Bankruptcy Court Holds Failure To Disclose PI Claims Is Grounds To Revoke Discharges

| Jul 31, 2013 | Firm News

Until 2012, Rhode Island’s bankruptcy court had had just one judge and for 44 years that was the Honorable Arthur Votolato who was initially appointed as a bankruptcy referee.  He retired last year and Diane Finkle was appointed to replace him after 30 years in private practice, primarily as a creditor’s attorney in federal and Superior Court.  There have already been some changes in procedures in bankruptcy court.  Local practitioners are evaluating whether there will be other, substantive changes in the adjudication of bankruptcy cases.

In this case, the Court held that the debtors’ failure to disclose pending personal injury claims was grounds to revoke their discharges.  The debtors were a husband and wife.  The husband suffered work-related personal injuries in 2007 and 2010, including an auto accident.  He retained counsel to pursue both workers compensation and third-party claims for these injuries. In 2009, he rejected a $65,000 settlement offer for the 2009 injury which was made in response to a $350,000 demand, which demand he withdrew before filing suit.

In 2011, the debtors filed their bankruptcy petition.  They claimed that their bankruptcy attorney told them that they did not have to disclose the personal injury claims in their schedules because there were no written or pending settlement offers.  In response to specific questions from the trustee at the Section 341 meeting, they denied that they had any claims against anyone, or any injuries or any car accidents, again, supposedly, on advice of counsel.  The trustee subsequently recommended that the debtors receive a discharge and the Court entered a discharge order in June 2011.

The trustee subsequently learned of the debtors’ pending personal injury claims and, in October 2011, filed an adversary proceeding against them seeking to revoke their discharges.  During an evidentiary hearing, the debtors’ attorney acknowledged telling them they did not need to disclose the claims in their bankruptcy schedules.  However, he denied telling them to deny the claims during the Section 341 hearing.  (He subsequently consented to a sanctions motion filed by the trustee).

The Court first noted that the purpose of bankruptcy is to “grant a fresh start to the honest but unfortunate debtor.”  Accordingly, revoking a discharge is an “extraordinary remedy” that should be construed liberally in favor of the debtor and strictly against those objecting to the discharge.

The Court based the ruling on Section 727(d)(1) as interpreted by the First Circuit Bankruptcy Appellate Panel’s decision, In re Gillis, 403 B.R. 137 (B.A.P. 1st Cir. 2009).  The Court said the trustee had to show (1) the debtor obtained the discharge through fraud, (2) the trustee had no knowledge of the fraud prior to the discharge, and (3) the fraud, if known, would have resulted in denial of the discharge.  Under this section, fraud includes reckless indifference to the truth.

The Court said the most important evidence was the debtors’ answers to the trustee’s questions at the Section 341 meeting.  In addition, there was abundant evidence from the personal injury claims that the husband considered the injuries to be devastating to his health and his family’s finances.  The Court said that while poor legal advice might explain the debtors’ failure to disclose the claims in their bankruptcy schedules, it did not explain their denials in response to the trustee’s questions.  The Court said the debtors exhibited reckless indifference to the truth. The Court concluded that the debtors had obtained their discharges through fraud and held the discharges should be revoked.

In re Jason Webster, 2013 WL 145581 (Bank.D.R.I. Jan. 14, 2013)

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