A Short Primer on Bankruptcy and Capacity to Sue

Plaintiffs in legal malpractice suits are often in financial distress, and bankruptcy filings loom.  When a petition in bankruptcy is filed, significant changes to the debtors' estate may take place.  There are differences when the filing takes place, and each of the three major chapters have different results, whether Chapter 7,11 or 13.  Here, in a decision written by Justice Whelan is a well presented discussion.  West v Young   2013 NY Slip Op 23011   Decided on January 15, 2013   Supreme Court, Suffolk County   Whelan, J.
 

"The object of a bankruptcy proceeding commenced under Chapter 7 of the Bankruptcy Code is to provide the debtor with a "fresh start" upon discharge by the liquidation of all non-exempt property in the bankruptcy estate for the benefit of creditors. Pursuant to 11 USC §541(a)(1), the bankruptcy estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case" including, contingent civil claims for damages possessed by the debtor (11 USC §541[a][1]). It also includes "any interest in property that the estate acquires after the commencement of the case" (11 USC §541[a][7]). Referred to as a catchall provision, §541(a)(7) embodies the principle that the estate, having a separate legal identity from the debtor, is an active entity comprised of not only property interests the debtor held at the commencement of the case, but of property the estate itself generates while operating under the aegis of the Bankruptcy Code (see Wade v Bailey, 287 B.R. 874, 880—881 [S.D.Miss.2001]). It does not, however, serve as an independent basis for the creation of estate property. By its express terms, §541(a)(7) only operates when property is encompassed within the estate in the first instance, after which time any property generated by that estate property becomes, itself, included in the estate (see In re Doemling, 116 B.R. 48, 50 [Bankr.W.D.Pa.1991]).

Once an asset is deemed to belong to the bankruptcy estate, the asset may no longer be controlled by the debtor (see Matter of Educators Group Health Trust, 25 F.3d 1281, 1284 [C.A 5 1994]). It is thus clear that a bankruptcy trustee appointed in a Chapter 7 proceeding has the exclusive authority to prosecute a non-bankruptcy cause of action belonging to the estate (see Matter of New Era, Inc., 135 F.3d 1206 [C.A. 7 1998]; Matter of Educators Group Health Trust, 25 F.3d 128, supra; Matter of S.I. Acquisition, Inc., 817 F.2d 1142, 1153—54 [C.A. 5 1987]; Long Is. Forum for Tech. v New York State, 85 AD3d 791, 925 NYS2d 535 [2d Dept 2011]). It is equally clear that a debtor is required to schedule such causes of action as assets on the bankruptcy petition so that the trustee can determine whether the claims should be abandoned or administered by the bankruptcy court for the benefit of the creditors (see Dynamics Corp. of Am. v Marine Midland Bank—New York, 69 NY2d 191, 195—196, 513 NYS2d 91 [1987]; Tri-State Sol-Aire Corp. v Martin Assoc., Inc., 7 AD3d 514, 776 NYS2d 99 [2d Dept 2004]; Mehlenbacher v Swartout, 289 AD2d 651, 734 NYS2d 290 [3d Dept 2001]). If an estate cause of action is not listed in the schedule of [*3]assets, it cannot be deemed to have been abandoned by the trustee (see 11 USC §554), and such cause of action remains the property of the estate (see 11 USC §554[d]; First Natl. Bank of Jacksboro v Lasater, 196 U.S. 115, 25 S.Ct. 206 [1905]). A debtor has thus been held to lack the legal capacity to sue on all such undisclosed claims during or subsequent to the close of a Chapter 7 bankruptcy proceeding (see Dynamics Corp. of Am. v Marine Midland Bank—New York, 69 NY2d at 195—196, supra; Whelan v Longo, 23 AD3d 459, 808 NYS2d 95 [2d Dept 2005], affirmed 7 NY3d 821, 822 NYS2d 751 [2006]; Santori v Met Life, 11 AD3d 597, 599, 784 NYS2d 117 [2004]; Coogan v Ed's Bargain Buggy Corp., 279 AD2d 445, 719 NYS2d 260 [2d Dept 2001]).

In contrast to Chapter 7 proceedings, the object of a Chapter 13 filing is the rehabilitation of the debtor under a plan that adjusts debts owed to creditors by the debtor's regular periodic payments derived principally from income (see 11 USC §1301, et. seq.; First Capital Asset Mgt., Inc. v Satinwood, 385 F.3d 159 [C.A. 2 2004]). The bankruptcy estate under Chapter 13 is broader than the estate in Chapter 7 proceedings since a Chapter 13 estate continues to accumulate property following the filing of the petition. Under USC §1306, all property specified in §541 that the debtor acquires after the commencement of the action, but before the case is closed, dismissed or converted is the property of the estate. Inclusion of both pre-petition assets and post-petition assets in a Chapter 13 estate is due to the following: 1) that distribution of the estate assets administered by the trustee, principally income, must be made only in accordance with a plan that has been confirmed by the court; 2) except as to income and assets controlled by the trustee under the terms of the plan, the debtor is deemed to remain in possession of all property of the estate (see 11 USC §1306[b]; 1327[b]); and 3) the confirmation of the plan "vests all the property of the estate in the debtor" (see 11 USC §1327[b]). Assets acquired post-confirmation are not included as property of the estate, unless they are necessary to maintain the plan (see 11 USC §1306[a]; §1326]).
 

Unlike Chapter 7 cases, there is no real disconnect of the estate property from the debtor under a Chapter 13 filing, except to the extent that the plan, as confirmed by order of the court, places control over an asset in the hands of the trustee.

A filing under Chapter 13 thus changes the calculus in determining the issue of standing or the capacity to prosecute civil causes of action from that applied to Chapter 7 cases. "While Chapter 7 and Chapter 11 debtors lose standing to maintain civil suits - which must be brought and/or maintained by their bankruptcy trustees - it is clear that Chapter 13 debtors like plaintiffs are not subject to this restriction" (Murray v Board of Educ. of City of New York, 248 B.R. 484, 486 [S.D.N.Y.2000], citing Olick v Parker & Parsley Petroleum Co., 145 F.3d 513 [2d Cir.1998]). In Olick, the Second Circuit addressed for the first time the differences between Chapter 7 and Chapter 11 cases and found "that a Chapter 13 debtor, unlike a Chapter 7 debtor, has standing to litigate causes of action that are not part of a case under title 11" (id. 45 F3d at 515). This holding was premised, in part, upon the fact that the focus of a Chapter 13 bankruptcy is the repayment of debts, regularly, through future earnings rather than from a liquidation of assets owned by the debtor at the time of filing. The Olick court also relied upon the legislative history of §1303 of Chapter 13 as drawn from remarks in the Congressional Record: "[C]ertainly it is intended that the [Chapter 13] debtor has the power to sue and be sued" (id. at 516 quoting 124 Cong. Rec. H. 11,106; S. 17,423).

Numerous other federal cases have also held that Chapter 13 debtors are not deprived of [*4]standing to assert pre-petition causes of action and others accruing post-petition (see Ponton v AFSCME, 395 Fed.Appx. 867 [C.A.3 2010]; Smith v Rockett, 522 F.3d 1080 [C.A.10 2008]; Autos Inc. v Gowin, 244 Fed.Appx, 2007 WL 2269443 [C.A.10 2007]; Crosby v Monroe County, 394 F.3d 1328 [C.A. 11 2004]; Cable v Ivy Tech., 200 F.3d 467, 472-74 [C.A. 7 1999]; Bennett v Flagstar Bank, 2011 WL 6152940 [S.D. Ga. 2011]; M & T Mtge. Corp. v White, 736 F.Supp.2d 538 [E.D.N.Y 2010]; In re Stewart, 373 B.R. 801 [Bankr. S.D. Ga. 2007]; Snowden v Fred's Stores of Tennessee, 419 F.Supp2d 1367 [M.D Al. 2006]; In re Bowker, 245 B.R. 192 [D.N.J. 2000]). While it is unclear from these case authorities whether a Chapter 13 debtor has an exclusive right to sue (see In re Bowker, 245 B.R. 192, supra) or possesses such right concurrently with the trustee (see In re Stewart, 373 B.R. 801, supra), that which is clear is that the debtor has standing to prosecute non-bankruptcy causes of action (see Looney v Hyundai Motor Mfg. LLC., 330 F.Supp.2d 1289 [M.D. Al. 2004]).

This court's review of state case authorities that have addressed the capacity of a Chapter 13 debtor to sue reveals that the issue is less than settled. In Gray v City of New York, 958 AD3d 448, 449, 872 NYS2d 7 (1st Dept 2009), which was a breach of contract action prosecuted by a Chapter 13 debtor, the First Department unequivocally held that the "plaintiff's failure to include his notice of claim in his bankruptcy petition deprived him of his capacity to sue (Whelan v Longo, 7 NY3d 821, 822 NYS2d 751[2006]), even if the omission was innocent (Dynamics Corp. of Am. v Marine Midland Bank - NY, 69 NY2d 191, 513 NYS2d 91 [1987])". In Quiros v Polow, 135 AD2d 697, 522 596 (2d Dept 1987), a legal malpractice action decided prior to Olick, the Second Department also held that a Chapter 13 debtor lacked capacity to sue citing Dynamics Corp. of Am. v Marine Midland Bank - NY, (69 NY2d 191, supra). However, neither Whelan nor Dynamics, involved a Chapter 13 debtor.

In contrast, the Second Department held in Giovinco v Goldman, 276 AD2d 469, 713 NYS2d 700 (2d Dept 2000), that a Chapter 13 debtor has capacity to sue on medical malpractice claims. As authority for its holding, the Giovinco court relied upon Olick v Parker & Parsley Petroleum Co., (145 F.3d 513, supra) and no fewer than ten other federal case authorities. Two cases emanating out of the Fourth Department also followed the Second Circuit's holding in Olick v Parker & Parsley Petroleum Co., (145 F.3d 513, supra ) and found that a Chapter 13 debtor has capacity to sue on legal claims (see Kenney v National Fuel Gas Distrib. Corp., 8 AD3d 989, 778 NYS2d 352 [4th Dept 2004]; In re Miller, 1 AD3d 885, 767 NYS2d 729 [4th Dept 2003]).

There are a plethora of cases that fail to identify which Chapter of the Bankruptcy Code the plaintiff filed under (see Mathus v Bouton's Bus. Mach., Inc., 78 AD3d 476, 910 NYS2d 633 [1st Dept 2010]; R. Della Realty Corp. v Block 6222 Constr. Corp., 65 AD3d 1323, 88 NYS2d 157 [2d Dept 2009]; Wright v Meyers & Spencer, LLP, 46 AD3d 805, 849 NYS2d 274 [2d Dept.2007]; Quinn v Guerra, 26 AD3d 872, 811 NYS2d 238 [4th Dept 2006]; Monson v Israeli, 35 AD3d 680, 828 NYS2d 424 [2d Dept 2006]; Santori v Met Life, 11 AD3d 597, supra; Whelan v Longo, 23 AD3d 459, supra; Martinez v Desai, 273 AD2d 447, 710 NYS2d 372 [2d Dept 2000]). While cited frequently by defendants desirous of non-suiting a plaintiff on lack of capacity grounds, these cases offer no authority that Chapter 13 debtors may likewise be non-suited. [*5]"