Litigating a Bankruptcy Debtor's Nonbankruptcy Claims
| Citation | Vol. 90 No. 5 Pg. 52 |
| Pages | 52 |
| Publication year | 2021 |
September, 2021
Bankruptcy Debtor's Nonbankruptcy Claims
By Hon. Mitchell L. Herren and Jana Deines Abbott
I. Introduction
Lawyers who do not regularly practice in bankruptcy court may find themselves representing clients in personal injury lawsuits, divorces or contract disputes before or after the clients have filed a chapter 7 or chapter 13 bankruptcy. They may be surprised to learn that their client's bankruptcy affects their engagement and subjects them to compliance with certain provisions of the Bankruptcy Code and Rules. Failing to comply with these provisions can result in severe adverse consequences, including loss of compensation, even when the lawyer has otherwise provided valuable legal services. Though the requirements seem daunting, a basic understanding of the provisions and the process makes them navigable. Then the nonbankruptcy lawyer can focus on the business of the client's nonbankruptcy lawsuit or dispute.
This article aims to chart a path for nonbankruptcy practitioners to follow when they are asked to represent a bankruptcy debtor in a nonbankruptcy proceeding. We begin with a brief explanation of relevant bankruptcy terminology, key differences between chapter 7 and chapter 13 consumer bankruptcies, and a primer of applicable sections of the Bankruptcy Code and applicable Rules that lawyers must navigate in order to get employed and paid. The example used throughout will be that of a personal injury lawyer handling a debtor's claim during the bankruptcy, but the principles apply to any nonbankruptcy court representation of a debtor's interests, be it a contract, domestic, real estate matter or collecting worker's compensation. At the end of the article, we will provide a checklist of practice tips.[1]
II. Commencement of the Bankruptcy Case
Individual debtors commence a voluntary bankruptcy case by filing a petition.[2] Section 109 defines a debtor's eligibility for the various chapters of bankruptcy. A chapter 13 debtor must have a regular income and is subject to certain debt limits; a chapter 13 case is a reorganization.[3] Because a chapter 7 bankruptcy is a liquidation rather than a reorganization, a chapter 7 debtor is not subject to similar requirements.[4] In a chapter 7 case, the chapter 7 trustee collects all nonexempt property and liquidates it for payment to unsecured creditors. A chapter 13 debtor must file a plan with the petition that sets forth the manner in which the debtor proposes to pay creditors over a three- or five-year period, depending upon whether the debtor is a below-median- or above-median-income debtor.[5]The bankruptcy court must approve, or "confirm," the chapter 13 plan.[6] The debtor makes plan payments to the chapter 13 trustee, who then distributes payments to creditors as the terms of the confirmed plan specify.
Along with the petition, debtors in both chapters must file a questionnaire called a "statement of financial affairs," and various schedules listing their real and personal property, assets and liabilities, income and expenses, and a list of the creditors who have claims against them.[7] Debtors sign their petition, schedules and statement of financial affairs under penalty of perjury.[8]
Debtors have a duty to fully disclose all of their assets.[9] Those include any cause of action or claim against third parties, whether or not the debtor has filed a lawsuit on that claim. This asset is disclosed on Schedule A/B, Part 4, line 33.[10 ] The statement of financial affairs also requires the debtor to disclose lawsuits, court actions and litigation to which debtor has been a party in the year prior to filing bankruptcy.[11] That includes any personal injury lawsuits pending at the time debtor files for bankruptcy relief. Debtors have a continuing duty to amend their schedules to correct omissions or errors and should do so promptly.[12] Debtor's failure to disclose a personal injury claim in the bankruptcy case may give rise to a judicial estoppel defense, barring debtor from pursuing the claim.[13]
III. Property of the Estate
The commencement of a bankruptcy case creates a bankruptcy estate.[14] Federal law - the Bankruptcy Code -determines the extent to which a debtor's prepetition interest in property becomes property of the estate on the date of filing.[15] State law determines whether debtor has an interest in property, and the nature and extent of that interest.[16] If the property is property of the estate, it is subject to administration in the bankruptcy case.
Section 541(a) broadly defines property of the estate in both a chapter 7 case and chapter 13 case.[17] It includes property "wherever located and by whomever held," and includes "all legal or equitable interests of the debtor in property as of the commencement of the case."[18] It includes property interests that may be contingent, nonpossessory and unvested at the time of their creation.[19] Property of the estate also encompasses proceeds from property of the estate.[20] Property of the estate initially includes exempt property, but upon a debtor's valid claim of exemption, it is removed from property of the estate and returned to debtor.[21]
It is well-settled that a debtor's cause of action for personal injuries is property of the estate under § 541(a)(1) if it accrued on or before the filing of the bankruptcy petition.[22]The accrued cause of action is property of the estate, even if the debtor has not filed the lawsuit for damages.[23] A personal injury settlement is also property of the estate as proceeds of the cause of action, even if the settlement occurred postpetition.[24]
The thornier question is whether debtor had an interest in the cause of action prior to filing bankruptcy. Under Kansas law, a cause of action for personal injury accrues when the act giving rise to the cause of action first causes substantial injury, or under the discovery rule, when the fact of injury becomes reasonably ascertainable.[25] For a personal injury claim arising from an automobile accident, the debtor's injuries from the accident are usually apparent and the cause of action accrues at the time of the accident.[26] In other personal injury settings, debtor's injuries may not be immediately apparent nor discovered until some period of time after the underlying negligent or wrongful act. Thus, the underlying act giving rise to the cause of action may occur prior to filing bankruptcy, but discovery of the injury caused by the act may occur after filing bankruptcy. In such an instance, the cause of action may not be property of the estate.[27] The personal injury lawyer should be well-versed in accrual of causes of action under state law to determine whether the cause of action accrued prepetition and is property of the estate.[28]
In a chapter 13 case, property of the estate is defined even more broadly than a chapter 7 case.[29] In addition to property of the estate under § 541, as noted above, it also includes debtor's post-petition earnings and "all property of the kind specified in [§ 541] that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted ..."[30] Thus, in a chapter 13 case, a cause of action that accrues before the bankruptcy filing or during the case, can become property of the estate.[31] While the chapter 7 estate stops with assets the debtor owned at the petition date (and their proceeds), chapter 13 adds to that corpus, assets acquired thereafter.
IV. Chapter 7 and Chapter 13 Distinctions
A. Chapter 7
In general, upon filing a chapter 7 case the debtor retains only exempt assets. All of debtor's nonexempt property becomes property of the estate. A chapter 7 trustee is appointed as the representative of the estate and tasked with collecting property of the estate, liquidating it and paying the proceeds of such property to creditors under the Code's distribution priority scheme.[32] Section 704(a) enumerates the chapter 7 trustee's duties in administering the estate. The Code also requires debtors and others "in possession, custody, or control" of property of the estate during the case, to deliver (or turnover) the property or account for the value of the property to the chapter 7 trustee.[33] Thus, if debtor has a cause of action that becomes property of the estate, the chapter 7 trustee (and not the debtor) is the real party in interest who administers the cause of action on behalf of the estate. The lawsuit is brought in the name of the chapter 7 trustee.[34] Upon a successful recovery or settlement of the cause of action, the trustee will disburse net proceeds to pay administrative expenses and unsecured creditors. Only if the chapter 7 trustee abandons property of the estate as burdensome or of inconsequential value, or if there is a surplus after the creditors have been paid in full (a very rare event), will the property be returned to the debtor.[35]
B. Chapter 13
In contrast, a chapter 13 case allows the debtor to retain possession of property of the estate, provided debtor proposes and obtains court confirmation of a plan to repay debtor's debts over a three- to five-year period.[36]The contents of the plan and the requirements for obtaining confirmation of the plan are prescribed by statute.[37] The chapter 13 debtor is sometimes referred to as the debtor in possession, but the debtor's possession of property of the estate does not make it debtor's property.[38] Rather, under § 1303, the chapter 13 debtor retains, exclusive of the trustee, the right and powers of a trustee to use, sell or lease property of the estate under § 363 of the Code.[39] Thus, the chapter 13 debtor, and not the chapter 13 trustee, has the authority to prosecute the personal injury claim, even...
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