Failure to Disclose Affirmative Claim in Bankruptcy Proceedings May be Fatal to Post Bankruptcy Litigation of That Claim
December, 2005
by Christopher T. Scanlon and Robert A. Stern
Accrued claims not disclosed in bankruptcy filings are subject to dismissal in post bankruptcy litigation, provided the debtor/plaintiff obtained a discharge of his debts or the functional equivalent of a discharge. Two recent decisions, less than a week apart, illustrate the point. B.N. Realty Assoc. v. Lichtenstein, 21 A.D.3d 793, 801 N.Y.S.2d 271 (1st Dep’t 2005); Vega-Ruiz v. Keller, 9 Misc.3d 1123(A), 2005 WL 2850910 (N.Y.Sup., Bronx County 2005).
In Vega-Ruiz, the trial court discussed the implications of a medical malpractice plaintiff having failed to disclose claims of malpractice which arose prior to Plaintiff’s filing of his bankruptcy petition. Defendants did not discover when Plaintiff filed for bankruptcy until over five and one half years after commencement of the malpractice action and were unable to obtain the bankruptcy records for another five months thereafter. Those records revealed that Plaintiff’s schedule of assets did not disclose the existence of any of the malpractice claims even though the alleged acts underlying the claims had occurred prior to commencement of Plaintiff’s bankruptcy proceedings and the bankruptcy estate was fully administered prior to conclusion of those proceedings.
Defendants moved for permission to amend their answers to include an affirmative defense that Plaintiff lacked standing to pursue his malpractice claim, and if granted, an order of dismissal. Vega-Ruiz, at * 1. The court stated that “The trustee of the bankrupt’s estate is vested with title to all of the bankrupt’s property including ‘rights and choices in action existing at that time.’” Id. at * 3 (citation omitted). The court explained that property addressed or abandoned by the trustee can re-vest in the debtor after the bankruptcy proceedings are concluded, but “[c]laims that are not listed in the schedule of assets, that exist at the time of the filing of a petition for bankruptcy remain vested in the trustee.” Id. at * 2 (citation omitted).
The court granted permission to amend Defendants’ Answers to include an additional affirmative defense that Plaintiff lacked standing to pursue the malpractice claims at issue. Id. at * 5. The court then held that Plaintiff lacked standing to pursue the malpractice claims, because those undisclosed claims were vested in the bankruptcy trustee, and dismissed Plaintiff’s malpractice causes of action. Id. The court left open the possibility that the trustee could re-open the bankruptcy proceedings and pursue the malpractice claims on behalf of Plaintiff’s creditors.
In B.N. Realty, Defendant owed overdue rents to Plaintiff. Defendant served an Answer, asserting various counterclaims, set offs and affirmative defenses. Four years later, while the litigation was still pending, Defendant filed for bankruptcy, but failed to list the counterclaims, set offs and affirmative defenses as an asset. Ultimately, the bankruptcy court took action which served to dismiss the petition, without discharging Defendant/debtor’s debts. B.N. Realty, 801 N.Y.S.2d at 273.
After the conclusion of the bankruptcy proceedings, Plaintiff moved for summary judgment and to dismiss Defendant’s counterclaims, set offs and affirmative defenses. Plaintiff asserted that since Defendant did not list the counterclaims, set offs and affirmative defenses in the bankruptcy petition, Defendant lack “standing to assert such matters in this action.” Id. The trial court denied Plaintiff’s motion for summary judgment.
On appeal, the Appellate Department discussed and then distinguished Kunica v. St. Jean Fin., Inc., B.R. 46 (S.D.N.Y.), amended on other grounds 63 F.Supp.2d 342 (S.D.N.Y. 1999), which involved a corporate debtor’s chapter 11 bankruptcy. In Kunica, the court held that “notwithstanding § 349(b)(3), the dismissal of a bankruptcy case did not revest certain litigant claims in the debtor because the debtor had not disclosed such claims in the bankruptcy proceeding.” B.N. Realty, at 275.
The Appellate Court noted that Defendant’s “bankruptcy case did not result in any impairment of his creditors’ ability to collect their debts from him once the automatic stay was lifted. Rather, the case was dismissed before there had been any administration of assets or restructuring of debt.” Id. Further, the Appellate Court stated that Defendant “did not obtain ‘the functional equivalent of a discharge’ as a result of his bankruptcy filing”; therefore, the dismissal of his bankruptcy “restored his standing to assert his alleged counterclaims, defenses and offsets in this action.” Id. at 276. The Appellate Court affirmed the trial court’s denial of Plaintiff’s motion for summary judgment on liability and standing.
Vega-Ruiz and B.N. Realty demonstrate that in New York’s First Department, a debtor’s failure to disclose claims and existing causes of action in bankruptcy filings can deprive the debtor of the ability to pursue those claims post-bankruptcy. If, however, the bankruptcy proceedings are terminated without any impairment of creditors’ ability to collect from the debtor, it appears that the courts will allow prosecution of those claims by the debtor after the bankruptcy matters are concluded, notwithstanding the debtor’s failure to include them among his assets while seeking a discharge of his debts.
Learning Point:
It is imperative in any litigation to determine whether a party asserting an affirmative claim has filed for bankruptcy protection. If counsel determines that the party did file for bankruptcy protection, counsel must acquire a copy of the Petition and list of assets, as well as determine exactly how the bankruptcy was resolved. In certain circumstances, the party may be prohibited from asserting those affirmative defenses and a quick motion can have the claims dismissed. •
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