The Impact of Pre-Loss Bankruptcies on an Insurance Claim

You see it all the time in insurance claims: Susan submits a claim to XYZ Insurance Company for the theft of her jewelry and her collection of Elvis memorabilia as well as electronic items and cash. Susan has no receipts for the jewelry or memorabilia, but she has pictures of the items and has provided detailed testimony describing how she collected the jewelry and mementos over the last 20 years. Based on her testimony, pictures, and affidavits she provides from friends and family, the claims examiner and company attorney are satisfied that the insured owned the claimed items before the loss.

The catch? Assuming you have determined that the loss likely happened, or at least that you cannot disprove it, the remaining problem is that Susan declared bankruptcy before the loss. In fact, her Chapter 7 bankruptcy action was discharged by the court only six months before the theft occurred.

As part of the claims investigation, you obtain a copy of the entire bankruptcy file. In it, you see schedules that outline the insured’s (debtor’s) interest in real and personal property. Flipping through, you find a Schedule B-Personal Property form and are surprised to find that Susan has selected “none” when asked about her interest in jewelry and collections. She also answered “none” when asked about her interest in household goods and furnishings, audio, video, and computer equipment. At this point, you cannot help asking yourself whether the insured was lying to the bankruptcy court or whether she lied when she submitted the claim to XYZ Insurance Company.

Insureds often give some pretty interesting explanations when questioned at their examinations under oath regarding the above types of discrepancies, but the usual explanation is that (1) they did not read the form before they signed it; or (2) their attorney told them to put down the value the items would have at a fire sale. (Practice pointer: Start questioning by asking the insured if everything on their bankruptcy petition is true and correct, verifying their signature, and finding out whether they read the form before signing it.)

With regard to signing the form, there is a declaration at the end that requires a signature, and it states, “I declare under penalty of perjury that I have read the foregoing summary and schedules, consisting of ___ sheets, and that they are true and correct to the best of my knowledge, information, and belief.” As for the insured’s point that they wrote down the fire sale value, be aware that the Schedule B form asks for the “current value of debtor’s interest in property without deducting any secured claim or exemption.” While the meaning of the term “current value” can be debated, in many instances there is simply no question that a greater value should have been listed if the debtor truly owned the item at the time the bankruptcy petition was filed. And in Susan’s case, certainly the substantial amount on her claim form for jewelry, collectibles, and other items cannot be reconciled with her attestation of “none” on the Schedule B form.

What do you do in such a circumstance? Under 11 U.S.C. § 541(a), the filing of a bankruptcy petition creates a bankruptcy estate, consisting of all legal and equitable property interests of the debtor. The debtor’s property remains in the bankruptcy estate until it is administered by the trustee.

Property that is scheduled but not administered by the trustee is abandoned to the debtor by operation of law at the close of the bankruptcy case. On the other hand, property that is not formally scheduled is not abandoned when the estate is closed and, therefore, remains part of the estate. In Kunica v. St. Jean Fin. Inc., the court stated, “A debtor may not conceal assets and then, upon termination of the bankruptcy case, utilize the assets for its own benefit.” If the property remains part of the bankruptcy estate, it is owned by the estate rather than the insured. 

In addition to cases that hold that non-disclosed property reverts to the bankruptcy trustee, several cases hold that the doctrine of judicial estoppel precludes a debtor from taking an inconsistent position with respect to the scheduled property.

As in Rosenshein v. Kleban, the rationale for these estoppel decisions is that the integrity of the bankruptcy system depends on full and honest disclosure by debtors of all of their assets. This principle was applied in the context of an insurance claim in Hamilton v. State Farm, in which the court stated:

In this case, we must invoke judicial estoppel to protect the integrity of the bankruptcy process….The Bankruptcy Code and Rules “impose upon the bankruptcy debtors an express, affirmative duty to disclose all assets….” Hamilton’s failure to list his claims against State Farm as assets on his bankruptcy schedules deceived the bankruptcy court and Hamilton’s creditors…it is his failure to disclose assets on his bankruptcy schedules that provides the most compelling reason to bar him from prosecuting claims against State Farm.

In evaluating the amount to be paid by an insurance carrier, the claims examiner will need to give attention to the date the item was purchased, with the insured being bound by the Schedule B information for pre-bankruptcy purchases but able to recover for items purchased post-bankruptcy if it appears that the purchases were truly made. This result is fair and encourages the integrity of the judicial process.   

Tips & Tidbits

While representing an insurer in a very severe bad-faith case, I attended the deposition of the defense attorney who handled the underlying claim. This was a property claim and the plaintiffs’ attorney very effectively questioned the insurance attorney by having him admit that although he had been in practice for more than 20 years, he accepted this case without ever having handled any first-party property loss claims and had never taken a single EUO. This was never disclosed to the carrier, but equally as he testified, “they never asked.” Insurers must learn that while you may have a great bodily injury panel or house counsel attorney, it does not mean they know how to handle a property loss claim. Ask the right questions and screen your attorneys carefully.-Matthew J. Smith, Esq., Smith, Rolfes, & Skavdahl. CLM member since 2009.