Written by Lee Hoyle, Esq.
Bankruptcy law and civil litigation rarely mix. When bankruptcy issues arise in civil lawsuits, it generally means that something has gone terribly wrong for one side or the other. If the defendant is invoking the automatic stay, pausing the civil litigation while a bankruptcy case is administered, the civil defendant probably has bigger problems than the lawsuit. Along the same lines, if a civil plaintiff’s bankruptcy pops up as an issue in the civil case, the civil case may be in jeopardy of dismissal.
The reason why having bankruptcy enter a civil claim at all is so dangerous for the plaintiff is that it probably means that the plaintiff messed something up. When a person (or company for that matter) declares bankruptcy, all of their assets become part of the bankruptcy estate. If the debtor wants to remove an asset from the bankruptcy estate, they need to disclose the item and have it exempted or otherwise taken out of the estate. In Virginia, civil lawsuits are exempt from creditors in the bankruptcy process. As long as the debtor discloses the claim as an asset, the bankruptcy court should enter an order exempting the claim from the estate.
The Virginia Supreme Court has twice affirmed dismissals of civil claims asserted by debtors in bankruptcy. In Kocher v. Campbell, 282 Va. 113, 712 S.E.2d 477 (2011), the civil plaintiff filed for bankruptcy and received a discharge after the accident happened but before he filed his lawsuit. He did not disclose the existence of the potential civil claim to the bankruptcy court until after he filed suit. The defendant argued that the plaintiff could not file the lawsuit, because it remained part of the bankruptcy estate and, therefore, could only be filed by the bankruptcy trustee. The plaintiff dismissed his civil case, reopened the bankruptcy case, exempted the civil lawsuit, and re-filed. The Virginia Supreme Court held that the new lawsuit was barred by the statute of limitations, because the plaintiff lacked standing to file the original lawsuit. Because the plaintiff never disclosed and exempted the claim before he filed the first lawsuit, the plaintiff could not assert the claim, which remained in the estate. The first lawsuit was a legal nullity and the later case could not relate back for the statute of limitations.
The Virginia Supreme Court clarified Kocher last year in Ricketts v. Strange, 293 Va. 101, 796 S.E.2d 182 (2017). The civil lawsuit was not disclosed at all in Kocher. In Ricketts, the plaintiff’s bankruptcy filings had boilerplate language mentioning the possibility of a civil claim, but never confirmed the existence or value of the claim. The court held that the boilerplate disclosure was insufficient to put the bankruptcy trustee on notice that the claim actually existed. As such, the asset had not been exempted from the bankruptcy estate, and the statute of limitations barred the plaintiff’s lawsuit once he fixed the issue.
Kocher and Ricketts provide extremely powerful defenses to civil claims. If a debtor in bankruptcy has a civil claim (i.e., the injury has already happened) while the bankruptcy is pending but does not disclose the claim as an asset, then the debtor may lose the ability to bring that civil claim in the future. No matter how clearly the defendant is liable or how severe the plaintiff’s injuries, if the asset was not disclosed the plaintiff may not have standing to file. Unfortunately, Kocher and Ricketts apply to a relatively narrow set of circumstances. Those cases arise out of Chapter 7 bankruptcies, which are not terribly common. Furthermore, Chapter 7 bankruptcies tend to resolve within a matter of months. For the civil plaintiff to lack standing, the claim must exist but not be disclosed to the bankruptcy court. The quick nature of the Chapter 7 case provides a narrow window when the defense will apply. The defense is strong, but rarely applicable.
Eilber v. Floor Care Specialists, Inc. hinted that the bankruptcy defense may be broader than previously thought. In Eilber, the plaintiff was a debtor in a Chapter 13 bankruptcy case. Unlike Chapter 7 bankruptcies, which are liquidations that typically conclude in a matter of months, Chapter 13 bankruptcies involve payment plans over the course of years. In Chapter 13 cases, the debtor also retains possession of the assets in the bankruptcy estate, while in Chapter 7 cases the bankruptcy trustee (at least in theory) has possession of the assets. This latter distinction might have legal importance to whether or not a Chapter 13 debtor lacks standing to bring a lawsuit. The debtor/plaintiff in Eilber argued that, unlike the plaintiffs in Kocher and Ricketts, he had standing, because he retained possession of the estate’s assets.
The trial court granted the defendant in Eilber summary judgment on the basis that the debtor lacked standing, but also on the alternative ground that the debtor’s claim was barred by judicial estoppel. Judicial prohibits parties to litigation from taking contradictory positions of fact in subsequent proceedings. The trial court held that the debtor/plaintiff had taken the position of fact that the claim did not exist in the bankruptcy court, so he could not take the subsequent inconsistent position that the claim existed in the civil lawsuit. Federal courts in Virginia have recognized this defense, but the Virginia Supreme Court has not addressed it.
The Virginia Supreme Court sidestepped the substance of the bankruptcy question, instead addressing only the limited issue of whether the defendant could raise judicial estoppel after discovery when that defense had not been included in the Answer. The Court held that the defense was not waived, which was sufficient to affirm the trial court’s ruling, because the plaintiff had not preserved other arguments against the trial court’s decision.
As it stands, Eilber hints (but does not confirm) that there may be two separate defenses where a civil claim is not disclosed in bankruptcy, and that a Chapter 13 debtor lacks standing like a Chapter 7 debtor. If that is the case, defendants may be able to raise bankruptcy as a defense to civil claims in far more situations than those covered by Kocher and Ricketts. Every defendant should seek information about whether a civil plaintiff has declared bankruptcy and, if so, whether the civil lawsuit was disclosed as an asset in that bankruptcy. If the claim was not disclosed, the plaintiff’s case may be over before it began.