Judicial Estoppel In Bankruptcy And The Quandary Of The Undisclosed Cause Of Action

Collisions occur at the intersection of bankruptcy law and equity. Recently several courts have tried their hands at traffic control where bankruptcy law intersects with the equitable principle known as “judicial estoppel.” The results have been mixed and evidence the tension between the goals of protecting the integrity of the courts and returning value to creditors.
Judicial estoppel has been described as follows:

“[W]here a party assumes a certain position in a legal proceeding, and succeeds in maintaining that position, he may not thereafter, simply because his interests have changed, assume a contrary position, especially if it be to the prejudice of the party who has acquiesced in the position formerly taken by him.” New Hampshire v. Maine, 532 U.S.742 (2001), quoting from Davis v. Wakelee, 156 U.S. 680, 689 (1895).

The collision occurs most often when a debtor (currently or formerly) in a bankruptcy case pursues a cause of action which he did not disclose as an asset in the bankruptcy case. The defendant typically will challenge the debtor’s ability to pursue the action on two grounds: first, that the debtor lacks standing (because a trustee should control the asset); second, that the debtor and his trustee are barred by judicial estoppel from pursuing the case.

The Bankruptcy Code (11 U.S.C. §§ 101, et seq.) imposes several duties upon a debtor. Among these duties is the requirement that the debtor file “a schedule of assets and liabilities.” 11 U.S.C. §521(a)(1) Official Form 6B, the required schedule for personal property, includes a line item (item 21) for “[o]ther contingent and unliquidated claims of every nature, including tax refunds, counterclaims of the debtor, and rights to set off claims” together with a requirement that the debtor “[g]ive the estimated value of each.” The debtor is under an affirmative duty to fully disclose all claims. Howe v. Richardson, 193 F.3d 60, 61 (1st Cir. 1991).

Irrespective of whether the debtor has fully disclosed his assets, section 541(a) of the Bankruptcy Code says that the filing of the case creates an estate composed of all of the debtor’s property “wherever located and by whomever held….” In other words, the bankruptcy estate is not restricted to those assets which the debtor has scheduled but extends to all property, disclosed or undisclosed. The tension between judicial estoppel and bankruptcy arises when a debtor fails to disclose a “claim” on the schedules, but the claim is nonetheless property of the estate and should be available to pay creditors.

Courts generally cite three elements in barring the pursuit of a claim on the basis of judicial estoppel. First, the party against whom estoppel is asserted must have argued a contrary position in a prior case. Second, the court before whom the contrary position was argued must have accepted the position. Third, the assertion of the contrary position either conferred an “unfair advantage” on the party asserting the contrary position, or imposed an “unfair detriment” on the opposition. “ABI Consumer Bankruptcy Committee News”, Volume 9, Number 3 (August 2011). These are the three elements traditionally cited, although the Supreme Court has cautioned that the circumstances under which the judicial estoppel may be applied “are probably not reducible to any general formulation.” New Hampshire v. Maine, supra at ___, quoting Allen v. Zurich Ins. Co., 667 F.2d 1162, 1166 (4th Cir. 1982).

In the context of a bankruptcy case, the first traditional element (“argument of a contrary position”) is satisfied when a debtor pursues a cause of action which he has failed to disclose on his bankruptcy schedules. The second element (“court adoption of the initial position”) is typically satisfied when the debtor receives his discharge in bankruptcy, and the assumed fact that a Bankruptcy Court would not grant a discharge to a debtor if it were known that the debtor had filed inaccurate asset schedules. Guay v. Burack, 677 F3d 10, 18 (1st Cir. 2012) The third element (“unfair advantage or detriment”) is satisfied by the fact that the debtor is presumed to seek to keep the recovery on the claim for his own benefit and to not share it with his creditors. Moses v. Howard University Hospital, 606 F.3d 789, 799 (D.C. Cir. 2010).

Among recent appellate decisions discussing judicial estoppel in the bankruptcy context are: Guay v. Burack, 677 F3d 10 (1st Cir. 2012); Reed v. City of Arlington, 620 F.3d 477 (5th Cir. 2010); Love v. Tyson Foods, Inc., 677 F3d 258 (5th Cir. 2012); and Flugence v. Axis Surplus Insurance Company, et al., 738 F.3d 126 (5th Cir. 2013).

The facts of the Guay case are quite intriguing. Kevin and Lorraine Guay filed a chapter 11 bankruptcy case. Several months after the chapter 11 filing, the debtors and their property were subjected to an improper warrantless search by state authorities during an investigation into environmental law violations. Subsequently, the debtors sued the State for damages arising from the warrantless search. About a month after the suit was filed, the debtors’ chapter 11 bankruptcy case was converted to a case under chapter 7.

The existence of the suit was no secret. The State knew about the bankruptcy case. The chapter 7 trustee knew about the suit because the State raised it at the creditors’ meeting. However, the Guays did not schedule the lawsuit as an asset, even after the court instructed them to amend their schedules. To the contrary, they actually filed an affidavit with the court affirming that their schedules were complete.

Ultimately, the bankruptcy court granted the Guays a discharge. After the entry of the discharge, the State requested that the damages suit be dismissed on two grounds: a) that the debtors lacked standing because the cause of action belonged to the bankruptcy estate and was controlled by the trustee; and, b) that the Guays were judicially estopped from recovery because they had never reflected the claim as an asset in the bankruptcy case. The chapter 7 trustee subsequently abandoned the suit indicating that he had determined that the suit was either burdensome to the estate or of inconsequential value. Nevertheless, the State succeeded in having the case dismissed on the basis of judicial estoppel. The State prevailed and the First Circuit affirmed, finding that: a) the Guays had adopted a contrary position when they failed to schedule the lawsuit in their bankruptcy case; and b) the bankruptcy court accepted the contrary position in when it granted the bankruptcy discharge.

The First Circuit did not require proof that the Guays had gained an unfair advantage over the State. In fact, the State had stipulated that the Guays had not gained an unfair advantage. Rather the First Circuit focused on the need to protect the “integrity of the bankruptcy process…..even where it creates windfall for an undeserving defendant.” 677 F.3d at 19. The First Circuit’s decision emphasizes the need to preserve the integrity of the bankruptcy process. The opinion says little about the effect of the chapter 7 trustee’s abandonment of the claim, and that the abandonment essentially meant that the claim was of no value to the debtors’ creditors. The panel dismissed the debtors’ argument that the “oral” disclosure of the suit at the creditors’ meeting militated against the application of judicial estoppel. It was the State and not the debtors that had initiated the discussion of the suit, noted the panel. Further, “oral” disclosure did not excuse the debtors’ failure to be complete when preparing their bankruptcy schedules.

No one doubts that a debtor should be barred from pursing for his own benefit (and not for the benefit of his creditors) a cause of action which the debtor knowingly has failed to disclose on his bankruptcy schedules. The problem cases are those in which creditors stand to benefit from a recovery. Should innocent creditors bear the consequences of the debtor’s bad acts?

In Reed v. City of Arlington the Fifth Circuit, in an en banc opinion, appeared to have answered that question:

The question before the en banc court is whether judicial estoppel bars a blameless trustee from pursuing a judgment that the debtor – having concealed the judgment during bankruptcy-is himself estopped from pursuing. We hold that it does not. This result upholds the purpose of judicial estoppel, which in this context is to protect the integrity of the bankruptcy process, by adhering to the tenets of bankruptcy laws and by preserving the assets of the bankruptcy estate for equitable distribution to the estate’s innocent creditors.

650 F3d 571, 572. The debtor, a firefighter, won a substantial judgment against the City of Arlington pursuant to the Federal Medical Leave Act. The City appealed the decision to the Fifth Circuit. During the appeal, the firefighter and his wife filed a chapter 7 bankruptcy case. They did not disclose the judgment on their bankruptcy schedules. The debtors received their discharge and the case was closed.

The Fifth Circuit affirmed the judgment but remanded for a recalculation of damages. While the case was on remand, the City became aware of the bankruptcy case and notified the bankruptcy trustee. The trustee moved to reopen the bankruptcy case and to substitute herself as the real party in interest. The City moved to dismiss the case on the grounds that both the debtor and the trustee were judicially estopped from pursuing the claim. The district court fashioned a remedy whereby the debtor was judicially estopped, but the bankruptcy trustee was not and could pursue the claim for the benefit of creditors.

The City appealed to the Fifth Circuit. The panel first hearing the appeal reversed the district court and held that both the debtor and the trustee were estopped. Re-hearing the matter en banc, the Fifth Circuit changed course and affirmed the lower court.

We now affirm the judgment of the district court and state a general rule that, absent unusual circumstances, an innocent trustee can pursue for the benefit of creditors a judgment or cause of action that the debtor fails to disclose in bankruptcy.

650 F.3d at 573.

The law in the Fifth Circuit appeared stable until the Circuit’s recent ruling in Love v. Tyson Foods, Inc. The operative facts of the case follow the standard pattern to a great extent. Love was a debtor in a bankruptcy case when he filed a discrimination/retaliation case. He did not disclose the claim in his bankruptcy case. Tyson Foods found out about the bankruptcy case and moved to dismiss the claims against it on the grounds that the debtor was judicially estopped. The district court dismissed the case. The Fifth Circuit panel affirmed.

The feature which distinguishes Love from Reed is that Love was a debtor in a case under chapter 13 of the Bankruptcy Code rather than a debtor in a case under chapter 7. Although there is a “chapter 13 trustee,” the trustee does not typically take control of the debtor’s assets or the debtor’s business. The central function of the chapter 13 trustee is to collect a portion of the debtor’s future earnings and distribute it to creditors in accordance with the terms of the debtor’s plan. The chapter 13 debtor remains in control of the bankruptcy estate.

Love not only failed to disclose his discrimination/retaliation claim on his schedules, but also did not account for it in his chapter 13 plan. Love was not the “blameless trustee” of the sort protected by the Fifth Circuit’s decision in Reed v. City of Arlington. The panel affirmed the lower court’s determination that he was judicially estopped from pursuing his claim.

Circuit Judge Haynes issued a spirited dissent. He argues, quite persuasively, that regardless of Love’s personal failings, he still has the role of a trustee (in the same sense as the trustee in the Reed case), and that the rationale of Reed should prevail here. Haynes argued that a remedy should be fashioned by which creditors, but not Love, benefit. To do otherwise, argues Haynes, is to do “inequity in the name of equity.” 677 F.3d at275, quoting 27A Am.Jur.2d Equity § 84 (2012).

And, someone was listening. In Flugence, the panel reaffirmed the basic tenant of Love that while a chapter 13 debtor may be judicially estopped from enjoying the benefits of a knowingly undisclosed claim, the chapter 13 trustee may pursue the claim for the benefit of creditors. Flugence, 738 F.3d at 131-132. In other words, the panel in Flugence extended the sentiment of the ruling of Reed to chapter 13 cases.

In those cases in which there is an innocent trustee available to pursue a claim, the prospective defendants will not escape liability merely because the debtor has knowingly failed to disclose it. On the other hand, the debtor should not be allowed to receive any portion of a recovery. An example of the lengths to which a bankruptcy court may go to allow creditors to benefit while protecting the integrity of the judicial system can be seen in the Memorandum Opinion of Bankruptcy Judge Jeff Bohm in In re Vincent C. Jackson, 2012 WL 3071218 (Bankr., S.D. Tex, July 27, 2012), aff’d., ___ Fed. App.___, 2014 WL 2800812 (5th Cir., June 20, 2014).

Of course, this is not an exhaustive discussion of the law applicable to these issues. For more information on this topic, please email Pat Autry, trial lawyer with BRANSCOMB |PC. His contact information is pautry@branscomblaw.com or (210) 598-5400.