In a previous post I stressed the importance of a debtor’s full disclosure of pending personal injury and other causes of action to the bankruptcy court and promised this post on the doctrine of “judicial estoppel.” Judicial estoppel cases are necessarily fact driven and sometimes require interpretation of ambiguous provisions of the Bankruptcy Code. There are l-o-n-g articles available that go into great detail on every potential estoppel nuance. I have decided that such an analysis is beyond the scope this blog – please consider this to be a primer. I am working on “Judicial Estoppel, Part 2” which will deal with the practical application of judicial estoppel in Mississippi state courts and how to work with the bankruptcy trustee.
In recent years, the Fifth Circuit Court of Appeals has issued several opinions on judicial estoppel involving undisclosed claims by bankruptcy debtors and has created a fairly consistent body of law. See In re Coastal Plains, Inc., 179 F.3d 197 (5th Cir. 1999); In re Superior Crewboats, Inc., 374 F.3d 330 (5th Cir. 2004); Kane v. Nat’l Union Fire Ins. Co., 535 F.3d 380 (5th Cir. 2008); Reed v. City of Arlington, 650 F.3d 571(5th Cir. 2011)(en banc); Love v. Tyson Foods, Inc., 677 F.3d 258, 261 (5th Cir. 2012). These cases establish that “judicial estoppel” is a federal common law doctrine courts use to prevent a party from asserting a position in a legal proceeding that is inconsistent with a position taken in a previous proceeding. For example, the official bankruptcy schedules of assets require debtors to disclose all property, tangible and intangible, including causes of action and claims of every sort. If a debtor fails to schedule a personal injury claim, he has represented to the bankruptcy court that no such claim exists. Accordingly, judicial estoppel is invoked where “intentional self-contradiction is being used as a means of obtaining unfair advantage in a forum provided for suitors seeking justice.” Superior Crewboats, 374 F.3d at 334-35 (citations and quotations omitted).
The Fifth Circuit has established a three-part test for determining whether a debtor should be judicially estopped from pursing an undisclosed cause of action:
(1) The debtor is judicially estopped only if his position is clearly inconsistent with the previous one (the allegations in the complaint are clearly inconsistent with the representations in the bankruptcy schedules);
(2) The court must have accepted the previous position (the bankruptcy court discharged the debtor’s debts or took some other action relying on the bankruptcy schedules); and
(3) The non-disclosure must not have been inadvertent. “[T]he debtor’s failure to satisfy its statutory disclosure duty is ‘inadvertent’ only when, in general, the debtor either lacks knowledge of the undisclosed claims or has no motive for their concealment.” Superior Crewboats, 374 F.3d at 335 (quoting Coastal Plains, 179 F.3d at 210).
After Coastal Plains and Superior Crewboats were decided, there was a question whether judicial estoppel should apply to the bankruptcy trustee serving in the case. As a general rule, under Section 541 of the Bankruptcy Code a bankruptcy trustee succeeds to the debtor’s interest in property, but has no greater rights in property than the debtor. However, in Kane, 535 F.3d at 387, the Fifth Circuit ruled that a bankruptcy trustee should be able to pursue a claim on behalf of the creditors that the debtor himself would be judicially estopped from pursuing:
[The debtor’s] nondisclosure in bankruptcy harmed his creditors by hiding assets from them. Using this same nondisclosure to wipe out [the debtor’s claim against the defendant] would complete the job by denying creditors even the right to seek some share of the recovery. Yet the creditors have not contradicted themselves in court. They were not aware of what [the debtor] has been doing behind their backs. Creditors gypped by [the debtor’s] maneuver are hurt a second time by the district judge’s decision. Judicial estoppel is an equitable doctrine, and using it to land another blow on the victims of bankruptcy fraud is not an equitable application.
Id. at 387-388 (quoting Biesek v. Soo Line R.R. Co., 440 F.3d 410, 413 (7th Cir.2006)). Similarly, Reed held that where a debtor is individually estopped from pursuing an undisclosed claim, the trustee can pursue the claim for the benefit of creditors and any remaining funds after distribution would be refunded to the defendants and not to the debtor. Reed, 650 F.3d at 573.
A debtor’s failure to disclose pre-petition causes of action and pending litigation could be devastating to the lawyer who has spent time and incurred expenses pursuing the debtor’s personal injury case. If the Trustee can pursue the claim, but the debtor cannot receive any benefit, how do the parties deal with the possibility that the trustee may collect more funds than are necessary to pay the debtor’s creditors in full? Ordinarily, the debtor would receive the surplus. The Fifth Circuit addressed this contingency in its most recent case on judicial estoppel, In re Flugence, 738 F.3d 126 (5th Cir. 2013).
In Flugence, the debtor failed to disclose a personal injury claim in her Chapter 13 case. She completed her plan payments and the case was closed. The personal injury defendants learned of the bankruptcy and petitioned the bankruptcy court to reopen the case. The debtor amended Schedule B to add the personal injury suit as an asset and the Chapter 13 trustee hired the debtor’s personal injury lawyer to pursue the claim on behalf of the trustee and the bankruptcy estate. The defendants filed an adversary proceeding seeking a declaratory judgment that the debtor was “judicially estopped” from pursing the personal injury claim due to her failure to disclose her personal injury claim in her bankruptcy proceedings. The bankruptcy court found that all of the elements of judicial estoppel were met and that the debtor was precluded from recovering any damages in the state court litigation. However, the court ruled that estoppel did not apply to the Chapter 13 trustee. The defendants then argued that since the debtor was estopped, the trustee was limited to recovering an amount sufficient to pay off creditors. The bankruptcy court rejected the argument and ruled that the trustee could pursue the personal injury case without regard to the claims filed in the bankruptcy case. This meant that the personal injury attorney could recover his full contingency fee under the original contract without limitation or reference to the claims filed in the case.
Neither side was satisfied and both sides appealed. The District Court overturned the bankruptcy court on the issue of judicial estoppel of the debtor and affirmed in all other respects.
The Fifth Circuit disagreed with the district court and reinstated the judgment of the bankruptcy court. The Court ruled that, “[w]here a debtor is judicially estopped from pursuing a claim he failed to disclose to the bankruptcy court, the trustee, consistent with Reed, may pursue the claim without any limitation not otherwise imposed by law.” Id. at 132. The Court believed that to limit the recovery to creditors’ claims could negatively affect creditors because an attorney may not be willing to pursue the personal injury case if there were a limitation on the potential recovery.
If one clear message arises from the Fifth Circuit cases on judicial estoppel, it is that no one, especially the creditors in a case, should be negatively affected by a debtor’s failure to disclose a cause of action (no one other than the debtor).
One last point. This post focused on the omission of personal injury or other causes of action and the effect on creditors and the trustee. However, judicial estoppel could be applied in other contexts – consider bankruptcy schedules versus domestic relation disclosures in chancery court and similar proceedings.