An Incomplete Truth: U.S. Supreme Court Establishes Standard For Consequences of a Debtor’s Failure to Disclose Assets in Bankruptcy Proceedings
By David M. Eisenberg and Deborah S. Lapin
Debtors in bankruptcy proceedings have an ongoing obligation to put their asset and liability cards on the table. They need to disclose all assets in the Bankruptcy Court, including unliquidated or contingent claims, as well as any claims that arose after the bankruptcy was commenced, such as those in a personal injury lawsuit. Failure to make such required disclosures carries judicially imposed consequences, which may include the loss of any such undisclosed claims. But what those consequences are and under what circumstances they should be applied have been the subject of contention among different Bankruptcy Courts.
In a rare unanimous decision, however, the United States Supreme Court recently resolved a circuit split on this issue, establishing the test for determining whether a debtor’s failure to disclose an asset was “inadvertent or mistaken” such that they should be spared from the harsh application of the principle of “judicial estoppel” and its effect of barring an undisclosed claim for damages.
Judicial Estoppel
As Justice Ketanji Brown Jackson wrote for the Court in its decision in Keathley v. Buddy Ayers Construction, Inc., judicial estoppel is an “equitable doctrine” intended “to protect the integrity of the judicial process” by generally preventing “a party from assuming inconsistent positions in successive litigation” or “deliberately changing positions according to the exigencies of the moment.” Put another way, you can’t deny a contract existed in one lawsuit and then file a breach of contract lawsuit based on the same agreement your previous suit said didn’t exist.
The named appellant in Keathley and his wife filed for Chapter 13 bankruptcy protection in December 2019. The Bankruptcy Code requires debtors to disclose their assets to the bankruptcy court to facilitate the creation of an accurate bankruptcy estate. These assets include any claims the debtor has against third parties, regardless of whether those claims have already been asserted in an active lawsuit.
After the court confirmed the Keathleys’ Chapter 13 repayment plan, Keathley was involved in a car accident with a driver employed by respondent Buddy Ayers Construction, Inc. Even though Keathley’s bankruptcy case remained open, neither Keathley nor his bankruptcy counsel disclosed the potential personal injury claims to the Bankruptcy Court. Keathly then sued Ayers Construction in a federal court in Mississippi for negligence. Keathley did not notify the Bankruptcy Court of the existence of his claims at this point, either.
Ayers Construction then moved for summary judgment in Keathley’s negligence lawsuit on grounds of judicial estoppel based on Keathley’s failure to disclose his personal injury claims in the open bankruptcy proceeding. Keathley immediately filed an amended schedule notifying the Bankruptcy Court of his personal injury claims. Then, in response to the pending motion for summary judgment in the personal injury suit, Keathley explained that the omission had been inadvertent.
Relying on Fifth Circuit precedent, the district court granted Ayers’ motion for summary judgment, explaining that the omission of a claim on the bankruptcy schedules will be considered the result of inadvertence or mistake only if (1) the debtor did not know the facts underlying the claim, or (2) there was no potential motive to conceal the claim. Since Kathley concededly knew of the facts underlying his personal injury claims and had a hypothetical motive to conceal, the court held that judicial estoppel barred his negligence claim. The appellate court affirmed.
“Fact-Specific Inquiry” Required Before Applying Judicial Estoppel
The Supreme Court, however, disagreed and instead adopted the approach taken by five other circuits, which relies on “a more fact-specific inquiry and do[es] not so stringently limit the analysis.”
Justice Jackson wrote that “the Fifth Circuit’s understanding of ‘inadvertence or mistake’ is simultaneously too rigid and too broad.” On the former point, she noted “[t]hat rigidity is out of step with equity,” and the lower court instead “should have examined the totality of the circumstances surrounding Keathley’s failure to report his personal-injury claims earlier.”
On the overly broad nature of the Fifth Circuit’s framework, Justice Jackson noted that every “debtor will almost always hypothetically benefit from not revealing such a claim to his creditors.” Accordingly, such a “one-size-fits-all test” is “patently incompatible” with the equitable nature of judicial estoppel, “which suggests that circumstances—and outcomes—may vary.”
For parties seeking to avoid claims by a debtor based on an inadvertent omission in their required disclosures in bankruptcy, this decision means that doing so won’t be as easy as it was under the Fifth Circuit’s approach. Nevertheless, a debtor’s failure to list all assets, including potential claims against third parties, is not without consequences, and creditors who discover such an omission, especially if intentional, may be able to secure a denial of discharge of debts in bankruptcy.
If you have any questions about this decision, please contact Deborah Lapin or David Eisenberg at Maddin Hauser.