It’s not often that bankruptcy law intersects with corporate dissolution proceedings based on deadlock or minority shareholder oppression, but when it does, likely it’s bad news for the petitioner seeking to liquidate the company or to be bought out by another shareholder.

Such was the fate of the plaintiff in a recently decided dissolution case called Light v. Boussi, 2008 NY Slip Op 51212(U) (Sup Ct Kings County June 19, 2008).  In 2006, plaintiff Beril Light sued Samuel Boussi for an accounting, imposition of constructive trust, damages and an order compelling dissolution of a real estate holding company formed in 1995 called 10-18, Inc.  Light claimed that he and Boussi were 50-50 shareholders.  Light alleged that Boussi failed to maintain corporate formalities, provide him with notice of corporate meetings or financial information, or distribute to Boussi 50% of the company profits.  Boussi denied that Light ever was a shareholder and also asserted as affirmative defenses that Light lacked legal capacity to sue, and that Light’s claims were barred by the doctrine of judicial estoppel.

Both defenses arose from the fact that in 1998, Light and his wife filed a voluntary petition under Chapter 11 of the Bankruptcy Code.  Their petition listed various assets owned by them including real properties and interests in stock corporations, but made no mention of 10-18, Inc.  The bankruptcy court entered a final decree in 2002, Light’s bankruptcy case was closed, and the trustee was discharged.

The court’s decision, written by Justice Carolyn E. Demarest of Kings County Supreme Court’s Commercial Division, sustains both of Boussi’s defenses based on the omission from the bankruptcy petition, and consequently dismisses the case.

Under Section 541 of the Bankruptcy Code, all property that a debtor owns or subsequently acquires, including a cause of action, vests in the bankruptcy estate upon the filing of a voluntary petition.  As Justice Demarest explains,

“title to the debtor’s property will remain in the bankruptcy estate unless the property is listed in the schedule of assets filed with the [bankruptcy] court or otherwise deemed abandoned” [and] “a debtor’s failure to list a legal claim as an asset in his or her bankruptcy proceeding causes the claim to remain the property of the bankruptcy estate and precludes the debtor from pursuing the claim on his or her own behalf”. 

Thus, under principles of federal bankruptcy law, even if it were true that plaintiff had a shareholder interest in 10-18, Inc., upon the filing of the bankruptcy petition, that alleged interest, if it existed, became the property of the bankruptcy estate.  As a result of plaintiff’s failure to list his alleged shareholder interest, that alleged asset did not revert back to plaintiff upon the conclusion of his bankruptcy case.  Consequently, plaintiff now lacks legal capacity to assert claims based upon his alleged interest in 10-18, Inc. [Citations omitted] 

Light argued that his failure to list the corporation in his bankruptcy petition was “inadvertent” and had no affect on his ownership interest.  Justice Demarest calls this contention “devoid of merit” and finds it immaterial to Light’s loss of legal capacity to sue mandated by the substantive bankruptcy law.

The court’s decision also sustains Boussi’s defense based on the state law doctrine of judicial estoppel, which prevents a party who asserts a factual position in one legal proceeding from taking an inconsistent position in subsequent litigation.  On that point Justice Demarest writes:

Under the doctrine of judicial estoppel, a discharged debtor who fails to list an asset in his or her prior bankruptcy proceeding is precluded from asserting claims based on ownership of that asset (see e.g. Madden v Corey, 251 AD2d 257, 258 [1998]; Manhattan Ave. Dev. Corp. v Meit, 224 AD2d 191, 192 [1996]; Cafferty v Thompson, 223 AD2d 99, 102 [1996]). Thus, inasmuch as plaintiff failed to disclose any alleged shareholder interest in 10-18, Inc. in his bankruptcy petition or at any time during his bankruptcy proceeding, he is precluded, under the doctrine of judicial estoppel, from asserting the claims herein based upon an alleged ownership of an interest in 10-18, Inc.

I’ve seen this issue arise once before in the dissolution context, in another Kings County Supreme Court decision from 2002 in Matter of Kessler (Steven Kessler Motor Cars, Inc.).  The record before the court did not show whether the petitioner’s bankruptcy petition reflected his previously commenced dissolution proceeding, so the court ordered the petitioner to submit a copy of his debtor schedule of assets filed with the bankruptcy court along with a copy of the bankruptcy trustee’s final report.  What also made Kessler interesting was that prior to the bankruptcy, the respondent shareholder in the dissolution proceeding had elected to purchase the petitioner’s stock interest in 1997, but the petitioner waited until 2002 to prosecute the valuation proceeding, during which time he filed for bankruptcy and obtained a discharge in 2000.

It’s difficult to fathom how someone can file a bankruptcy petition, not disclose in their schedule of assets a stock interest or a pending dissolution proceeding, obtain discharge, and still expect to pursue a dissolution or valuation.  Then again, that may explain why there are so few cases like Light and Kessler.