No. 57 Perspectives on Developments in the Law from The Sharp Law Firm, P.C. February 2012
State Courts Now Recognize Doctrine
Judicial Estoppel Proves Potent
Weapon Against Bankruptcy Fraud
By John T. Hundley, Jhundley@lotsharp.com, 618-242-0246
The judicial estoppel doctrine, which has emerged as one of the most potent weapons against bankruptcy fraud in federal courts, finds equally fertile ground in Illinois’ state courts, a recent Appellate Court decision shows.
Under the doctrine, federal courts increasingly have been holding that when a bankrupt fails to disclose in his bankruptcy case that he has a claim which might lead to a financial recovery, he becomes estopped to assert that claim in a separate legal action.
Now Berge v. Mader, 2011 IL App (1st) 103778, has made clear that the doctrine may be used in state courts as well. However, a recent decision of U.S. Court of Appeals for the 5th Circuit suggests the doctrine may not be effective when the claim is discovered and brought by the bankruptcy trustee. Reed v. City of Arlington, 650 F.3d 571 (5th Cir. 2011).
In Berge, the bankrupt originally filed for reorganization of her debts under Bankruptcy Code Chapter 13 (11 U.S.C. §§ 1301 et seq.). Chapter 13 includes as property of the estate not only “all legal or equitable interests . . . as of the commencement of the case” (11 U.S.C. § 541), but also all such interests “that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under Chapter 7. . .” (§ 1306).
While Ms. Berge’s case was pending under Chapter 13, she was involved in an auto accident. She filed a tort case as a result of the accident, but never amended her bankruptcy papers to reflect it. Her bankruptcy case was converted to Chapter 7 (liquidation) and she was given a “no assets” discharge, which defendants then used as the basis for seeking summary judgment in the tort case under the judicial estoppel doctrine. The circuit court accepted defendants’ argument and dismissed her case.
On appeal, Ms. Berge first argued that the exclusive jurisdiction of the federal courts over bankruptcy matters meant that the state court lacked jurisdiction to determine whether she had in the bankruptcy court the “bad faith” which she claimed was necessary for judicial estoppel to apply. The First District found that bad faith was not a requirement for the doctrine, and that if it was, her concealment of the claim which could bring her financial gains, coupled with her statutory disclosure duties, were sufficient to constitute bad faith. With respect to the exclusivity argument, the panel held that state courts have jurisdiction over whether judicial estoppel applies to claims filed with them. See also Dailey v. Smith, 292 Ill.App.3d 22 (1997).
Moving to the merits, the panel noted that judicial estoppel in other contexts has five separate elements which it found equally applicable in the instant context: “(1) the two positions must be taken by the same party; (2) the positions must be taken in judicial proceedings; (3) the positions must be given under oath; (4) the party must have successfully maintained the first position, and received some benefit thereby; and (5) the two positions must be ‘totally inconsistent.’” See also Ceres Terminals, Inc. v. Chicago City Bank & Trust Co., 259 Ill.App.3d 836 (1994).
The panel found each of the elements present, and, noting the “paucity of state cases directly addressing the issue,” relied heavily on federal cases to hold the doctrine applicable in the present context. The court rejected as inconsequential (a) a claim that Ms. Berge had told her attorney about the suit and it was his fault it was not disclosed and (b) her attempt to have the bankruptcy reopened so that the claim could be belatedly disclosed.
When such a claim is disclosed in the bankruptcy case, the trustee generally has the right to pursue it for the benefit of creditors. In Reed, the claim was belatedly disclosed, the trustee attempted to take it over, and defendant contended that the estoppel which would apply against the bankrupt should apply against the trustee, under the theory that the trustee stood in the bankrupt’s shoes. Finding that such use of the estoppel doctrine would be inequitable, the 5th Circuit rejected the defendant’s argument. In so doing, it relied in part on suggestions in 7th Circuit precedent – Biesek v. Soo Line R.R, 440 F.3d 410 (7th Cir. 2006), and Cannon-Stokes v. Potter, 453 F.3d 446 (7th Cir. 2006).
A couple of observations may be offered in light of these developments.
First, Berge largely reiterates prior precedent on the judicial estoppel issue itself, but it does break ground in two areas: (1) in flatly rejecting the contention that state courts can’t decide the issue, and (2) in establishing an apparent per se rule that failure to disclose constitutes bad faith.
Second, the court’s refusal to let the Berge plaintiff off the hook by reopening her case is sound bankruptcy policy. Bankruptcy courts, trustees and creditors have a right to a full disclosure at the outset of the case; the common practice of reopening cases makes for wasteful use of resources that are often spread too thin in the first place.
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