A common interrogatory or deposition question often posed to a
plaintiff in an employment lawsuit is: "Have you filed for
bankruptcy, and if so, when?" This question is not academic.
The answer, in fact, could have significant implications for the
prosecution of an employment lawsuit, including dismissal of the
lawsuit or requiring substitution of parties.
The case law is consistent — a bankruptcy filing
fundamentally alters the judicial standing of the employee
plaintiff to proceed with an employment discrimination lawsuit. A
recent decision from the Sixth Circuit Court of Appeals in Auday v.
Wet Seal Retail Inc., 12-cv-5057 (6th Cir. Oct. 25, 2012),
reaffirms how a bankruptcy filing could preclude the plaintiff from
pursuing her claims.
Four days after the plaintiff, Karen Auday, was fired from her
job with clothing retailer Wet Seal in September 2009, she and her
husband filed for Chapter 7 bankruptcy. Some three months after
Auday filed her bankruptcy petition, her employment lawyer wrote to
the bankruptcy trustee to inform him that Auday believed she was
discriminated against on the basis of her age. However, this
information was not shared with the bankruptcy court and the
bankruptcy court discharged Auday from her debts in January
In February 2010, after Auday's debts had been discharged,
the trustee applied to the bankruptcy court for authority to hire
Auday's employment lawyer to pursue the claim against Wet Seal.
Notice of the application and opportunity to object were sent to
Auday's creditors. The bankruptcy claim, however, was never
amended. The bankruptcy court granted the trustee's
application, appointing Auday's employment attorney as a
special counsel to the trustee.
Five months later, for some unexplained reason, Auday, as
opposed to the bankruptcy trustee, sued Wet Seal in state court,
and the case was subsequently removed based on diversity
jurisdiction. The district court granted judgment on the pleadings
to Wet Seal, holding that Auday's failure to list the potential
employment claim on her bankruptcy petition judicially estopped her
from later bringing the claim. On appeal, the court also ruled, on
a different basis, that Auday could not bring a claim. As the court
explained, when Auday filed for bankruptcy, her estate became the
owner of all of her property, including tort claims that accrued
before she filed her bankruptcy petition. Because Auday's
employment claims accrued when she was fired, those claims became
property of her estate when she filed for bankruptcy four days
As such, absent abandonment of the claim in bankruptcy, only the
bankruptcy trustee, as the real party in interest, may bring the
discrimination claim. The plaintiff lacked standing to pursue the
claim alone. On this basis, the appellate court vacated the
judgment and remanded the case to the district court either to
allow Auday to dismiss the action or to allow Auday to amend her
complaint to substitute the bankruptcy trustee as the
This case reinforces the impact of a bankruptcy filing on
subsequent employment litigation. If a client has filed a Chapter 7
bankruptcy, plaintiffs' employment attorneys must determine if
the bankruptcy trustee will abandon the claim. The trustee may
choose to do that if the trustee assesses the case as having less
merit, for example. Abandonment would require the bankruptcy
trustee to give notice to creditors and if any object, the
bankruptcy court must hold a hearing. The claim could also revert
to the plaintiff if the plaintiff lists the complaint on his or her
schedule of assets and if the bankruptcy court closes the case
without disposing of it.
A bankruptcy filing does not necessarily permit an employer
defendant to escape liability for its allegedly discriminatory
acts. Under Fed. R. Civ. P. 17(a)(3), the district court may join
or substitute the real party in interest, such as a bankruptcy
trustee. The district court also has the option of permitting a
substitution to relate back to the date of the original complaint.
Assuming the court allows substitution of the trustee, the trustee
could pursue the litigation, and if successful, could recover
proceeds that would go to the plaintiff/debtor's creditors.
Thus, while this procedural defense would seem to be merely a
tactic to stall resolution of the merits of the claim, from a
defense perspective, because the plaintiff/debtor would have less
incentive to proceed with pursuing the employment claim, the
settlement value of the case could be significantly impacted. Thus,
both plaintiffs and defense counsel should know whether the
plaintiff has filed a Chapter 7 bankruptcy and appreciate the
implications for the bankruptcy filing on subsequent employment
Article that appeared in Employment Law360 on December 3,
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Chapter 11 plans routinely contain provisions either releasing, or enjoining litigation against, various stakeholders involved in the case, particularly where the plan contemplates an infusion of cash by those stakeholders.