Product Liability, Bankruptcy and the Proceeds of Legal Action

One of Many Implanted with Pelvic Mesh

Barbara G. Ross underwent surgery in 1999 to implant a medical device: a pelvic mesh sling. About five years after the surgery, in an unrelated matter, Ross filed a voluntary bankruptcy petition under Chapter 7 of the U.S. Bankruptcy Code on Nov. 23, 2004. As required by the Bankruptcy Code, Ross disclosed her assets and liabilities. Nothing in her filings indicated that she had a personal injury or product liability claim that she could make.

The bankruptcy trustee in the case was Allan B. Mendelsohn. In that capacity, Mendelsohn entered into a stipulation of settlement with Ross, which was approved by the bankruptcy court. In it, Ross gave up her interest in a piece of real property located in Islip, NY. The funds derived from the settlement — just shy of $50,000 — were distributed to Ross's creditors, with each unsecured creditor receiving approximately 23 cents on the dollar. Ross received a discharge in bankruptcy on March 22, 2005, and the case was ordered closed as an “Asset” case by a Final Decree issued on Aug. 2, 2006.

Nearly five years later, on July 13, 2011, the U.S. Food and Drug Administration (FDA), issued an advisory opinion warning health care providers and the public that pelvic mesh devices of the type with which Ross had been implanted could be defective. After becoming aware of this advisory opinion, Ross contacted an attorney and made a claim, even though she had not personally suffered any adverse consequences from her own pelvic mesh device. The claim was ultimately settled in the amount of $105,172.

Mendlesohn became aware of Ross's product liability settlement and, on Sept. 30, 2015, moved to reopen the bankruptcy proceeding. He asserted that because the product liability claim resulted from an “injury” Ross suffered before she filed her bankruptcy petition — the 1999 implantation of the pelvic mesh device — Ross's claim “arose” prior to her bankruptcy filing. This being so, Mendelsohn claimed, the proceeds of the settlement should be treated as part of the bankruptcy estate, to be distributed to Ross's creditors.

Ross countered that, because she didn't learn of her right to seek damages until five years after the bankruptcy matter was finalized, the proceeds of settlement could not logically be part of the bankruptcy estate.

A hearing on the motion to reopen was held in bankruptcy court on Feb. 3, 2016, with that court reasoning that the question before it was “whether there was a viable cause of action the Debtor could bring under applicable law on the date the petition was filed.” The bankruptcy court determined that it did not matter whether Ross knew of the cause of action on that date; the real inquiry must be into whether her cause of action “had matured” by the date of filing. If “no cause of action had matured,” stated the court, “it is irrelevant whether the Debtor ultimately develops an injury: the cause of action resulting from that injury would not be property of the estate.” Using this line of reasoning, the bankruptcy court determined that, on the date she filed for bankruptcy, Ross's product liability claim had not yet matured, so her creditors were not entitled to recover any of their losses from the proceeds of that claim.

The Trustee appealed, seeking vacatur, by filing a Notice of Appeal of the Bankruptcy Order on April 25, 2016.

The Appellate Court Finds Fault

All parties filed briefs for the court's consideration, and the court applied de novo review to determine whether clear error warranted reversal or remand.

The district court began its analysis by noting that a bankruptcy estate comes into being when the Chapter 7 bankruptcy petition is filed. In accordance with section 541 of the Bankruptcy Code, the bankruptcy estate is comprised of “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a)(1). Further, as explained in In re Yonikus, 996 F.2d 866, 869 (7th Cir. 1993), “[E]very conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative, is within the reach of § 541.”

The point of these broad definitions of what is included in the bankruptcy estate is to make sure that the creditors receive as much of what they are owed as is possible, as Congress intended when promulgating the bankruptcy laws, the court observed. Generally, since everything — including causes of action possessed by the debtor at time of filing — are part of the bankruptcy estate (see, e.g., Jackson v. Novak, 593 F.3d 171, 176 (2d Cir. 2010)), the question for the district court would be whether Barbara Ross “possessed” the cause of action against the medical device manufacturer as of the filing of her bankruptcy petition on Nov. 23, 2004. And, as District Court Judge Bianco here stated, “To determine whether a cause of action was possessed by the debtor at the time of filing, courts must examine whether such claims had accrued at the time of filing.”

For a claim to accrue, it must be in existence — in other words, a claim has not yet accrued if the claimant does not yet have a present cause of action. Wallace v. Kato, 549 U.S. 384, 388; Aetna Life & Casualty Co. v. Nelson, 67 N.Y.2d 169, (N.Y. 1986). Both Ross and Mendelsohn agreed that Ross's claim against the pelvic mesh manufacturer did not accrue in the traditional sense prior to the bankruptcy petition's filing, as she had not yet sustained an injury on which to base a product liability claim.

However, Judge Bianco pointed out that this was not the end of the inquiry, because there is, in fact, some property acquired post-petition that must be included in the bankruptcy estate; it is that property “sufficiently rooted in the pre-bankruptcy past.” Segal v. Rochelle, 382 U.S. 375, 380 (1966) (a post-petition tax refund based on pre-petition losses held part of the estate because it existed prior to the bankruptcy filing). Although the bankruptcy court stated that it looked to Segal while considering the motion to reopen Ross's bankruptcy matter, the district court concluded that it had incorrectly analyzed the test set out there, focusing instead on whether all elements of Ross's cause of action had coalesced by the time she filed for bankruptcy. They had not, so Ross won.

So how should the bankruptcy court have conducted a proper Segal inquiry?

Analyzing the Segal Elements

The Segal test tells courts to:

• Determine the extent to which the claim is rooted in the pre-bankruptcy past; then
• Determine how the claim is entangled in the debtor's ability to make a fresh financial start; then
• Weigh these two things in light of the purposes of the Bankruptcy Code.

(Note: After Segal, Congress amended the Bankruptcy Code, adding the language, “sufficiently rooted in the pre-bankruptcy past.” Congress did not also include Segal's requirement that the claim not be too much entangled in the debtor's ability to make a fresh start. This has not deterred some courts from considering the “fresh start” element of the Segal test when analyzing whether property acquired post-petition should be considered part of the bankruptcy estate.)

In his review of the bankruptcy court's decision, Judge Bianco cited to one case's example of a Segal inquiry that determined an asset acquired post-petition had to be included in the bankruptcy estate because it was rooted in the debtor's pre-bankruptcy past. The case of Chartschlaa v. Nationwide Mut. Ins. Co., 538 F.3d 116, 122 (2d Cir. 2008), dealt with a lawsuit concerning a contract signed post-petition. The court there found that this asset should be included in the estate because the contract was formed by a company the debtor had begun to form pre-petition, though incorporation took place post-petition. The court determined that the new corporation was simply a renaming of the old one that had declared bankruptcy, and the other party to the contract had dealt for some time with the bankrupt company.

The contract in issue was, therefore, simply the product of the continuation of a long-standing business relationship. In making its decision, the court specifically cited to the Bankruptcy Law Manual for the proposition that it is important “to distinguish between property that is acquired after the case is commenced and property that merely changes in form.”

Turning to the bankrupcty court's analysis in Mendelsohn v. Ross, the district court began by noting that it had failed to “specifically analyze whether, despite the fact that a claim had not accrued under state law as of the petition date, the settlement proceeds were nonetheless 'sufficiently rooted in the pre-bankruptcy past' of appellee [Ross] that they should be considered part of her bankruptcy estate.”

How to determine such sufficiency? In Ross's case, she had, as of the time of the settlement with the pelvic mesh manufacturer, not suffered any discernible injury. The settlement required her to release all possible claims, present or future, that she might have. Why did the settlement come about, then, when no injury had developed? It was a combination of three things: 1) the implantation of the mesh device; 2) the FDA's issuance of an advisory opinion concerning the possible defects of the device; and 3) Ross's learning of such possible defects. “Without the post-bankruptcy events, the pre-bankruptcy event [the implantation of the device] would be rendered meaningless insofar as plaintiff's ability to obtain settlement proceeds,” stated the court, because without the FDA's action, the still-uninjured Ross would have no basis for a claim. “Thus,” the court concluded, “under the particular facts of this case, it simply cannot be said that her interest was 'sufficiently rooted in the pre-bankruptcy past' to render the settlement proceeds property of the bankruptcy estate.”

Conclusion

The district court disagreed with the bankruptcy court's methods, but affirmed its decision based on further analysis using the Segal elements as guidance. But if debtor Ross had actually suffered a physical injury and made a claim based upon that harm, the outcome would probably have been quite different — the injury, occurring pre-petition and being the last element necessary for the claim to accrue, would have placed the proceeds of the case in the realm of the bankruptcy estate.

This case shows that there are things for all interested parties to consider when a product liability, medical malpractice or other claim ripens after a bankruptcy filing. Is the claim “sufficiently rooted in the pre-bankruptcy past” for a claimant's creditors to reach the monies gained through verdict or settlement, even years after discharge? Under the right circumstances, the answer might surprise many bankruptcy debtors, and their creditors.

*****
Janice G. Inman is Editor-in-Chief of Medical Malpractice Law & Strategy.

When does a cause of action accrue for an injury caused by an implanted medical device?

This is a question that usually comes up when determining whether an allegedly injured plaintiff has brought his or her lawsuit in a timely enough manner to keep the claim from being thrown out on statute of limitations grounds. But if the case has been settled, or tried to a verdict that is not appealed, aren't we done with this question?

Maybe not. The date of injury and accrual of a product liability cause of action might also impact on bankruptcy creditors, as evidenced by the recent dispute decided on appeal by U.S. District Court Judge Joseph F. Bianco in Mendelsohn v. Ross, 2017 U.S. Dist. LEXIS 70982 (E.D.N.Y 5/9/17). The case dealt with an unusual question presented to a bankruptcy court by a debtor's medical device product liability claim: If, at the time of bankruptcy filing, the debtor has a potential civil claim that lacks some of the elements necessary for recovery (which elements may never develop), yet later receives settlement, are the proceeds of that settlement part of the bankruptcy estate?

One of Many Implanted with Pelvic Mesh

Barbara G. Ross underwent surgery in 1999 to implant a medical device: a pelvic mesh sling. About five years after the surgery, in an unrelated matter, Ross filed a voluntary bankruptcy petition under Chapter 7 of the U.S. Bankruptcy Code on Nov. 23, 2004. As required by the Bankruptcy Code, Ross disclosed her assets and liabilities. Nothing in her filings indicated that she had a personal injury or product liability claim that she could make.

The bankruptcy trustee in the case was Allan B. Mendelsohn. In that capacity, Mendelsohn entered into a stipulation of settlement with Ross, which was approved by the bankruptcy court. In it, Ross gave up her interest in a piece of real property located in Islip, NY. The funds derived from the settlement — just shy of $50,000 — were distributed to Ross's creditors, with each unsecured creditor receiving approximately 23 cents on the dollar. Ross received a discharge in bankruptcy on March 22, 2005, and the case was ordered closed as an “Asset” case by a Final Decree issued on Aug. 2, 2006.

Nearly five years later, on July 13, 2011, the U.S. Food and Drug Administration (FDA), issued an advisory opinion warning health care providers and the public that pelvic mesh devices of the type with which Ross had been implanted could be defective. After becoming aware of this advisory opinion, Ross contacted an attorney and made a claim, even though she had not personally suffered any adverse consequences from her own pelvic mesh device. The claim was ultimately settled in the amount of $105,172.

Mendlesohn became aware of Ross's product liability settlement and, on Sept. 30, 2015, moved to reopen the bankruptcy proceeding. He asserted that because the product liability claim resulted from an “injury” Ross suffered before she filed her bankruptcy petition — the 1999 implantation of the pelvic mesh device — Ross's claim “arose” prior to her bankruptcy filing. This being so, Mendelsohn claimed, the proceeds of the settlement should be treated as part of the bankruptcy estate, to be distributed to Ross's creditors.

Ross countered that, because she didn't learn of her right to seek damages until five years after the bankruptcy matter was finalized, the proceeds of settlement could not logically be part of the bankruptcy estate.

A hearing on the motion to reopen was held in bankruptcy court on Feb. 3, 2016, with that court reasoning that the question before it was “whether there was a viable cause of action the Debtor could bring under applicable law on the date the petition was filed.” The bankruptcy court determined that it did not matter whether Ross knew of the cause of action on that date; the real inquiry must be into whether her cause of action “had matured” by the date of filing. If “no cause of action had matured,” stated the court, “it is irrelevant whether the Debtor ultimately develops an injury: the cause of action resulting from that injury would not be property of the estate.” Using this line of reasoning, the bankruptcy court determined that, on the date she filed for bankruptcy, Ross's product liability claim had not yet matured, so her creditors were not entitled to recover any of their losses from the proceeds of that claim.

The Trustee appealed, seeking vacatur, by filing a Notice of Appeal of the Bankruptcy Order on April 25, 2016.

The Appellate Court Finds Fault

All parties filed briefs for the court's consideration, and the court applied de novo review to determine whether clear error warranted reversal or remand.

The district court began its analysis by noting that a bankruptcy estate comes into being when the Chapter 7 bankruptcy petition is filed. In accordance with section 541 of the Bankruptcy Code, the bankruptcy estate is comprised of “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a)(1). Further, as explained in In re Yonikus, 996 F.2d 866, 869 (7th Cir. 1993), “[E]very conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative, is within the reach of § 541.”

The point of these broad definitions of what is included in the bankruptcy estate is to make sure that the creditors receive as much of what they are owed as is possible, as Congress intended when promulgating the bankruptcy laws, the court observed. Generally, since everything — including causes of action possessed by the debtor at time of filing — are part of the bankruptcy estate ( see, e.g., Jackson v. Novak , 593 F.3d 171, 176 (2d Cir. 2010)), the question for the district court would be whether Barbara Ross “possessed” the cause of action against the medical device manufacturer as of the filing of her bankruptcy petition on Nov. 23, 2004. And, as District Court Judge Bianco here stated, “To determine whether a cause of action was possessed by the debtor at the time of filing, courts must examine whether such claims had accrued at the time of filing.”

For a claim to accrue, it must be in existence — in other words, a claim has not yet accrued if the claimant does not yet have a present cause of action. Wallace v. Kato , 549 U.S. 384, 388; Aetna Life & Casualty Co. v. Nelson , 67 N.Y.2d 169, (N.Y. 1986). Both Ross and Mendelsohn agreed that Ross's claim against the pelvic mesh manufacturer did not accrue in the traditional sense prior to the bankruptcy petition's filing, as she had not yet sustained an injury on which to base a product liability claim.

However, Judge Bianco pointed out that this was not the end of the inquiry, because there is, in fact, some property acquired post-petition that must be included in the bankruptcy estate; it is that property “sufficiently rooted in the pre-bankruptcy past.” Segal v. Rochelle , 382 U.S. 375, 380 (1966) (a post-petition tax refund based on pre-petition losses held part of the estate because it existed prior to the bankruptcy filing). Although the bankruptcy court stated that it looked to Segal while considering the motion to reopen Ross's bankruptcy matter, the district court concluded that it had incorrectly analyzed the test set out there, focusing instead on whether all elements of Ross's cause of action had coalesced by the time she filed for bankruptcy. They had not, so Ross won.

So how should the bankruptcy court have conducted a proper Segal inquiry?

Analyzing the Segal Elements

The Segal test tells courts to:

• Determine the extent to which the claim is rooted in the pre-bankruptcy past; then
• Determine how the claim is entangled in the debtor's ability to make a fresh financial start; then
• Weigh these two things in light of the purposes of the Bankruptcy Code.

(Note: After Segal, Congress amended the Bankruptcy Code, adding the language, “sufficiently rooted in the pre-bankruptcy past.” Congress did not also include Segal's requirement that the claim not be too much entangled in the debtor's ability to make a fresh start. This has not deterred some courts from considering the “fresh start” element of the Segal test when analyzing whether property acquired post-petition should be considered part of the bankruptcy estate.)

In his review of the bankruptcy court's decision, Judge Bianco cited to one case's example of a Segal inquiry that determined an asset acquired post-petition had to be included in the bankruptcy estate because it was rooted in the debtor's pre-bankruptcy past. The case of Chartschlaa v. Nationwide Mut. Ins. Co. , 538 F.3d 116, 122 (2d Cir. 2008), dealt with a lawsuit concerning a contract signed post-petition. The court there found that this asset should be included in the estate because the contract was formed by a company the debtor had begun to form pre-petition, though incorporation took place post-petition. The court determined that the new corporation was simply a renaming of the old one that had declared bankruptcy, and the other party to the contract had dealt for some time with the bankrupt company.

The contract in issue was, therefore, simply the product of the continuation of a long-standing business relationship. In making its decision, the court specifically cited to the Bankruptcy Law Manual for the proposition that it is important “to distinguish between property that is acquired after the case is commenced and property that merely changes in form.”

Turning to the bankrupcty court's analysis in Mendelsohn v. Ross, the district court began by noting that it had failed to “specifically analyze whether, despite the fact that a claim had not accrued under state law as of the petition date, the settlement proceeds were nonetheless 'sufficiently rooted in the pre-bankruptcy past' of appellee [Ross] that they should be considered part of her bankruptcy estate.”

How to determine such sufficiency? In Ross's case, she had, as of the time of the settlement with the pelvic mesh manufacturer, not suffered any discernible injury. The settlement required her to release all possible claims, present or future, that she might have. Why did the settlement come about, then, when no injury had developed? It was a combination of three things: 1) the implantation of the mesh device; 2) the FDA's issuance of an advisory opinion concerning the possible defects of the device; and 3) Ross's learning of such possible defects. “Without the post-bankruptcy events, the pre-bankruptcy event [the implantation of the device] would be rendered meaningless insofar as plaintiff's ability to obtain settlement proceeds,” stated the court, because without the FDA's action, the still-uninjured Ross would have no basis for a claim. “Thus,” the court concluded, “under the particular facts of this case, it simply cannot be said that her interest was 'sufficiently rooted in the pre-bankruptcy past' to render the settlement proceeds property of the bankruptcy estate.”

Conclusion

The district court disagreed with the bankruptcy court's methods, but affirmed its decision based on further analysis using the Segal elements as guidance. But if debtor Ross had actually suffered a physical injury and made a claim based upon that harm, the outcome would probably have been quite different — the injury, occurring pre-petition and being the last element necessary for the claim to accrue, would have placed the proceeds of the case in the realm of the bankruptcy estate.

This case shows that there are things for all interested parties to consider when a product liability, medical malpractice or other claim ripens after a bankruptcy filing. Is the claim “sufficiently rooted in the pre-bankruptcy past” for a claimant's creditors to reach the monies gained through verdict or settlement, even years after discharge? Under the right circumstances, the answer might surprise many bankruptcy debtors, and their creditors.

*****
Janice G. Inman is Editor-in-Chief of Medical Malpractice Law & Strategy.