proceeds of the suit by virtue of the security interest. The sequence of events above would then look like this:

1) A lawsuit claim (personal injury or contract claim) was not scheduled in bankruptcy
2) The bankruptcy case closed
3) The debtor files a state court lawsuit
4) The debtor's state court case is facing dismissal due to lack of standing to sue,
5) The trustee made aware of the claim well after the statute of limitations had run,
6) The bankruptcy case is reopened;
7) The lawsuit claim is abandoned back to the debtor, in exchange for a security interest in the proceeds;
8) The debtor, retroactively, becomes the owner of the claim dating back to when the bankruptcy was filed;
9) Therefore, as the debtor was considered the owner of the claim when the post-bankruptcy lawsuit was filed, the debtor actually had standing to sue and the state court case was not dismissed.
5) Therefore, the trustee unable to pursue the claim.

I was pretty please with myself for coming up with that scheme, and then later found a couple of other New York cases where the exact same strategy was successful.

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