Death Penalty Sanctions Applied in Case of Double-Dealing Attorneys

In a disturbing 52-page opinion, Judge Stacey Jernigan has administered “death penalty” sanctions against The Cadle Company based on double-dealing and non-disclosures by Cadle’s long-time attorneys who also represented the trustee.     The Cadle Company, LLC v. Brunswick Homes, LLC, Adv. No. 06-3417 (Bankr. N.D. Tex. 4/23/12).  The opinion may be found here.    The Court went so far as to state that “the entire Adversary Proceeding has been tainted and the temple of justice has been defiled.”   Opinion, p. 5.  

  

The Cadle Company is a sophisticated party that purchases and collects debts.    It is known for its aggressive tactics in collecting debts from parties in bankruptcy.   Many of the leading Fifth Circuit cases involving Section 727 were brought by The Cadle Company.    (Disclosure:    I represented the debtor in Bobby D Associates v. Walsh (In re Walsh), 143 Fed.Appx. 580 (5^th Cir. 2005), a case brought by a Cadle affiliate).     I have previously written about the Cadle Company here, here and here.

In this particular case, The Cadle Company succeeded in having the debtor’s discharge denied and made new law with regard to a trustee’s ability to settle rather than settle claims, see Cadle Co. v. Mims (In re Moore), 608 F.3d 253 (5^th Cir. 2010).    However, their trail of successes in the case came to a screeching halt when the Court found out that Cadle had been simultaneously paying the attorneys for both sides to a dispute without making disclosure of that fact.    

What Happened

The Cadle Company several large debts against James H. Moore, III.   In an attempt to collect those debts, it filed a suit in state court against several entities related to the debtor seeking to hold them liable as transferees or alter egos of the debtor.    When the debtor filed bankruptcy in 2006, the state court action was removed to bankruptcy court.    The Cadle Company recognized that the claims now belonged to the trustee and arranged for the trustee to be substituted in as plaintiff.

Cadle’s long-time attorneys, Bell, Nunnally & Martin, LLP offered to represent the trustee on a contingent fee basis.   This appeared to be a good deal for the trustee since Bell Nunnally was familiar with the file and agreed to take the case on a contingent fee basis.    Bell Nunnally signed an engagement agreement with the trustee which was incorporated into an application to be employed as special counsel.    The application and the engagement agreement represented among other things:

That BNM had previously represented the Cadle Company but understood “that it represents and owes fiduciary duties only to the Trustee in the Action and not the Cadle Company.”

“Compensation to BNM, if any, will be paid only upon recovery of money or property of value in connection with the Adversary Action on behalf of the estate and will be subject to the Court’s approval of a fee application to be filed by BNM at the conclusion of the Adversary Action.”

“No promises have been made to BNM or any of its partners or associates as to compensation in connection with this case other than in accordance with the provisions of the Bankruptcy Code.”

The application to employ was filed on August 22, 2006.    

Three days later, on August 25, 2006, Bell Nunnally filed an adversary proceeding objecting to the debtor’s discharge on behalf of Cadle.   

On October 23, 2006, the Court held a hearing on the application to employ.    The Court noted that “there was no disclosure of any special arrangements whereby the Creditor-Cadle might pay BNM’s fees and expenses in connection with the Veil-Piercing Action.”    Opinion, p. 14.

Just two weeks later, on November 6, 2006, Bell Nunnally entered into a letter agreement with the Cadle Company that was, according to the Court “the proverbial smoking gun.”    In the letter agreement, Cadle confirmed that it would pay Bell Nunnally for both its work on behalf of the Trustee and in the adversary proceeding to deny discharge.   The letter stated:

The Cadle Company has agreed to pay our firm’s fees related to the prosecution of the adversary proceeding [the Veil-Piercing Action] as well as to the representation of The Cadle Company’s interests as a creditor in the main case and its unrelated action to deny discharge.   At the conclusion of the case, assuming a positive result, we will request payment of the fees and expenses incurred by our firm in the prosecution of the [Veil-Piercing Action].    Upon receipt of payment from the Trustee, this firm will reimburse Cadle for the fees and expenses it has actually paid our firm in connection with the adversary proceeding.

This side agreement was problematic, since the firm had previously represented under oath that it had no other agreements for compensation.    Besides constituting a false oath (something the firm knew much about since it often filed actions under section 727(a)(4)), it created a possible conflict between its two masters.   As determined by the Court, that possible conflict matured into an actual conflict.

On April 18, 19 and 25, 2007, the Court conducted a trial on the objection to discharge, which ultimately resulted in denial of discharge.   While this trial was pending, Bell Nunnally filed a motion to withdraw as the trustee’s counsel in the Veil-Piercing Action for a reason that aroused the Court’s suspicion.   In the Motion to Withdraw, Bell Nunnally stated that its agreement with the trustee was that its fees would be contingent, but The Cadle Company would pay its expenses.   The firm further represented that as of April 5, 2007, it had “it had learned definitively that Cadle was not willing to pay any expenses to assist Mims Trustee.”   

In one pleading, the firm managed to contradict both its own Engagement Agreement with the Trustee (which did not include any reimbursement of expenses from The Cadle Company) and its November 6, 2006 agreement with Cadle (which provided for payment of both fees and expenses.    It was also false in that Cadle continued to pay fees and expenses until February 2009.

The Court was not pleased.    At the hearing on the motion to withdraw on May 15, 2007, expressed surprise that there was an agreement for Cadle to pay expenses.   At one point, the Court asked, “If there was an agreement, show me the agreement.”    Notwithstanding the Court’s request, the firm did not disclose the November 6, 2006 letter.    The Court denied the motion, finding that the trustee would be prejudiced.   The Court denied the motion without prejudice to being re-urged, but added that if it did so, the Court expected that the firm would “present some proof that there was an agreement that The Cadle Company would pay the ongoing expenses of BNM in pursuing this matter.”    

Bell Nunnally succeeded in defeating a motion for summary judgment filed by one of the defendants.   However, the Court’s opinion highlighted the difficulties the plaintiff would have in ultimately proving its case.

On the eve of trial, the Trustee reached an agreement with the defendants to settle for $37,500.   This is when the conflict matured from possible to full-blown.   The Cadle Company, acting through other lawyers, objected to the settlement, stating that it would pay $50,000 to purchase the causes of action.    The Court ruled that the Trustee was entitled to settle the claims rather than auction them.   

At the hearing on the settlement, Cadle’s representative testified that there was no agreement to pay Bell Nunnally’s expenses, but that Cadle had paid “some bills” totaling $50,000-$60,000 towards the litigation.    The Trustee was not pleased to learn that his ostensible lawyer was being paid by the other side and demanded that the attorneys amend their disclosures to the Court.   They did not.

Cadle appealed the Court’s order.   For reasons that are not clear in the opinion, the Trustee continued to retain Bell Nunnally to represent him on the appeal.    This meant that for a period of time, Cadle was footing the bills for both sides to the appeal.   (Cadle stopping paying Bell Nunnally in February 2009, about nine months into the appeal).    This conflict was even more serious because Bell Nunnally was sending invoices to Cadle for its trustee representation which referenced privileged communications with the trustee.    The trustee, however, neither knew that Cadle was receiving the invoices or saw them himself.  

The day before oral argument in the Fifth Circuit, the principal attorney who had been representing the trustee left Bell Nunnally for another firm.    Although the oral argument had been scheduled for six weeks, the lawyers at Bell Nunnally apparently had not planned for this contingency.    The departing lawyer declined to handle the oral argument.  Instead, the firm sent a first year lawyer to the Fifth Circuit.     This later raised suspicions that the firm had intentionally taken a dive on the appeal to curry favor with Cadle.     (Note:    The Fifth Circuit’s opinion in Cadle Co. v. Mims was solidly reasoned so that sending a more experienced lawyer probably would not have made a difference.    However, the appearance was not good).    The Court found that “the surrounding circumstances here give every indication of the Chapter 7 trustee having been treated like the proverbial ‘hot potato.’”    Opinion, p. 34.

After the Cadle Company prevailed on the appeal, the trustee conducted an auction sale of the cause of action.    Cadle was the high bidder at $41,500, an amount just $4,000 more than had been offered by the defendants to settle and $8,500 less than it had previously indicated that it was willing to pay.    The Court commented:   “A marvelous result?   Hardly.”    Opinion, p. 36.

At this point the plot thickened.   As recounted by Judge Jernigan:

At the April 11, 2011 sale hearing, in the midst of this lackluster result, Attorney BA appeared—purportedly on behalf of the Chapter 7 Trustee—seeking a continuance of the trial date in the Veil-Piercing Action.    At that point, the bankruptcy court raised questions as to whom exactly Attorney BA considered himself to be representing?   On the one hand, Attorney BA had apparently not felt like he could represent the Chapter 7 trustee at the Fifth Circuit oral arguments—because he had gone to a new firm.    Now, suddenly, Attorney BA was filing pleadings for the Chapter 7 Trustee.    But the Chapter 7 Trustee indicated that he had not instructed Attorney BA to seek a continuance or even talked to him about it.    Attorney BA’s actions had all the appearance of him seeking a continuance for the benefit of Creditor-Cadle, which had just newly purchased the claims in the Veil-Piercing Action.

Opinion, pp. 36-37.  

The Court granted the continuance but ordered that a representative of Cadle be present “to address some of the conflicts issues that had seemed to percolate to the surface.”    

At the next hearing, Cadle sent a representative who stated that it was not able to find any agreement to pay Bell Nunnally for representing the Trustee, but that they had paid $92,000 to the firm over a two year period anyway.   

Upon hearing this testimony, the defendants filed a motion to dismiss the adversary proceeding.     The Court conducted three days of hearings upon the motion and heard testimony from Cadle, Attorney BA (the former Bell Nunnally attorney) and the trustee.    The Court found the trustee’s testimony to be credible, while describing Attorney BA’s testimony as “cavalier” and “mostly devoid of any regret or concern.”    Opinion, pp. 39, 42.   

The Ruling

Employment of professionals is strictly regulated in bankruptcy.    In order to be employed as a professional, a person must “not hold or represent an interest adverse to the estate” and be a disinterested person.   11 U.S.C. Sec. 327.     In order to evaluate a professional’s eligibility, the Court relies upon the disclosures submitted.   As stated by Judge Jernigan:

If a proposed attorney for the trustee represents a creditor, and a party-in-interest objects (which, by the way, did happen in this case in 2006), the bankruptcy court must look to whether there is an actual conflict of interest.   Conflicts of interest are often a matter of degree. They are fact-intensive analyses.

So how does a bankruptcy court ascertain if there is an actual conflict of interest? Bankruptcy Rule 2014 is designed to help in this regard. Bankruptcy Rule 2014 states that an employment application for a professional person seeking to represent a trustee “shall state,” among other things, “any proposed arrangement for compensation” and “all of the person’s connections with . . creditors” and a verified statement of the person to be employed as to such connections. In other words, there are critical disclosures contemplated so that conflicts of interest can be identified and analyzed.

Opinion, p. 44.   

In a display of understatement, the Court described the firm’s disclosures as “amazingly inadequate.”    The Court recounted the various misrepresentations and failures to disclose discussed in the factual recitation discussed above.  The Court referred to the firm’s actions as “inexcusable and baffling” and that “the circumstances are highly suspect.”    The Court added:

Bankruptcy requires an open kimono when it comes to possible conflicts.    Here, there was no open kimono.   There was no transparency.   

Opinion, pp. 45-46.

The Court noted that “there is more that has happened here than simple nondisclosure.”   The Court noted that the conduct included breaching the duty to maintain confidences and disregarding the instructions of a client.  

However, the Court was not content to simply blame the attorneys.   The Court stated:

But the problematic behavior lies not merely at the feet of Attorney BA and BNM, but also at the feet of Creditor-Cadle. This is not just a case of rogue attorneys. Creditor-Cadle has some accountability in all of this. Creditor-Cadle is a sophisticated party that regularly hires lawyers to monetize assets. Here, as earlier stated, the bankruptcy court believes that the very temple of justice has been defiled. Here, there is not merely a situation of lawyers representing a bankruptcy trustee that were conflicted and compromised by loyalty to another client. Creditor-Cadle itself failed twice to testify candidly about the exact financial arrangements it had with BNM . . . . . Creditor-Cadle is, again, a sophisticated party. BNM and Attorney BA were Creditor-Cadle’s trusted lawyers. It appears that Creditor-Cadle was happy for a while to quietly pay BNM while BNM ostensibly represented the Chapter 7 Trustee. But then, after a year of paying both sides of litigation and an appeal, someone at Creditor-Cadle said “no more.”

            * * *

             

There is enough here to connect the dots. And it is not pretty. BNM and attorney BA had divided loyalties, and Creditor-Cadle was fine with that—it benefitted Creditor-Cadle having “its” lawyers on the other side of it in litigation. The various nondisclosures and conflicts of interest attributable to the Creditor-Cadle and its counsel (at both the bankruptcy court level and throughout much of a multi-month appeal) were so serious, so improper, and so demonstrative of callous indifference to applicable duties and ethical standards, that the entire Adversary Proceeding has been tainted. In the world of bankruptcy, lawyers are not only bound by the Rules of Professional Conduct, but lawyers and parties must abide by the Bankruptcy Code and Bankruptcy Rules. Bankruptcy Code section 327 and Bankruptcy Rule 2014 were totally side-stepped here.

“The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” 11 U.S.C. § 105(a). Here, the court believes the evidence is clear and convincing that Creditor-Cadle and Attorney BA acted in bad faith and recklessly disregarded their duties.   Thus, the “death penalty” (i.e., dismissal with prejudice) in this Adversary Proceeding seems entirely fitting.     

Opinion, pp. 48-50.

 What Does It Mean?

     This is an opinion that should be discussed whenever ethics in bankruptcy is studied. This was not simply a case of crossing the line; the lines were obliterated. This opinion deserves more attention than I am capable of giving it. Therefore, I will limit myself to a few points

1. The court acted appropriately under its inherent authority.

There is a line of cases that holds a court possesses inherent authority to punish bad faith conduct which exists beyond 28 U.S.C. Sec. 1927 and Rule 11.   Chambers v. NASCO, Inc., 501 U.S. 32 (1991); In re First City Bancorporation, 282 F.3d 864 (5^th Cir. 2002).   While sanctions under the court’s inherent power are usually levied against attorneys, there is no reason why they would not apply to a party as well.   

The court’s conclusion that the entire process had become tainted justified termination of the litigation.    Where the court did not otherwise have an adequate remedy, ending the court’s participation was appropriate.    Besides the blatant disregard of rules and ethical standards amply documented by the Court, there is another subtext.   This was a case in which Cadle paid one set of lawyers $92,000 to pursue claims on behalf of the trustee, paid a second set of lawyers to appeal the case to the Fifth Circuit and then offered only $41,500 for the claims themselves.  It seems hard to understand what economic motive The Cadle Company was pursuing.  

Lawyers of any experience will confirm that sometimes litigation is pursued not for legal or economic principles, but for vengeance, the ability to inflict punishment upon another human being.   I can’t say definitively that malice explains this case.    However, it does look that way to this jaded observer.    It is a good thing when courts have the ability to terminate spiteful litigation.   Courts should exist to resolve conflict rather than to magnify it.   In this case, Judge Jernigan aborted a lawsuit which had become hideously deformed.   

2. Disclosures matter.

The disclosures that attorneys file in order to be employed by a bankruptcy estate are signed under penalty of perjury.    Just because they are routine does not mean that they are unimportant.   John Gellene went to jail and lost his license for non-disclosures that were arguably far less egregious than those in this case.   See United States v. Gellene, 182 F.3d 578 (7^th Cir. 1999).   In a recent case that I have not had time to blog about, a firm failed to disclose the source of its retainer and its prior connections with the debtor.   The court found that the firm was still disinterested notwithstanding the omitted information and that the omission was innocent.   Nevertheless, the court made the firm disgorge $135,000 in payments it had received.   Waldron v. Adams & Reese, LLP, 2012 U.S. App. LEXIS 6367 (5^th Cir. 2012).

3. Bankruptcy requires a heightened awareness of conflicts.

Others have made the point better than I, but conflicts in bankruptcy are more complicated than conflicts in ordinary two party litigation.    Under section 327(e), a law firm that represented a creditor may represent the trustee as special counsel.    However, in doing so, they must always remember that their fiduciary duty is to the trustee and not to their original client.    As a practical matter, this may be difficult to manage when, as here, the creditor is a regular client of the firm and may have unrealistic expectations about counsel’s loyalties.   The same situation arises when counsel has represented a creditor and becomes counsel for the creditor’s committee.   In that situation, counsel cannot use the committee to provide his client with inside information or to advance the original client’s agenda.   When an attorney represents a debtor-in-possession, he represents the artificial construct of the Debtor-in-Possession, but must take direction from the flesh and blood human beings who constitute the debtor’s management.    

Update:

Judge Jernigan's opinion was reversed by the Fifth Circuit.   You can read about it here. 

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.

Florida Case Provides Textbook Example of How to Handle a Discharge Violation

A case involving an elderly woman and egregious violations of the discharge has generated a bit of buzz in the blogosphere. I first noticed it here on the Huffington Post. I decided to write about this case because I was frustrated with trying to verify the posts and because I think ithe case offers a good example of how to efficiently deal with a discharge violation. The case is In re Anita Smith, No. 6:08-bk-01035, which can be found here.

What Happened

The Debtor filed a chapter 7 petition on February 15, 2008. One of the debts that she listed was a mortgage debt owing to Countrywide Home Lending. The debtor surrendered the property during the chapter 7. The Debtor received a discharge on June 6, 2008 and Countrywide received notice of the discharge. Bank of America acquired Countrywide and obtained a judgment of foreclosure upon the real property.

At some point, Bank of America began calling the Debtor to try to try to collect upon the debt. Neither the opinion nor the motion say when the calls started, but on June 24, 2010, the Debtor's lawyer sent a polite letter to Bank of America informing them that they were violating the discharge.

The calls continued. In fact, at least fifty calls were made after the first letter.

The Debtor's attorney sent a second letter on November 16, 2011. The second letter informed Bank of America that the Debtor "is 79 years old, in deteriorating health, and has been hospitalized recently."

The calls continued.

The Debtor called Bank of America twice in November and December 2011 to ask them to stop calling.

The calls continued. There were forty-nine calls during a three week period from November 16, 2011 to December 6, 2011.

At this point, Debtor's counsel filed a Motion to Reopen the Case and a Motion for Sanctions.

Bank of America did not appear for the sanctions hearing.

The Court's Ruling

The Court did not have any problem finding a violation of the discharge. It stated:

Bank of America's behavior was intentional, egregious, and extreme. It blatantly and willfully ignored the discharge injunction, despite having received multiple notices of the discharge and requests to discontinue its collection efforts. Bank of America acted in bad faith. Its repeated telephone calls to the Debtor were vexatious and oppressive. Bank of America committed ninety-nine separate willful violations of the Debtor's discharge injunction.

Opinion, p. 5.

The Court awarded actual damages of $10,000.00 for "significant aggravation, emotional distress, and inconvenience." Opinion, p. 5. The Court stated:

Emotional distress constitutes actual damages. (citation omitted). Emotional distress is expected to occur where the conduct is egregious or extreme. (citation omitted). Significant emotional distress is readily apparent where the conduct is egregious and corroborating medical evidence is not required. (citation omitted). Entitlement to emotional distress damages exists "even in the absence of an egregious violation, if the individual in fact suffered significant emotional harm and the circumstances surrounding the violation make it obvious that a reasonable person would suffer significant emotional harm. (citation omitted.).

The Debtor's emotional distress is readily apparent due to Bank of America's intentional, egregious and extreme conduct. She is not required to present corroborating medical evidence. (citation omitted).

Opinion, pp. 8-9.

The Court awarded actual damages of $10,000.00 and attorney's fees of $1,500.00.

What the Debtor and the Debtor's Attorney Did Right

My firm is in the unusual position that we both represent debtors in bankruptcy and defend debt collectors accused of violating the stay or the discharge. In the former capacity, it is not unknown to get hit with a complaint that goes on for pages and pages of boilerplate allegations based on a few isolated contacts with no cease and desist letter from counsel.

In this case, counsel sent not one but two cease and desist letters. In the second letter, counsel specifically informed Bank of America that his client was elderly and, as a result, very sensitive, to continued calls. Counsel also had the Debtor document the continuing violations. The Motion for Sanctions details forty-nine (49) specific violations, identifying them by date and time.

Debtor's counsel also showed considerable restraint in filing a motion for sanctions rather than a complaint. While many plaintiff's lawyers prefer to file an adversary proceeding, there is no reason why contempt cannot be dealt with by motion. In this case, the debtor's attorney was able to proceed from motion to written opinion in a mere six weeks with only five hours of attorney time. Debtor's counsel was able to obtain relief for his client in a prompt, efficient manner. In my opinion, counsel placed his client's well-being ahead of his ability to recover fees, which is commendable.


A Note on Accuracy in the Blogosphere

Blogs sometimes get a bad reputation. When my daughter was doing a research project recently, her professor forbade the use of blogs as authority on the basis that they were "just someone's opinion." At A Texas Bankruptcy Lawyer's Blog, I make it a practice to provide case citations and links to original documents so that the reader can verify the accuracy of my comments. In this case, neither the initial post from The Bankruptcy Law Network nor the followup on The Huffington Post, provided much information from which the facts could be verified. Indeed, it is entirely possible that we are writing about different cases. I found the case that I wrote about above by researching recent opinions from Judge Arthur Briskman involving Bank of America. However, the case that I wrote about involved ninety-nine (99) violations, while the other posts refer to a case with thirty-eight (38) violations. While the failure to provide attribution may have led me to a more egregious case, it could just as well have caused the reader to dismiss it as unsubstantiated rumor.

Fifth Circuit Finds Inherited IRAs Exempt

In a case of first impression for the Fifth Circuit or any other court of appeals, the Fifth Circuit has ruled that inherited IRA accounts may be claimed as exempt under 11 U.S.C. Sec. 522(d)(12). Matter of Chilton, No. 11-40377 (5th Cir. 3/12/12), which can be found here.

In Chilton, one of the debtors inherited an IRA account in the amount of $170,000. The debtors established an IRA account to receive distributions from the inherited account. The trustee objected that the account was not a "retirement account" and was not the type of tax exempt account identified in section 522(d)(12). The bankruptcy court sustained the objection, but was reversed by the district court.

Section 522(d)(12) allows a debtor who elects federal exemptions (an option available only to debtors in about eleven states since most states have opted out of federal exemptions), to exempt "(r)etirement funds to the extent that such funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a)of the Internal Revenue Code of 1986." Thus, there are two requirements: 1. the funds must be retirement funds and 2. they must be held in an account exempt from taxation under one of the designated sections.

The court rejected the argument that funds set aside for the retirement of another could not be "retirement funds:"

The plain meaning of the statutory language refers to money that was “set apart” for retirement. Thus, the defining characteristic of “retirement funds” is the purpose they are “set apart” for, not what happens after they are “set apart.” Here, there is no question that the funds contained in the debtors’ inherited IRA were “set apart” for retirement at the time Heil deposited them into an IRA. This reasoning finds further support from 11 U.S.C. § 522(b)(4)(C), which provides that “a direct transfer of retirement funds from 1 fund or account that is exempt from taxation under section . . . 408 . . . of the Internal Revenue Code of 1986, . . . shall not cease to qualify for exemption under . . . subsection (d)(12) by reason of such direct transfer.” In other words, the direct transfer of “retirement funds” does not alter their status as “retirement funds.” As we see no reason to interpret the statutory language differently from its plain meaning, we hold that the $170,000 contained in the inherited IRA constitute “retirement funds” as that phrase is used in section 522(d)(12).

Opinion, p. 5.

The Court also ruled that the account was held under the proper section of the Internal Revenue Code. The Trustee argued that the account was tax exempt pursuant to 26 U.S.C. Sec. 402(c)(11)(A), while the Debtor contended that section 408(e) was the relevant section. While this discussion of the Internal Revenue Code would seem arcane and of little interest to bankruptcy lawyers, the Court relied on the expansive language of section 408(e), which stated that "(a)ny individual retirement account is exempt from taxation under this subsection . . . " Because the account was an individual retirement account, it fell within the definition of "any" individual retirement account. Thus, common sense construction carried the day even thought the subject matter was the tax code.

On a final note, the Court of Appeals decided this appeal quite expeditiously. The case was argued on February 22, 2012 and decided on March 12, 2012, just nineteen days later. Judge Carl Stewart should be commended for his prompt work.

Circuits Split Over Impact of Stern on Counterclaims

Following last year’s Stern v. Marshall bombshell, cases are slowly trickling up to the Court of Appeals level. After I wrote about a recent Fifth Circuit opinion which held that the jurisdiction of U.S. Magistrate Judges was not invalidated, a commenter pointed out a recent Seventh Circuit decision. In this post, I will look at that case, In re Ortiz, 665 F.3d 906 (7^th Cir. 2011), in which the Seventh Circuit granted a direct appeal and then concluded that it did not have a final decision to review, as well as an even more recent First Circuit case which appears to reach the opposite conclusion.

The Seventh Circuit Undoes a Direct Appeal

Ortiz involved a health care provider that filed proofs of claim in an estimated 3,200 bankruptcy cases in the Eastern District of Wisconsin over a five year period which disclosed the debtors’ confidential medical information. Two sets of debtors filed class action proceedings under a Wisconsin non-disclosure statute.* Bankruptcy Judge Susan Kelley** granted summary judgment for the health care provider, finding that the debtors had not shown actual damages as required by the Wisconsin statute. Both parties requested a direct appeal to the Seventh Circuit, which was approved. However, in light of Stern v. Marshall, the Seventh Circuit concluded that it was not permitted to allow the direct appeal because there was not a “final” order.

Direct appeals to the Court of Appeals are authorized under 28 U.S.C. §158(d) in three instances:

*Final orders;

*Interlocutory orders increasing or decreasing the debtor’s exclusive period to file a plan; and

*With leave of court over interlocutory orders and decrees.

Even though no party had raised the jurisdictional issue, the Court concluded that it had “an independent duty to determine whether we have jurisdiction.”

The Court noted the schizophrenic nature of the Stern decision which, on the one hand, claims to be a narrow decision, but on the other hand, appears to prohibit the bankruptcy courts from going beyond the power to adjudicate claims. The Court wrote:

The first question (whether the bankruptcy court had authority to enter a final order) requires a close reading of Stern v. Marshall. Although the Court noted that the question presented was "narrow," it was quite significant as Congress "may no more lawfully chip away at the authority of the Judicial Branch than it may eliminate it entirely." (citation omitted). The Court held that Article III prohibited Congress from giving bankruptcy courts authority to adjudicate claims that went beyond the claims allowance process. (citation omitted). The decision rebuffed an intrusion into the Judicial Branch that would "compromise the integrity of the system of separated powers and the role of the Judiciary in that system, even with respect to challenges that may seem innocuous at first blush." (citation omitted).

665 F.3d at 911.

Prior to Stern, the bankruptcy court’s authority would have appeared clear for this was a matter “arising in” a title 11 case. Because proofs of claim only exist in title 11 proceedings, claims arising from proofs of claim could only arise in the bankruptcy context. However, the Court found that the Wisconsin non-disclosure claims were similar to the counterclaim filed by Vicki Lynn Marshall in the Stern case:

Just as Pierce's filing of a proof of claim in Vickie's bankruptcy did not give the bankruptcy judge authority to adjudicate her counterclaim, Aurora's act of filing proofs of claim in the debtors' bankruptcies did not give the bankruptcy judge authority to adjudicate the debtors' state-law claims. The debtors' claims seek "to augment the bankruptcy estate--the very type of claim that . . . must be decided by an Article III court." (citation omitted). Non-Article III judges may hear cases when the claim arises "as part of the process of allowance and disallowance of claims," (citation omitted), or when the claim becomes "integral to the restructuring of the debtor-creditor relationship," (citation omitted). Although there is some factual overlap between the debtors' claims and Aurora's proofs of claim, the bankruptcy judge "was required to and did make several factual and legal determinations that were not 'disposed of in passing on objections' to" Aurora's proofs of claim. (citation omitted). In granting Aurora's summary judgment motion, the bankruptcy judge interpreted a Wisconsin state law to require proof of actual damages as an essential element of the debtors' claims and found that there was no genuine issue of material fact as to the lack of actual damages. Nothing about these decisions involved an adjudication of Aurora's proofs of claim and there is no "reason to believe that the process of adjudicating [Aurora's] proof[s] of claim would necessarily resolve" the debtors' claims. (citation omitted). Stern reaffirmed that "Congress may not bypass Article III simply because a proceeding may have some bearing on a bankruptcy case; the question is whether the action at issue stems from the bankruptcy itself or would necessarily be resolved in the claims allowance process." (citation omitted). The debtors' action owes its existence to Wisconsin state law and will not necessarily resolve in the claims allowance process. That the circumstances giving rise to the claims involved procedures in the debtors' bankruptcies is insufficient to bypass Article III's requirements. Stern v. Marshall makes plain that the bankruptcy judge in our cases "exercised the 'judicial Power of the United States' in purporting to resolve and enter final judgment on" the debtors' Wisconsin state-law claims. (citation omitted). We thus hold that the bankruptcy judge lacked authority under Article III to enter final judgments on the disclosure claims.

665 F.3d at 914.

The Court of Appeals concluded that because the bankruptcy court lacked authority to enter a final order, that it lacked authority to grant a direct appeal. If the court had stopped there, its decision would have been clear. However, it added a cryptic comment suggesting that the bankruptcy court lacked any authority in the matter:

For the bankruptcy judge's orders to function as proposed findings of fact or conclusions of law under 28 U.S.C. § 157(c)(1), we would have to hold that the debtors' complaints were "not a core proceeding" but are "otherwise related to a case under title 11." (citation omitted). As we just concluded, the debtors' claims qualify as core proceedings and therefore do not fit under § 157(c)(1). The direct appeal provision in 28 U.S.C. § 158(d)(2)(A) also does not authorize us to review on direct appeal a bankruptcy judge's proposed findings of fact and conclusions of law.

665 F.3d at 915.

Many commentators have concluded that the Stern decision created a third category of claims to the core/non-core taxonomy: core claims in which the bankruptcy court could not enter a final judgment. The prevailing sentiment, indeed one fostered indirectly by the Stern decision itself, is that the bankruptcy courts may enter proposed findings of fact and conclusions of law in all matters in which they lack authority to enter a final judgment. The Ortiz opinion suggests that this may not be the case, but finds it unnecessary to decide the issue.

The First Circuit Shrugs Off Stern in a Footnote

The Ortiz opinion can be contrasted with a brief discussion contained in a First Circuit opinion. In re Divittorio, 2012 U.S. App. LEXIS 248 (1^st Cir. 1/6/12). In re Divittorio is another chapter in the home mortgage wars being fought in the courts. In that case, the debtor consented to an order conditioning the automatic stay and modifying the underlying loan. After the debtor defaulted, the creditor obtained relief from the automatic stay. The debtor then sought to “rescind” the loan. He filed an adversary proceeding for rescission under the Massachusetts Consumer Credit Cost Disclosure Act and sought to vacate the order lifting the automatic stay. The bankruptcy court declined to vacate the prior order, but stayed the foreclosure for 90 days to determine the rescission claim. The bankruptcy court concluded that the creditor had not violated the MCCCDA and the debtor appealed.

In a footnote, the court noted its belief that its jurisdiction was unimpaired.

We do not believe that the Supreme Court's recent decision in Stern v. Marshall, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011), affects the jurisdiction of the bankruptcy court to render a decision in this matter. Stern held:

Article III of the Constitution provides that the judicial power of the United States may be vested only in courts whose judges enjoy the protections set forth in that Article. We conclude today that Congress, in one isolated respect, exceeded that limitation in the Bankruptcy Act of 1984. The Bankruptcy Court below lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof of claim.

(citation omitted). Here, however, it first was necessary to resolve the validity of Mr. DiVittorio's claim under the MCCCDA to determine whether HSBC was entitled to relief from the automatic stay.

2012 U.S. App. LEXIS at *18, n. 4. The Court ultimately decided the appeal in favor of the creditor.

The First Circuit’s discussion is rather unsatisfying because it assumes that determination of the counterclaim was necessary to determine the motion to lift stay. However, how is this distinguishable from the argument that the Wisconsin non-disclosure claims were necessary to determine proofs of claim filed by the health provider? If anything, the automatic stay context is less compelling than determination of a proof of claim, since a motion to lift stay is a summary proceeding. Grella v. Salem Five Cent Savings Bank, 42 F.3d 26 (1^st Cir. 1994).

While the Court’s stated rationale may be unsound, it can probably be vindicated based on consent, since both parties litigated the matter through the bankruptcy court, district court and court of appeals without objection. The Ortiz court rejected consent. However, that case was factually distinguishable because BOTH parties objected to determination by the bankruptcy court. The debtors asked the bankruptcy court to abstain or remand, while the creditor sought to withdraw the reference.

What It Means

The two decisions may or may not signal a split between the circuits. The First Circuit’s decision is so perfunctory that it may be possible for the court to distinguish it away. However, the larger lesson for creditors is that Stern v. Marshall cuts both ways. If a creditor litigates and wins in bankruptcy court, an appellate court may decide that jurisdiction to enter a final judgment was lacking and send the creditor back to relitigate. Thus, the legacy of Stern may be unending litigation.

*--While Federal Rule of Bankruptcy Procedure 9037 imposes privacy restrictions with respect to bankruptcy court filings, including proofs of claim, courts are split over whether it creates a private right of action. Cases allowing a claim for sanctions, include Matthys v. Green Tree Servicing, LLC (In re Matthys), 2010 Bankr. LEXIS S.D. Ind. 2010); French v. American General Financial Services (In re French), 401 B.R. 295 (Bankr. E.D. Tenn. 2009), while cases rejecting such a right include Carter v. Flagler Hospital, Inc., 411 B.R. 730 (Bankr. S.D. Fl. 2009); Lentz v. Bureau of Medical Economics (In re Lentz), 405 B.R. 893 (Bankr. N.D. Ohio 2009); Cordier v. Plains Commerce Bank (In re Cordier), 2009 Bankr. LEXIS 2009).

**--Judge Kelley’s current claim to fame is that she is the judge presiding over the case of the Archdiocese of Milwaukee. As a woman and a practicing Catholic, she is in the unusual position of exercising at least some temporal authority over the male hierarchy of her own church.

Fifth Circuit Rules That Stern v. Marshall Does Not Invalidate Action By Magistrates

In a ruling that could shed some light (but not very much) on the authority of bankruptcy judges, the Fifth Circuit has ruled that a magistrate's ruling in an insurance coverage dispute did not run afoul of the Supreme Court ruling in Stern v. Marshall, ___ U.S. ___, 131 S.Ct. 2594 (2011). Technical Automation Services Corp. v. Liberty Surplus Insurance Corporation, No. 10-20640 (5th Cir. 3/5/12), which you can find here.

The Issue

Technical Automation Services Corp. involved whether an insurance company had a duty to defend an insured in an underlying lawsuit. The parties consented to trial before a U.S. Magistrate. The magistrate granted summary judgment in favor of the insured. On appeal, the Fifth Circuit requested briefing on the application of Stern v. Marshall to a magistrate. See "Fifth Circuit to Consider Impact of Stern v. Marshall on U.S. Magistrates" here.

In response to the question "whether Article III of the Constitution permits a federal magistrate judge, with the consent of the parties, to enter final judgment on a party's state law counterclaim," (opinion, p. 7), the Court answered "yes."

The Decision

By way of prelude, the Court noted that a prior panel of the Fifth Circuit had ruled in favor of the ability of a magistrate to proceed with consent. Puryear v. Ede's Ltd., 731 F.2d 1153, 1154 (5th Cir. 1984). Thus, the court was bound to follow the prior precedent "absent an intervening change in the law, such as by a statutory amendment, or the Supreme Court or by our en banc court." Opinion, p. 9. This framed the question of whether Stern v. Marshall overruled prior decisions about the power of magistrates.

While noting the many similarities between bankruptcy judges and magistrates, the Court chose to base its ruling on the Supreme Court's insistence that Stern was a narrow decision.

Accordingly, the Court reaffirmed that Congress may not withdraw “from judicial cognizance any matter which, from its nature, is the subject of a suit at the common law, or in equity, or admiralty.” (citation omitted). The Supreme Court emphasized that even the slightest “chipping” away of Article III can lead to “illegitimate and unconstitutional practices,” and accordingly held that the jurisdiction of the bankruptcy courts did not extend to most counterclaims based on common law. (citation omitted).

This holding can be translated to the many similarities of the statutory powers of federal magistrate judges. Whereas Article III judges “hold their offices during good behavior, without diminution of salary,” bankruptcy judges and federal magistrate judges are Article I judges who lack tenure and salary protection. (citation omitted). Moreover, the text of 18 U.S.C. § 157(b) (the statute addressed in Stern) and the text of the Magistrates Act, 28 U.S.C. § 636(c), allow Article I judges to enter final judgments, allow for judges’ final judgment to be binding without further action from an Article III judge, entitle the decisions to deference on appeal, and permit the courts to exercise “substantive jurisdiction reaching any area of the corpus juris.” (citation omitted).

Although the similarities between bankruptcy judges and magistrate judges suggest that the Court’s analysis in Stern could be extended to this case, the plain fact is that our precedent in Puryear is there, and the authority upon which it was based has not been overruled. Moreover, we are unwilling to say that Stern does that job sub silentio, especially when the Supreme Court repeatedly emphasized that Stern had very limited application. Id. at 2620. (emphasizing the limited scope of the decision, saying that the issue addressed was a “narrow one” that related only to “certain counterclaims in bankruptcy”) (internal quotation omitted) see also id. (“Article III of the Constitution provides that the judicial power of the United States may be vested only in courts whose judges enjoy the protection set forth in that Article. We conclude today that Congress, in one isolated respect, exceeded that limitation in the Bankruptcy Act of 1984.”) (emphasis added). Article III jurisprudence is complex, requiring the court to do an examination of every delegation of judicial authority. (citation omitted). Notwithstanding that this constitutional question may be seen in a different light post Stern, we will follow our precedent and continue to hold, until such time as the Supreme Court or our court en banc overrules our precedent, that federal magistrate judges have the constitutional authority to enter final judgments on state-law counterclaims. (emphasis added).

Opinion, pp. 11-12.

What It Means

On the most basic level, Technical Automation Services says very little about the authority of bankruptcy judges. It simply holds that Stern does not upset prior Fifth Circuit precedent governing the authority of magistrate judges. However, it provides advocates of bankruptcy court authority with two valuable arguments:

1. The Fifth Circuit is willing to take Chief Justice Roberts at his word when he says that Stern is a narrow decision. While many were concerned that Stern could be another Marathon Pipeline and could signal a return to the old summary/plenary distinction under the Bankruptcy Act, the Fifth Circuit is willing to take it slow. If the other circuits slow play the decision and the Supreme Court strategically declines to grant cert, it could be decades before the issue reaches the Supreme Court again.

2. Since a central feature of magistrate jurisdiction is consent, Technical Automation provides a powerful rebuttal to parties who want to consent to bankruptcy court decision making and then cry "Stern" when they don't like the result.

If nothing else, Technical Automation is significant because it didn't change anything significant.

Post-Script: Although I edited it from the quote above for purposes of brevity, the opinion contains a wonderful quote from Chief Justice Rehnquist's concurrence in Northern Pipeline where he referred to Article III cases as "but landmarks on a judicial 'darkling plain' where ignorant armies have clashed by night." Northern Pipeline Construction Company v. Marathon Pipe Line Company, 458 U.S. 50, 91 (1982)(Rehnquist, J. concurring). I know that I will be looking for ways to include this language in future Stern briefs.

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.