Friday, July 25, 2008

Trustee Avoids Judicial Estoppel Finding As Fifth Circuit Comes Full Circle

Good things come in threes. Think of the first Star Wars trilogy or Lord of the Rings. Now the Fifth Circuit has completed a trilogy of cases on judicial estoppel which brings its exposition of the doctrine full circle. Kane v. National Union Fire Insurance Company, No. 07-30611 (5th Cir. 7/14/08).

Judicial estoppel “is a common law doctrine that prevents a party from assuming inconsistent positions in litigation.” In re Superior Crewboats, Inc., 374 F.3d 330 (5th Cir. 2004). The elements of judicial estoppel are: (1) the party is judicially estopped only if its position is clearly inconsistent with the previous one; (2) the court must have accepted the previous position; and (3) the non-disclosure must not have been inadvertent. In bankruptcy, the doctrine is frequently applied to prevent parties from pursuing undisclosed claims. The doctrine enforces the debtor’s duty to make full disclosure of all assets on his schedules.

The first of the recent Fifth Circuit cases was In re Coastal Plains, Inc., 179 F.3d 197 (5th Cir. 1999). In that case, the Debtor’s CEO formed a company which acquired the assets of the debtor corporation. The insider purchaser then filed suit on a claim which had not been disclosed in the schedules. The purchaser recovered $3.6 million on the undisclosed claim. The Fifth Circuit reversed on appeal, finding that accepting the argument that the claims were inadvertently left off the schedules “would encourage bankruptcy debtors to conceal claims, write off debts, and then sue on undisclosed claims and possibly recover windfalls.” In re Coastal Plains at 213.

Next came In re Superior Crewboats, 374 F. 330 (5th Cir. 2004). In that case, it was the debtor who was estopped. In that case, one of the debtors was injured prior to bankruptcy. During their chapter 13 case, they filed suit on a claim which was not listed in their schedules. After their case was converted to chapter 7, the debtors told the trustee about their claim, but represented that it was barred by limitations. As a result, the trustee abandoned the claim which the debtors continued to pursue. When the trustee learned about the case, he attempted to substitute in. However, the court granted summary judgment for the defendant.

The trend of ruling in favor of defendants continued with the lower court opinion in Kane. In Kane, the debtor filed a personal injury suit prior to bankruptcy. However, he did not list it on his schedules. Once the debtor received his discharge, the defendant moved for summary judgment based on judicial estoppel. The debtors then tried to do the right thing by asking that their bankruptcy case be re-opened so that the trustee could administer the undisclosed lawsuit. The case was reopened and the trustee asked to be substituted as real party in interest. Relying upon Superior Crewboats, the District Court granted the defendants’ motion for summary judgment and denied the trustee’s request to substitute in as real party in interest.

While Kane looked a lot like Superior Crewboats, the Fifth Circuit found an important distinction. The Court stated:

There, because the trustee had abandoned the claim, he was not the real party in interest and was not entitled to be substituted as such. Rather, following the trustee’s abandonment, the interest in the claim had reverted to the debtors, who stood to collect a windfall from the asset at the expense of the creditors. In the case before us, the Kanes’ personal injury claim became an asset of their bankruptcy estate when they filed their Chapter 7 petition. The Trustee became the real party in interest in the Kanes’ lawsuit at that point and never abandoned his interest therein.
Kane at 8.

The Fifth Circuit noted that the present case did not present any equitable concerns. Indeed, the creditors would be harmed if judicial estoppel was applied to preclude the trustee from pursuing the claims. The court quoted from a great Seventh Circuit opinion which made the obvious point:

[The debtor’s] nondisclosure in bankruptcy harmed his creditors by hiding assets from them. Using this same nondisclosure to wipe out [the debtor’s claim against the defendant] would complete the job by denying creditors even the right to seek some share of the recovery. Yet the creditors have not contradicted themselves in court. They were not aware of what [the debtor] was doing behind their backs. Creditors gypped by [the debtor’s] maneuver are hurt a second time by the district judge’s decision. Judicial estoppel is an equitable doctrine and using it to land another blow on the victims of bankruptcy fraud is not an equitable application.

Kane at 10, quoting Biesek v. Soo Line R.R. Co., 440 F.3d 410, 413 (7th Cir. 2006).

Thus, the Fifth Circuit reversed the summary judgment based on judicial estoppel and remanded to consider whether the trustee should be permitted to substitute as real party in interest (an issue which had not been considered by the district court).

In any good trilogy, things appear darkest after the second part. Here, the Superior Crewboats decision appeared to foreclose even a suit by the trustee. This was much like saying that the creditors had to be punished to protect the integrity of the system which was intended to protect the creditors, or to put it another way, it was necessary to destroy the village in order to save it.

Kane corrects this misimpression by pointing out that judicial estoppel only applies against the party who took the inconsistent position, namely the debtor; it does not apply against the trustee as the representative of the innocent creditors. Kane has an added bonus in that it encourages debtors to correct their mistakes. If the debtor omits a cause of action, but later repents, the trustee is not prejudiced. The debtor protects himself by mitigating the effects of his previous non-disclosure. The debtor also stands to benefit directly if the litigation proceeds are used to pay non-dischargeable claims or if there estate produces a surplus.

Thanks to St. Clair Newbern for the pointer on this case.


Anonymous said...

Unfortunately, not all attorneys or even Superior Court judges seem to appreciate the severe impact that a bankruptcy non-disclosure can have on creditors left in the dark. I'm a defendant in a case in Washington State wherin the debtors did not disclose a real estate contract in a "no asset" chapter 7. I discovered it years later, after they filed a subsequent chapter 13. I eventually got sued by these guys in Superior Court and was court-ordered to surrender title. And so I did. It never occurred to 3 different attorneys who represented me to argue judicial estoppel. I now have a fourth guy who finally recognized it as the proper defense. Regardless, the lawsuit goes on because the debtors are bashing me and the judge seems to have a sympathetic ear. It's been a painful and expensive experience so far but I have to believe that justice will eventually prevail.

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