On August 11, the Fifth Circuit Court of Appeals overturned the decision of a three judge panel of the same court that would have disallowed a bankruptcy trustee from pursuing a judgment owned by a debtor, who concealed assets during the bankruptcy proceeding, based on the concept that the Chapter 7 trustee “steps into the shoes of the debtor.” The City of Arlington maintained that the debtor’s failure to disclose estopped the trustee from collection on the judgment.
From a creditor’s perspective, this decision is very important. The three judge panel’s decision, which reversed the district court’s opinion, held that the trustee effectively stepped into the debtor's shoes for purposes of judicial estoppel and, therefore, was prohibited from pursuing a $1 million judgment that the debtor had recovered against the city of Arlington, which the debtor failed to disclose in his schedules.
The en banc court, in Reed v. City of Arlington, reversed the panel’s decision and provides that in the Fifth Circuit, as a general rule, “absent unusual circumstances, an innocent trustee can pursue for the benefit of creditors a judgment or cause of action that the debtor fails to disclose in bankruptcy.”
The decision is important for several reasons. First, as the Fifth Circuit notes, it protects the interest of creditors as well as the integrity of the bankruptcy process, which has at its core the concept that all assets should be preserved and be available to satisfy creditor claims. Second, it recognizes clearly that creditors should not be punished for a debtor's intentional non-disclosure of assets. Finally, the decision begs a number of questions: What about a situation in which the asset was unintentional or deceptively concealed? What constitutes “unusual circumstances?" When would a trustee not be innocent? These questions will be left for the bankruptcy court to determine.
Source: Bruce W. Akerly, Cantey Hanger LLP