Fifth Circuit Report: Oct.-Dec. 2015

The Fifth Circuit decided cases dealing with appellate procedure, exemptions, judicial estoppel, jurisdiction, sanctions, standing and surcharging collateral during the fourth quarter of 2015.  A common theme among the cases is parties being disappointed in a variety of contexts, including having an appeal dismissed on procedural grounds, having a lawsuit dismissed based on incomplete filings in a bankruptcy case, losing exemptions based on unfortunate timing and failure to establish damages after dismissal of an involuntary petition.  

Let's Be Careful Out There: The Danger of Omitting Assets

Filing bankruptcy is serious business.    The mere act of filing a petition creates an automatic stay effective against all entities.    Liens can be modified, taxes can be paid out and debts can be discharged.   The price of admission for getting all these benefits is full disclosure.   Unfortunately some debtors either don't understand these obligations or think they can selectively disclose only the assets they want to list.   The consequences for omitting assets can be severe as illustrated by two recent opinions from the Fifth Circuit and a press release from the Acting U.S. Attorney for the Southern District of Illinois.

Fifth Circuit Report: August-September 2015

The summer months have been slow at the Fifth Circuit.   August and September's opinions include an update on a prior opinion about abstention related to a chapter 15, judicial estoppel, mootness of an appeal of a sale order, a motion to compromise, removal of a trustee, recognition of a foreign judgment and issues relating to a homestead.
 

Fifth Circuit Declines to Apply Judicial Estoppel to Inconsistent Creditor Claims in Subsequent Case

The Fifth Circuit has added a new decision to its judicial estoppel jurisprudence, holding that a creditor that submitted claims in different amounts in successive cases was not estopped.   While it may seem that the court is applying the estoppel doctrine in an uneven manner, penalizing debtors but not creditors, the decision faithfully follows the elements laid out by the court.    Wells Fargo Bank, N.A. v. Oparaji (Matter of Oparaji), No. 11-20871 (5^th Cir. 10/5/12), which can be found here.   

What Happened

The Debtor Titus Chinedu Oparaji filed a chapter 13 proceeding on September 2, 2004 (“First Case”).   During the First Case, he fell behind on his mortgage payments to Wells Fargo.   Over time, Wells Fargo filed several amended claims and the Debtor filed several modified plans.   The amended claims filed by Wells Fargo understated the amount of the post-petition arrearages.  When the Debtor failed to complete his plan payments within five years, the First Case was dismissed.

After the First Case was dismissed, the Debtor continued to miss payments to Wells Fargo.  On February 1, 2010, the Debtor filed his second chapter 13 case (“Second Case”).   By this time, the arrearage owed to Wells Fargo had grown to $86,003.25.   The Debtor argued that based on the claims filed in the First Case that the arrearage could not possibly be that high.   The Bankruptcy Court found that Wells Fargo was bound by the claims filed in the First Case under the doctrine of judicial estoppel and the District Court affirmed.

The Ruling

The Fifth Circuit reversed, finding that Wells Fargo had not “asserted a legally inconsistent position that was accepted by the Bankruptcy Court.”   Opinion, p. 6.   

The elements of judicial estoppel are: (1)  a party asserts a legal position that is “plainly inconsistent” with the position taken in another case; (2) the court in the other case accepted the party’s original position; and (3) the inconsistent positions were not taken inadvertently.

The Court found that a creditor who files a post-petition claim in one case is not estopped from asserting a higher claim in a subsequent case.   Under section 1305(a), a creditor may file a post-petition claim but is not required to.   This contrasts with the common scenario where a debtor omits an asset.   While a debtor must list all assets in its schedules, the creditor is not under a duty to amend its proof of claim to include post-petition arrearages.   

The Debtor argued that while Wells Fargo was not required to file a post-petition claim, that once it did so, it was required to include all post-petition amounts.   The Fifth Circuit distinguished the Oparaji case from In re Burford, 231 B.R. 913 (N.D. Tex. 1999).  In Burford, the confirmation order required the creditor to create a payment schedule that would “fully retire the debt.”   However, in this case, the creditor submitted a claim without expressly representing that there were no additional amounts owing.

Because Wells Fargo never asserted that the amount contained in its post-petition claim constituted all the amounts owed, the Fifth Circuit found that it had not asserted inconsistent positions.   As a result, judicial estoppel did not apply.    The Court went further and found that even if Wells Fargo had asserted inconsistent positions, the dismissal of the First Case meant that the parties were returned to their position status quo ante.  

What It Means

Judicial estoppel is meant to prevent parties from gaming the system. While, on the surface, it might appear that Wells Fargo took inconsistent positions, its inconsistency was not legally significant.  Wells Fargo’s only fault was that they did not assert their rights in the First Case as aggressively as they could have.   Had the Debtor completed its plan in the First Case, the parties and the Court would have had a difficult time sorting out which post-petition defaults were included in the plan and which ones were not.   Had the Debtor filed an “all current” motion at the conclusion of its plan and obtained an order, it could have bound Wells Fargo.  However, neither one of these occurred.   The Debtor did not complete its plan and it did not obtain a determination that it was current on its mortgage.   

As a general rule, a dismissed case should rarely, if ever, give rise to judicial estoppel.   By definition, a dismissed case is one in which no party obtains relief (although the debtor enjoyed the benefits of the automatic stay for a period of time).    If a party does not obtain relief, then it is hard to say that the court accepted the party’s position in any meaningful respect.   The real benefit of this case may be for debtors who omit a creditor or an asset in an initial case and then accurately disclose it in a subsequent case.   In that instance, Oparaji should be good precedent that judicial estoppel will not apply.

Fifth Circuit Tackles Judicial Estoppel Yet Again Resulting in a Split Decision

Failure to schedule causes of action appears to be an endemic problem as shown by the fact that the Fifth Circuit has been asked to apply judicial estoppel to a bankruptcy case once again. However, the latest decision, Love v. Tyson Foods, Inc., No. 10-60106 (5th Cir. 4/4/12), which can be found here, shows just how difficult it is to draw the line between fairness and integrity as Judges Carolyn King and Catarina Haynes disagreed on how the doctrine should apply to a chapter 13 debtor's untimely disclosure. The Court, with Judge King writing the opinion, held that the debtor failed to meet his burden of proof to show a non-disclosure was inadvertent.

What Happened

Willie Love was dismissed from Tyson Foods after he failed a drug test. When the company refused to re-test him based on his contention that an antibiotic caused him to erroneously positive, he filed a charge of discrimination with the EEOC. and later filed suit. Along the way, he filed chapter 13 and did not list the claim The defendant successfully moved for summary judgment based on judicial estoppel based on the non-disclosure.

While this synopsis is accurate, the following time line gives a more complete understanding of what occurred.

Willie Love was dismissed from Tyson on April 2, 2008.

He filed chapter 13 on May 1, 2008 and did not list a potential cause of action.

Love filed a complaint of discrimination with the EEOC on May 30, 2008.

On September 22, 2008, the Debtor confirmed a chapter 13 plan which did not provide for a distribution to unsecured creditors.

Love received a right to sue letter from the EEOC on December 16, 2008.

The Debtor filed suit on March 12, 2009.

On July 16, 2009, Tyson moved for summary judgment.

On July 22, 2009, the Debtor amended his schedules to disclose the claim and moved to employ special counsel to pursue the claim.

On January 7, 2010, the District Court granted the Motion for Summary Judgment.

The Majority Opinion

Judge Carolyn King, writing for herself and Judge Jacques Weiner, upheld the summary judgment, finding that the debtor had failed to raise a fact issue as to whether the failure to disclose the asset was inadvertent. The opinion noted that the debtor's brief discussed only two of the elements of judicial estoppel and did not address inadvertence.

There are three elements to judicial estoppel:

“(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.”

Opinion, p. 4, citing Reed v. City of Arlington.

The debtor made the following argument to the District Court:

(1) “Plaintiff’s positions are no longer inconsistent as [Love] supplemented his Schedule to list the current case as an asset in his bankruptcy”; (2) “the Defendant has failed to show the bankruptcy court has accepted the Plaintiff’s prior position that he had no contingent claims”; (3) “Plaintiff will not derive any unfair advantage or impose any unfair detriment on any opposing party if not estopped”; and (4) “Plaintiff’s bankruptcy is still pending and any monies paid by Defendant through settlement or judgment in this case would go into the bankruptcy to pay Plaintiff’s creditors first.”

Opinion, p. 6.

The majority found this explanation to be insufficient, stating:

Critically, Love’s arguments before the district court did nothing to refute Tyson’s allegations or explain why Love did not disclose his claims when his disclosure obligations first arose. His first two arguments clearly do not speak to his motive to conceal his claims against Tyson. With respect to Love’s third argument, whether Tyson or Love would accrue an unfair detriment or benefit if the lawsuit were allowed to go forward after Tyson forced Love to disclose his claims is an entirely different issue than whether Love had a financial motive to conceal his claims against Tyson at the time Love failed to meet his disclosure obligations, which is the relevant time frame for the judicial estoppel analysis. (citations omitted). Regarding Love’s fourth argument, Love did state that he would pay his creditors before collecting any money from his claims against Tyson, but he made this assertion only after Tyson brought his nondisclosure to light. Love’s disclosure obligations arose long beforehand, and his statement about his post-disclosure conduct again fails to speak to his motivations while he was obligated to disclose his claims but had not yet done so. Consequently, we agree with the district court’s conclusion that Love ultimately provided “no basis for concluding that [the] failure to disclose th[e] litigation [against Tyson] to the bankruptcy court was ‘inadvertent.’” Thus, the district court did not abuse its discretion by applying judicial estoppel to Love’s claims.

Opinion, pp. 6-7. Thus, the Fifth Circuit affirmed the District Court. (The majority opinion included a thoughtful rejoinder to the dissent. While I am not discussing it here, I want to emphasize that the judges engaged each other in a respectful debate).

The Dissent

In a spirited fifteen-page dissent, Judge Catarina Haynes offered both procedural and substantive reasons why she believed the majority was wrong.

First, she argued that judicial estoppel is an affirmative defense. As a result, the Defendant had the burden of proof to show that there was no factual dispute as to any of the three elements. According to Judge Haynes:

As the party invoking judicial estoppel on summary judgment, Tyson thus bore the burden of proof and had to prove, not just hypothesize, that Love had knowledge and a motive for concealment. Tyson failed to do so.

Dissent, p. 14.

Judge Haynes went on to state that even if Tyson had met its burden of proof that the debtor's response was sufficient to raise a fact issue.

We should stop here, as I have shown that no summary judgment burden “shifted” to Love. However, even if it did, I disagree that Love failed to respond in kind, creating a material factual dispute on whether he had motive to conceal. Love’s summary judgment response set forth the Supreme Court’s judicial estoppel standard from New Hampshire v. Maine, 532 U.S. 742, 751 (2001). See also Hall v. GE Plastic Pac., 327 F.3d 391, 399 (5th Cir. 2003). There, he disclaimed the third prong of that standard. Indeed, he expressly responded to Tyson’s claim that his “motive” was to gain money “free and clear” by arguing in response that any recovery would not be paid to him but to the estate. He stated:

"Plaintiff will not derive any unfair advantage or impose any unfair detriment on any opposing party if not estopped. Plaintiff’s bankruptcy is still pending, and any monies paid by Defendant through settlement or judgment in this case would go into the bankruptcy to pay Plaintiff’s creditors first. To the contrary, if Plaintiff is judicially estopped his creditors would be injured, and would be prevented from receiving any monies from the current case."

Thus, if Tyson’s mere allegation that Love’s motive was to gain an unfair personal advantage by taking money “free and clear of creditors” is enough to satisfy its summary judgment burden on “motive,” then Love’s statement that any monies paid “would go into the bankruptcy to pay Plaintiff’s creditors first” should similarly discharge his non-movant’s burden. The majority opinion discounts Love’s argument because it does not use the “magic words” of “motive” or “inadvertence.” We have not so exalted form over substance, particularly in the face of a Supreme Court opinion using the exact language Love used. The majority opinion contends that whether the claim is “free and clear” or not, a potentially deviant debtor may always attempt to “collect any recovery on claims without his creditors’ knowledge.” I agree that there is something problematic about a debtor who conceals assets that do not belong to him in an effort to forever keep his creditors in the dark. This hypothetical deviant, however, does not, as a matter of law, establish Love’s intent to conceal where his only action was an omission and the claim remains property of the bankruptcy estate.

Dissent, pp. 17-19.

Judge Haynes went further and stated that under Reed v. City of Arlington and Kane v. National Union Fire Ins. Co., that the bankruptcy estate should not have been estopped. She wrote:

This case, though different in kind, is controlled by our decisions in Reed and Kane. Both concerned whether a Chapter 7 trustee is estopped from pursuing unscheduled claims on behalf of the estate where the debtor had wrongly concealed claims during the bankruptcy proceeding. (ctiations omitted). We held in both cases that the claims originally brought by the debtors were unabandoned assets of the estate and that “the only way the creditors would be harmed is if judicial estoppel were applied to bar the trustee from pursuing the claim on behalf of the estate.” (citations omitted).

It makes no difference under the circumstances of this case that Love is not a trustee as were the parties seeking to avoid estoppel in Reed and Kane. For our purposes, his role as essentially a debtor in possession puts him in an analogous position to a trustee. It follows that because the claim is the property of the estate, and the estate has not been administered, judicial estoppel should not apply to bar relief that would benefit creditors. (citation omitted). The debtors in Kane were virtually indistinguishable from Love in his position as debtor. While the Kanes’ lawsuit was pending in state court, they filed a Chapter 7 bankruptcy. (citation omitted). That bankruptcy resulted in a no-asset discharge. (citation omitted). It was not until a summary judgment motion was offered, arguing that judicial estoppel should apply, that the Kanes filed a motion to reopen the bankruptcy so the Trustee could administer the previously undisclosed lawsuit. (citation omitted). We reversed the district court’s summary judgment application of judicial estoppel, holding that equity did not compel barring the trustee from acting on behalf of the estate. (citation omitted). Indeed, we even highlighted the possibility that the debtors may recover in the event of surplus. (citation omitted).

It is true, as the majority opinion points out, that the claims in Reed and Kane were pursued by “innocent Chapter 7 trustees, and not by the debtors themselves.” But Love’s role as both debtor and protector does not make the analogy any less apt. The only real implication of the majority opinion’s distinction is that the trustees in Reed and Kane were “innocent.” This distinction is irrelevant, however, because the debtors in those cases were in the same position as Love, and the characterization of the trustee’s role as “innocent” has nothing to do with the imposition of judicial estoppel where that trustee’s duty, imposed post-disclosure, is to act on behalf of the estate.

Dissent, pp. 22-24.

In conclusion, she stated:

Unlike the litigants in our prior decisions concerning judicial estoppel, Love gains no potential legal advantage from his failure to disclose the claim against Tyson to the bankruptcy court. As Love explained to the district court—albeit somewhat ineloquently—the recovery sought against Tyson would aid his creditors, not defraud them. In this vein, Tyson has not established Love’s motive to conceal. Our precedent counsels against judicial estoppel in these circumstances.

Moreover, the court’s equitable discretion must be used against the backdrop of the bankruptcy system and the goals it espouses. The outcome affirmed by the majority opinion does not further those goals—either in dissuading future deviant bankruptcy litigants or in protecting third party creditors’ rights. At the very least, the remedy espoused in Reed could be utilized here in preventing unnecessary harm to creditors while preventing an allegedly deviant debtor from “playing fast and loose” with the courts.

None of the above represents some effort to “change the law.” Rather it seeks to hold alleged tortfeasors who would reap an admitted windfall to their summary judgment burden of proof. Further, while judicial estoppel certainly should be available in some circumstances, it should not be mechanically applied. It is an equitable doctrine, demanding nuance, not absolutes.

The majority opinion discusses a very real concern, that debtors may defraud the bankruptcy system by failing to schedule their claims. Using judicial estoppel to curtail this potential problem, however, is not the answer under all circumstances. There are other legal avenues to punish, and obtain relief from, fraudulent debtors without imposing a windfall on an alleged tortfeasor to the detriment of innocent creditors.

Accordingly, I respectfully dissent.

Dissent, pp. 26-27.

Who Got It Right?

This is a difficult opinion. Love v. Tyson Foods, Inc. presents a closer case because the debtor was both the person who failed to schedule the cause of action and later sought to pursue it. However, the case is more ambiguous because (i) the claim had not been filed on the petition date and (ii) the debtor promptly amended his schedules to disclose the claim once the omission was pointed out. In the balance between integrity and fairness implicated by judicial estoppel, is it more important to punish the initial omission or to encourage disclosure, however belated, for the benefit of the creditors?

I think that Judge Haynes has the better argument. At a minimum, this was not a case that should have been resolved on summary judgment.

First, although it was not clearly discussed by either opinion, the debtor unambiguously contested two out of the three elements of judicial estoppel. The debtor noted that while he had taken an inconsistent position, he had amended his ways. Further, he did not obtain a benefit from taking an inconsistent position. The majority glosses over this point, noting that the debtor had confirmed a plan which did not propose any distribution to the unsecured creditors. However, no chapter 13 plan is final until it is completed. Under 11 U.S.C. Sec. 1329(a), a chapter 13 plan may be modified after confirmation upon request of the debtor, the trustee or a creditor to increase the amount of payments under the plan. Thus, there was still time to include the litigation proceeds in the funds to be distributed to creditors under the plan. Because there were fact issues on the first two prongs of Tyson's affirmative defense, the court should not have reached the third prong.

With respect to the third prong, inadvertence, the facts detailed by the majority speak loudly to the practical realities. On the date the debtor filed bankruptcy, he had not filed a charge of discrimination with the EEOC, he had not received a right to sue letter and he had not actually filed suit. While he had an obligation to disclose the potential cause of action, it is far more more believable than not that an unsophisticated debtor could have missed this distinction. As a practicing attorney, I am often frustrated with the wooden terms employed in the schedules. Schedule B21 asks the debtor to disclose:

Other contingent and unliquidated claims of every nature, including tax refunds, counterclaims of the debtor, and rights to setoff claims.

This language is unlikely to resonate with the typical debtor. It would be much much more useful to ask:

Are you suing anyone? Do you want to sue anyone? Has anyone done anything wrong to you?

That would be much more useful than asking about "contingent" and "unliquidated" claims, setoffs and tax refunds. (Indeed, my spell check does not believe that "unliquidated" is even a word).

On procedural grounds, the court should have ruled that there were fact issues and that summary judgment was improvidently granted.

Substantively, Judge Haynes has the better argument as well. This decision does not punish the debtor. The debtor will receive a chapter 13 discharge if he completes his payments. However, the creditors will not receive any distribution. While there were only two unsecured creditors who filed claims in the aggregate amount of $2,305.74, I am sure they would have preferred to receive payment.

eCast Settlement Corporation was a creditor in both this case and in Reed. eCast makes its money by purchasing unsecured claims and seeking recovery in bankruptcy. By minimizing the recovery to creditors such as eCast, the Court reduces the amount that eCast and other debt buyers will pay for distressed debt, which will reduce the amount paid to the initial creditor.s While the individual case may only affect two small unsecured claims, it has the potential to affect millions of claims.

What Should Be Done?

Normally, when two intelligent, articulate judges reach different results, one would hope that the losing party would seek panel rehearing or rehearing en banc to allow the court to reconsider the issue. However, in this case, the court notes that while the debtor had one counsel in the bankruptcy case and another in the district court case, that the debtor was pro se on appeal. The fact that a pro se party made it this far is remarkable. However, it is less likely that an unrepresented party will take the next step, which would be a shame. It would be nice if the Court were to reconsider the matter on its own motion.

Texas State Court Gets Judicial Estoppel Right

The Dallas Court of Appeals has published a new decision correctly applying the doctrines of judicial estoppel and standing relating to a cause of action omitted from a bankruptcy filing. Norris v. Brookshire Grocery Company, ___. S.W.3d ___ (Tex. App.--Dallas, 2/29/12, no pet.). You can find the opinion here.

In Norris, the plaintiff filed suit against Brookshire Grocery prior to filing bankruptcy. Upon filing bankruptcy, the plaintiff/debtor neglected to mention the suit in either the Schedules or the Statement of Financial Affairs. However, just thirteen days after filing bankruptcy, the debtors filed a motion to dismiss their bankruptcy case on the ground that they "desire to work a payout with creditors." No party objected and the case was dismissed.

After the bankruptcy case was dismissed, Brookshire moved for summary judgment based on judicial estoppel and lack of standing. The trial court granted the motion.

On appeal the Dallas Court of Appeals reversed finding:

1. In order for judicial estoppel to apply, the Bankruptcy Court must have "actually accepted" the debtors' non-disclosure of the asset. Where the debtors dismissed their case without receiving a discharge, there was not an opportunity for the bankruptcy court to "actually accept" their position.

2. Normally, an undisclosed asset remains property of the bankruptcy estate and is not abandoned when the trustee closes the case. This is not the case when the case is dismissed, since the estate ceases to exist. As a result, the debtors had standing to pursue their cause of action.

The opinion by the Dallas Court of Appeals should be commended for correctly applying difficult principles of bankruptcy law. The purpose of judicial estoppel is to prevent debtors from gaming the system and reaping a benefit from taking inconsistent positions. Reading between the lines, it seems likely that when debtors' counsel learned of the cause of action, he gave them a choice: proceed with the bankruptcy and lose the cause of action or dismiss the bankruptcy and keep the cause of action. Because the debtors effectively undid the omission by dismissing their bankruptcy, judicial estoppel did not apply.

Hat tip to St. Clair Newbern.

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.

Preserving Causes of Action In Plans

These days, defendants are getting more aggressive about repelling suits from bankruptcy estates. From jurisdictional squabbles based on Stern v. Marshall to judicial estoppel to failure to preserve a cause of action in a plan, the plaintiff’s road to judgment is just more difficult than it used to be. However, two recent decisions are examples of suits which avoided being detonated by clever challenges. In Matter of Texas Wyoming Drilling, Inc., No. 10-10717 (5^th Cir. 7/21/11), a chapter 7 trustee prevailed against a claim that the former debtor in possession had failed to failed to make a “specific and unequivocal” reservation of claims and defeated a judicial estoppel claim. In Crescent Resources Litigation Trust v. Burr, No. 11-1013 (Bankr. W.D. Tex. 7/22/11), a litigation trust created by a plan defeated a defense that claims had not been adequately preserved. (There was another very interesting decision released in the Crescent case the same day about turnover of files from the debtors’ former attorneys. Because that case does not retention language under a plan, I will save that one for another day). You can find the opinions here and here.

The Disclosure Statement Wins Out

The Debtor in Texas Wyoming filed for chapter 11 relief and confirmed a plan. The plan provided for preservation of “Estate Claims.” The Disclosure Statement defined “Estate Claims” as claims arising under Chapter 5 of the Bankruptcy Code and included a chart listing potential claims, including “Various pre-petition shareholders of the Debtor” who might be sued for “fraudulent transfer and recovery of dividends paid to shareholders.”

The Debtor then sued its former shareholders to recover dividends paid under a fraudulent conveyance theory. The defendants sought to dismiss the action claiming that: (a) the Plan did not include a “specific and unequivocal” reservation of claims, (b) the disclosure statement did not name the parties who could be sued; and (c) the Debtor did not disclose the claims in its schedules.

Under Fifth Circuit precedent, a plan must “specifically and unequivocally” retain a cause of action. In re United Operating Company, 540 F.3d 352 (5^th Cir. 2008). If the claim is not adequately reserved, then the post-confirmation debtor lacks standing to pursue it.

When the plan failed, the case was converted and the chapter 7 trustee pursued the claims. The Bankruptcy Court denied the defendants’ motion, but certified a direct appeal to the Fifth Circuit. The Fifth Circuit, in an opinion authored by Edith Brown Clement, made short work of the defendants’ claims.

The Fifth Circuit found that it was permissible to consult the disclosure statement to see whether claims had been adequately disclosed. The Court stated:

We observe that the disclosure statement is the primary notice mechanism informing a creditor’s vote for or against a plan. See 11 U.S.C. § 1125. Considering the disclosure statement to determine whether a post-confirmation debtor has standing is consistent with the purpose of In re United Operating’s requirement: placing creditors on notice of the claims the post-confirmation debtor intends to pursue. (citation omitted). In light of the role served by the disclosure statement, the purpose behind the rule in In re United Operating, and the fact that, in similar contexts, courts routinely consider the disclosure statement to determine whether a claim is preserved, we hold that courts may consult the disclosure statement in addition to the plan to determine whether a post-confirmation debtor has standing.

Opinion, pp. 6-7.

While the language in the Plan was generic, the language in the Disclosure Statement identified claims arising under Chapter 5 and stated that pre-petition shareholders were at risk for being sued for recovery of dividends. That was enough to satisfy the “specific and unequivocal” requirement under prior Fifth Circuit precedent.

The Fifth Circuit also rejected the argument that failure to list the claims in the schedules would bar the claims under the doctrine of judicial estoppel. The Court noted that there was no inconsistent position taken since the Disclosure Statement specifically identified the claims.

The defendant’s argument founders on the first requirement because TWD did not take clearly inconsistent positions. As explained above, TWD’s plan and disclosure statement retained the right to pursue the Avoidance Actions. Because TWD explicitly retained the same claims against the defendants that the trustee is now pursuing, there is no inconsistency in its position.

Opinion, p. 9.

This holding is a victory for common sense interpretation versus the magical view that any failure to disclose evaporates the claim.

The take away from Texas Wyoming is that careful drafting at the disclosure statement stage may avoid creditor heartaches down the road.

Court Chooses the Categorical Approach

The Crescent Resources case involved 122 related debtors who filed a chapter 11 bankruptcy in Austin in 2009. On December 20, 2010, the Court confirmed the Debtors’ Revised Second Amended Plan of Reorganization. A major feature of the plan was creation of a Litigation Trust. One claim pursued by the Trust was against Edward Burr, a former insider of the Debtors. The claims involved two transactions:

1. Payment of $1.925 million to Burr in April 2007 to cover his personal tax liabilities; and

2. Payment of $4.5 million in cash plus forgiveness of $71 million in debt owed to Crescent in November 2007 in return for termination of his employment and conveyance of a 20% interest in one of the debtors.

The Trustee alleged that the transfers constituted fraudulent conveyances under state and bankruptcy law. The Defendant sought to dismiss the claims, asserting that the plan had not “specifically and unequivocally” reserved the claims and asserting failure to plead fraud with specificity.

The Defendant raised two arguments with regard to retention of claims: 1) that the plan failed to disclose that the Trust would pursue claims against him personally; and 2) that if the overall description was sufficient, that the plan failed to preserve claims for turnover pursuant to 11 U.S.C. §542.

The Plan provided that:

The Litigation Trust Assets shall include, but are not limited to, those Causes of Action arising under Chapter 5 of the Bankruptcy Code including those actions which could be brought by the Debtors under §§ 544, 547, 548, 549, 550, and 551 against any Person or Entity other than the Litigation Trust Excluded Parties.

Causes of Action was defined to mean “any and all Claims, Avoidance Actions, and rights of the Debtor, including claims of a Debtor against another Debtor or other affiliate.”

It is clear that neither the Plan, the Trust Agreement or the Disclosure Statement specifically referred to Mr. Burr or referred to claims for turnover under 11 U.S.C. §542.

The opinion contains an excellent discussion of the cases interpreting United Operating. At the conclusion of its discussion, the Court summarized as follows:

(W)hile the Fifth Circuit has not defined what “specific and unequivocal” means, cases have interpreted different plan language on case-by-case bases which this Court can use as guideposts with which to judge the plan language at issue here. Courts have held that listing causes of action by code section is sufficiently “specific and unequivocal.” (citations omitted). The courts have also held that a generic blanket reservation is insufficient. (citations omitted).

The cases in the Fifth Circuit all cited United Operating. United Operating, in making its holding, also discussed that one of the purposes of bankruptcy is to “secure prompt, effective administration and settlement of all debtor‟s assets and liabilities within a limited time.”(citation omitted). In order to facilitate this resolution of the estate, “a debtor must put its creditors on notice of any claim it wishes to pursue after confirmation.” (citation omitted). It is for this reason—notice to creditors—that the Fifth Circuit determined that the retention language needed to be “specific and unequivocal.” (citation omitted).

This Court agrees with the reasoning behind those cases applying what has been referred to as the “Categorical Approach,” and adopts the test established in Texas Wyoming Drilling to determine if the plan language meets the “specific and unequivocal” requirement. (citation omitted). That test, again, was to make a determination “whether the language in the [p]lan was sufficient to put creditors on notice that [the debtor] anticipated pursuing the [c]laims after confirmation.” (citation omitted). If so, the language meets the “specific and unequivocal” requirement.

Opinion, pp. 21-22.

The Court found that the reference to “state fraudulent transfer law claims” was not specific and unequivocal because it did not refer to a specific code cite. The Court went on to find that a reference to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§544, 547, 548, 549, 550, and 551” was sufficiently detailed so that “a creditor could not feign surprise that the Trust would pursue a claim under Section 542.”

Conclusion

Taken together, Texas Wyoming and Crescent Resources set a fairly low bar for preserving claims and causes of action under a plan. Both cases take a pragmatic attitude, essentially relying on a surprise standard. From a policy standpoint, it is about fairness. If a creditor is being asked to vote on a plan, it should be clear whether that person runs the risk of being sued. In Texas Wyoming, the Disclosure Statement clearly signaled that the Debtor intended to sue former shareholders who had received dividends. In Crescent Resources, the language could have been stronger, but it wasn’t really surprising that an insider who had received large transfers prior to bankruptcy would be sued.

While the Court found that the Crescent language was sufficient, it would have been stronger if it had referred to “Causes of Action arising under chapter 5 of the Bankruptcy Code, including those actions which could be brought by the Debtor under §§542, 543, 544, 545, 547, 548, 549, 550, 551, 552 and 553 which may be brought against any entity receiving a transfer from any of the Debtors during the four years prior to bankruptcy, including but not limited to insiders, employees, officers, and equity holders of the Debtors.”