Fifth Circuit Muddles Judicial Estoppel; En Banc Review Needed

In a new opinion, the Fifth Circuit has taken a big step backward in sorting out the doctrine of judicial estoppel. Reed v. City of Arlington, No. 08-11098 (5th Cir. 9/16/10). While adopting the principle that one panel of the Fifth Circuit cannot overrule another one, the opinion appears to be inconsistent with the Fifth Circuit's most recent prior ruling on judicial estoppel, thus indicating the need for en banc review. The opinion can be found here.


Two Wrongs and Two Rights Make a Mess

The first wrong in this case originated with the City of Arlington. It violated the Family Medical Leave Act with regard to Kim Lubke, a former firefighter. Lubke obtained a one million dollar judgment against the City.

A year later, while the judgment was on appeal, Lubke filed chapter 7. He forgot that he had a valuable judgment and apparently omitted a number of other assets as well. The Trustee closed the case as a no-asset filing.

The Fifth Circuit remanded the case for recalculation of damages. Subsequent to the remand, the City offered to enter into a Rule 68 judgment for $580,000. In discussing this offer with his client, the Debtor's non-bankruptcy attorney, Roger Hurlbut first learned about the bankruptcy. He promptly informed the Trustee's counsel. The Debtor and the Trustee successfully reopened the bankruptcy case and the Trustee sought to be substituted as plaintiff. The Debtor also agreed to have his discharge vacated.

Let's recap who behaved well and who behaved badly at this point:

The City of Arlington behaved badly when it violated the FMLA.

The Debtor behaved badly when he lied on his schedules.

The Debtor's nonbankruptcy lawyer performed blamelessly, representing the Debtor competently in the FMLA action and promptly notifying the Bankruptcy Trustee once he learned upon the bankruptcy.

The Bankruptcy Trustee did what she was supposed to do by moving promptly to reopen the bankruptcy case and pursue the litigation.

So at this point, we have two wrongs and two rights. For their part, the creditors did nothing wrong.

The District Court Tries to Follow the Fifth Circuit

The District Court considered the issue of judicial estoppel. After considering the Fifth Circuit's conflicting precedents on judicial estoppel, it found that the Debtor was subject to judicial estoppel. However, it found that the Trustee and the creditors should not be punished for the Debtor's wrongdoing. It allowed the Trustee to proceed with the case, but provided that once creditors were paid, any excess funds would go back to the City of Arlington rather than to the Debtor. Had the District Court been affirmed, the bad would have been punished and the blameless would not.

However, the Fifth Circuit chose not to affirm the District Court.

The Law of Judicial Estoppel

The Supreme Court has fashioned a three pronged test for whether judicial estoppel should apply:

(1) whether a party's later position is clearly inconsistent with its position in a prior case; (2) whether the party succeeded in persuading the first court to accept its position, creating "the perception that either the first or the second court was misled;"and (3) whether the party espousing the inconsistency has gained an unfair advantage or imposed an unfair detriment on an opposing party by that means.

City of Arlington v. Reed, slip op., p. 5, discussing New Hampshire v. Maine, 532 U.S. 742 (2001).

Prior to Reed, the Fifth Circuit had completed a trilogy of cases on judicial estoppel in bankruptcy.

The first of the recent Fifth Circuit cases was In re Coastal Plains, Inc., 179 F.3d 197 (5th Cir. 1999). In that case, the Debtor's CEO formed a company which acquired the assets of the debtor corporation. The insider purchaser then filed suit on a claim which had not been disclosed in the schedules. The purchaser recovered $3.6 million on the undisclosed claim. The Fifth Circuit reversed on appeal, finding that accepting the argument that the claims were inadvertently left off the schedules "would encourage bankruptcy debtors to conceal claims, write off debts, and then sue on undisclosed claims and possibly recover windfalls." In re Coastal Plains at 213.

Next came In re Superior Crewboats, 374 F. 330 (5th Cir. 2004). In that case, it was the debtor who was estopped. In that case, one of the debtors was injured prior to bankruptcy. During their chapter 13 case, they filed suit on a claim which was not listed in their schedules. After their case was converted to chapter 7, the debtors told the trustee about their claim, but represented that it was barred by limitations. As a result, the trustee abandoned the claim which the debtors continued to pursue. When the trustee learned about the case, he attempted to substitute in. However, the court granted summary judgment for the defendant.

The third component of the trilogy was Kane v. Nat'l Union Fire Ins. Co., 535 F.3d 380, 384 (5th Cir. 2008). That case looked a bit like Superior Crewboats, but with one major distinction. In Kane, the Debtor failed to disclose a claim. However, the Trustee did not abandon the claim. Instead, once the Trustee learned of the deception, the Trustee sought to pursue the claim on behalf of the creditors. The District Court granted summary judgment, relying on Superior Crewboats. However, the Fifth Circuit said not so fast. In its opinion, it stated:

There, because the trustee had abandoned the claim, he was not the real party in interest and was not entitled to be substituted as such. Rather, following the trustee's abandonment, the interest in the claim had reverted to the debtors,who stood to collect a windfall from the asset at the expense of the creditors. In the case before us, the Kanes' personal injury claim became an asset of their bankruptcy estate when they filed their Chapter 7 petition. The Trustee became the real party in interest in the Kanes' lawsuit at that point and never abandoned his interest therein.

The Fifth Circuit noted that the Kane case did not present any equitable concerns. Indeed, the creditors would be harmed if judicial estoppel was applied to preclude the trustee from pursuing the claims. The court quoted from a great Seventh Circuit opinion which made the obvious point:

[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] was 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.

Kane, quoting Biesek v. Soo Line R.R. Co., 440 F.3d 410, 413 (7th Cir. 2006).

The Fifth Circuit's Ruling in Reed

Given that Reed and Kane involved nearly identical circumstances, the Trustee could have reasonably expected a similar result. However, that was not to be.

The Court acknowledged that its precedents might be a bit hard to follow. However, it insisted that it was necessary to disregard Kane and follow Coastal Plains and Superior Crewboats. Writing for the panel, Chief Judge Edith Jones stated:

What are the bankruptcy courts, which confront these problems regularly in our circuit, to make of these decisions? The grounds on which Kane distinguished In re Coastal Plains are that, in In re Coastal Plains, a corporate officer's misdeeds detrimentally influenced the corporate reorganization process as well as depriving creditors of the concealed cause of action. Id. Kane purports to distinguish In re Superior Crewboats, moreover, based on the differing procedural consequences between a trustee's abandonment of a claim (to the debtor) and the non-disclosure of assets that are not administered although still within the debtor's estate. Id. at 386-87. Whether these distinctions are correct in principle or on the facts are matters for another debate. Absent en banc harmonization, we must endeavor to reconcile the authorities. We are also guided by the principle that one panel of this court cannot overrule another panel decision. (citation omitted). Thus, judicial estoppel remains applicable to litigation claims that are undisclosed in bankruptcy, and the doctrine's essential ingredients remain the same.

Reed at 7 (emphasis added). When one judge within the circuit contends that an opinion by another panel "purports" to distinguish a prior precedent, these are very strong words. Why does Judge Jones believe that the per curiam opinion from Judges King, Wiener and Elrod merely "purports" to distinguish the prior precedent?

Judge Jones makes it seem as though it were a mere procedural distinction, the difference between abandonment and non-abandonment. However, it rests on something much more substantive. In order for judicial estoppel to apply, the case must involve the same parties. The trustee is not the same party as the debtor. Therefore, judicial estoppel should NEVER apply to the trustee based on the Debtor's actions.

Read the rest of the article at A Texas Bankruptcy Lawyer's Blog