Friday, August 12, 2011

En Banc Fifth Circuit Changes Course on Judicial Estoppel

In an important ruling, the Fifth Circuit Court of Appeals sitting en banc ruled that a debtor's nondisclosure would not bar a trustee from pursuing a large judgment for the benefit of creditors. Reed v. City of Arlington, No. 08-11098 (5th Cir. 8/11/11). The opinion overruled an earlier panel decision. You can read the new opinion here.

A Quick Trip Through the Facts

Diane G. Reed was appointed chapter 7 trustee for debtor Kim Lubke. When Lubke filed his schedules, he neglected to mention that he had recovered a one million dollar judgment against the City of Arlington. He omitted several other assets as well. While the bankruptcy was proceeding, Lubke's case went up to the Fifth Circuit, which remanded for a new calculation of damages. At this point, the Debtor mentioned his bankruptcy to his trial lawyer, Roger Hurlbut. Hurlbut promptly informed the trustee about the undisclosed claim. However, when the trustee sought to intervene as real party in interest, the City of Arlington withdrew an offer of judgment and sought summary judgment based on judicial estoppel. U.S. District Judge Terry Means rendered a mixed decision. He ruled that the trustee was not barred by judicial estoppel, but that the debtor would be barred from any recovery.

On appeal to the Fifth Circuit, Chief Judge Edith Jones authored an opinion finding that both the debtor and the trustee were estopped from pursuing the claim. I wrote about the panel opinion in Fifth Circuit Muddles Judicial Estoppel; En Banc Review Needed. The decision set up a conflict between the circuit's two most prominent bankruptcy experts. Chief Judge Jones dismissed a prior opinion by Judge Carolyn King, In re Kane, 535 F.3d 380 (5th Cir. 2008), on the basis that it "purported" to distinguish prior precedents.

The Trustee, supported by the Commercial Law League of America as amicus curiae, sought en banc review.

On August 11, 2011, the full court released its opinion. Judge Carolyn King, joined by eleven other judges wrote the majority opinion, while Chief Judge Edith Jones, joined by two other judges penned the dissent.

The Majority Opinion

The majority set the tone for its opinion with a statement of purpose.

Here, we apply judicial estoppel “against the backdrop of the bankruptcy system and the ends it seeks to achieve.” (citation omitted). These ends are to “bring about an equitable distribution of the bankrupt’s estate among creditors holding just demands,” (citation omitted), and to “grant a fresh start to the honest but unfortunate debtor,” citation . Therefore, judicial estoppel must be applied in such a way as to deter dishonest debtors, whose failure to fully and honestly disclose all their assets undermines the integrity of the bankruptcy system, while protecting the rights of creditors to an equitable distribution of the assets of the debtor’s estate.

Opinion, p. 4.

The Court cited the three-part test which has been a consistent factor in its decisions:

(1) the party against whom judicial estoppel is sought has asserted a legal position which is plainly inconsistent with a prior position;

(2) a court accepted the prior position; and

(3) the party did not act inadvertently.

In applying the test, the Court found that four factors supported a decision that the trustee was not bound by the debtor's omission:

1. The result followed from bankruptcy law;
2. The result followed from equity;
3. The result was consistent with the Court's prior precedents; and
4. The result was consistent with other circuits.

A. Judicial Estoppel and Bankruptcy Law

The Court wrote:
Judicial estoppel, as an equitable remedy, must be consistent with the law. (citations omitted). In this case, the relevant law is the Bankruptcy Code, which distinguishes between the debtor and the debtor’s estate immediately upon the filing of a Chapter 7 bankruptcy. Therefore, while Lubke himself was properly estopped for his dishonesty, his post-petition misconduct does not adhere to the Trustee, who received the judgment asset free and clear of a defense that arose exclusively from Lubke’s post-petition actions.
Opinion, p. 5. The Court walked through a series of Code sections with regard to property of the estate, the role of the trustee and preservation of undisclosed causes of action. The Court noted that the trustee inherits causes of action subject only to defenses existing on the petition date. As a result, the debtor's post-petition misconduct in concealing a cause of action could not bind the trustee.

B. Equity

Judge King found that equity favored the trustee as well. She wrote:

Because judicial estoppel is an equitable doctrine, courts may apply it flexibly to achieve substantial justice. (citation omitted). “The challenge is to fashion a remedy that does not do inequity by punishing the innocent.” (citation omitted). Estopping the Trustee from pursuing the judgment against the City would thwart one of the core goals of the bankruptcy system—obtaining a maximum and equitable distribution for creditors—by unnecessarily “vaporizing” the assets effectively belonging to innocent creditors.

Lubke’s unsecured creditors, including his FMLA attorney Roger Hurlbut, filed timely proofs of claim in the reopened bankruptcy case in the sum of $504,951.87. Other creditors filed late claims in the sum of $84,846.61. Those creditors having meritorious claims are entitled to an equitable distribution of the estate’s assets, which include the judgment against the City.

Opinion, pp. 8-9.

In its equitable analysis, the Court rejected an argument that it was inequitable to allow a claim to be pursued where an attorney would be the primary benefactor:
The City argues that equity does not favor the Trustee. Chief among its complaints is the fact that Roger Hurlbut, whose claim for legal fees stemming from the FMLA action makes him the primary creditor of Lubke’s estate, is an attorney. Section 726 of the Bankruptcy Code requires the property of the estate to be distributed without considering whether the debt is owed to an attorney, a credit card company, or any other type of creditor. (citation omitted). Unable to articulate why Hurlbut’s occupation is relevant here, the City suggests that Hurlbut is somehow associated with Lubke’s deception and is therefore not an innocent creditor. The district court explicitly found otherwise, (citation omitted), and we find no reason to doubt its conclusion.
Opinion, p. 9. As an attorney, I am encouraged that the court rejected the appeal to attorney bashing.

C. Prior Precedents

Between 1999 and 2010, the Fifth Circuit decided four cases involving judicial estoppel in bankruptcy. Those cases can be summarized as follows:

In re Coastal Plains, Inc., 179 F.3d 197 (5th Cir. 1999). Debtor's insider failed to disclose claim and then bought assets of the debtor. Purchasing company entered into a sharing agreement with the trustee where the trustee would receive only 15% of the proceeds. Judicial estoppel applied because the "recovery would benefit the individual who actually perpetrated the bankruptcy fraud in great disproportion to the bankruptcy estate."

In re Superior Crewboats, Inc., 374 F.3d 330 (5th Cir. 2004). Debtors did not schedule the claim and incorrectly told the trustee that the claim was proscribed by the statute of limitations. As a result, the trustee abandoned the claim. The Court held that the debtors were estopped to pursue the undisclosed/mis-disclosed claims.

Kane v. National Union Fire Insurance Co., 535 F.3d 380 (5th Cir. 2008). Debtor failed to disclose claim. Trustee sought to pursue claim. Judicial estoppel was not applied.

Reed v. City of Arlington, 620 F.3d 477 (5th Cir. 2010). Debtor failed to disclose claim. Trustee sought to pursue claim. Judicial estoppel applied to trustee.

In analyzing the precedents, the Court concluded that the common factor was that the cases turned on whether an innocent trustee sought to pursue claims for the benefit of innocent creditors. Under this test, the panel opinion in Reed v. City of Arlington was the odd case out.

D. Other Circuits

The Court noted that its ruling was consistent with rulings in the Seventh, Tenth and Eleventh Circuits. Biesek v. Soo Line Railroad Co., 440 F.3d 410 (7th Cir. 2006); Eastman v. Union Pacific Railroad Co., 493 F.3d 1151 (10th Cir. 2007); Parker v. Wendy's International, Inc., 365 F.3d 1268 (11th Cir. 2004).

By harmonizing its result with sister circuits, the Fifth Circuit avoided a circuit split and reduced the likelihood of a trip to the Supreme Court.

The Bottom Line
Absent unusual circumstances, an innocent bankruptcy trustee may pursue for the benefit of creditors a judgment or cause of action that the debtor—having concealed that asset during bankruptcy—is himself estopped from pursuing.
Opinion, p. 13.

The Dissent

In dissent, Chief Judge Jones argued that the majority's bankruptcy centered inquiry was too narrow. She wrote:

With due respect to my brethren, I respectfully dissent from their balancing of the equities in this case and from one significant legal point. We do not disagree on the general principles governing judicial estoppel except for one thing. The majority posits that only the interests of the bankruptcy process are involved here. I would contend that the federal district and circuit courts are part of the relevant judicial process, and that a broader view should have been taken of the impact of satellite litigation generated by Lubke’s deception. First, our court had to expend significant resources concluding an opinion in the original appeal of this case, only to find that the plaintiff was no longer the proper party. Accordingly, we were required to remand for reconsideration by the district court a plethora of procedural issues made necessary only by Lubke’s deception. These events necessitated a special oral argument hearing, another appellate opinion, and eventually, an en banc decision attempting to resolve our conflicting precedents. Second, because this two-party dispute evolved into a protracted three-party dispute with the trustee and her counsel, the fairness of the fee award exacted against the taxpayers of the City of Arlington has been seriously compromised, contrary to the courts’ duty to impose reasonable fees on a defendant. This may be brushed off as simply the logical consequence of the convoluted legal proceedings, but it is Lubke’s deception that set them in motion,not the City’s violation of his FMLA rights. Thus, the majority’s reasoning purports to protect the interests of creditors in general, while overlooking that the goal of judicial estoppel is to protect the integrity of the entire judicial process.

* * *

One may extol the virtues of “innocent” trustees, and I do not question the integrity of this trustee at all, but let us not romanticize what’s going on here. Lubke is going on with his life, effectively freed by the passage of time from the claims of unsecured creditors. It is pure speculation to say, as does the majority, that he has “no assets.” He was not honest about this litigation, why not about other assets? The expressed concern for “the creditors” lacks a certain depth of feeling. Those creditors were, and remain, almost exclusively credit card companies. Two-thirds of their claims will never be repaid because they were not renewed when the case was re-opened long after it had been declared a no asset filing. The record suggests that others cut their losses by bundling and selling their unpaid claims to third parties.

As for the lawyers, Hurlbut received over $100,000 from Lubke even before the bankruptcy was filed, yet claims from the estate nearly $450,000 in additional fees. The trustee and her attorney will be reimbursed well into six figures as administrative priority claimants who will be paid ahead of the unsecured creditors. All this is legal, but in the commercial world, the transactional costs of such creditor recovery are wildly disproportionate. Surely courts need not cover our eyes against the real dollar impact of our balancing of “equities.”

The majority notes that in “unusual circumstances,” the doctrine of judicial estoppel may occasionally prevent a trustee from recovering on a claim that the debtor concealed from the courts upon filing for bankruptcy relief. Unfortunately, the majority did not balance the factual equities here as I think was obviously appropriate.
Opinion, pp. 14-15, 16.

The dissent is curious. Its balancing test grants priority to the courts, who were required to spend undue time dealing with the debtor's dishonesty, and the City of Arlington, whose taxpayers will shoulder a greater obligation because its judicial estoppel argument failed. On the other hand, the interest of creditors was minimized because their claims were held by debt buyers and attorneys.

It is indisputable that the courts were required to exercise substantial resources to deal with the case. However, the courts were not a party to the dispute; rather, the courts exist for the purpose of resolving disputes. The City expended substantial resources. However, this was a direct result of the unsuccessful legal positions taken by the City. If the City had not withdrawn its Offer of Judgment, its taxpayers would have been better served.

Finally, the dissent's argument that the identity of the unsecured creditors is relevant is disturbing. Equal treatment of similar claims is a core principal of bankruptcy. Once we start down the road of dividing creditors between the worthy and the less worthy, we start down a slippery slope. Should we find that it is more equitable to favor trade vendors than banks? Should we look with greater favor on community banks than national banks? Should we look down on the tort victim who hit a home run in the litigation lottery? The majority's emphasis on the equality of creditors is both statutorily correct and practically sound. Congress established priorities among different classes of creditors. It is not for the courts to rewrite those priorities.

While I may be biased (see Personal Note and Disclosure below), the dissent seems rather subjective. Equity should be about more than picking winners and losers based on our personal predilections. Indeed, the entire concept of the rule of law over the rule of man seems to be that we make decisions without regard to whether we like the persons who benefit, or perhaps that we make decisions based on fixed rules despite our personal preferences. The dissent seems to be based on the lowest common denominator of deciding who we like and ruling in their favor.

We are all subject to subjectivity. If I were a taxpayer in the City of Arlington, I would not like the result in this case. However, the focus of that anger should be at the public officials who caused the liability, not the courts or the trustee or the debtor's creditors.

Personal Note and Disclosure:

In this blog, I have written favorably about Kane and have critiqued the panel opinion in Reed. I was the principal author of the amicus brief filed by the Commercial Law League of America and participated in oral argument on behalf of the League. I consider the opportunity to argue before the full Court of Appeals, if only for ten minutes, to be one of the most exciting moments of my career.

While I am a partisan, my views are my own. No client paid me to blog on this issue and the Commercial Law League did not pay me to write their brief (although they did reimburse my expenses to travel to New Orleans to argue on their behalf--thanks CLLA!).

As a lawyer, I am pleased that the majority resisted the urge to find that lawyers are less equal than other creditors. As a bankruptcy lawyer, I am gratified that the majority found that the statutory structure and goals of the bankruptcy system formed an appropriate frame of reference.

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