Judicial Estoppel and Res Judicata Are Insufficient to Prevent Post-Chapter 11 Cure and Reinstatement of Partnership Interest

On June 2, 2017, the Fifth Circuit Court of Appeals issued its decision in Asarco LLC v. Montana Resources Inc., affirming an order on appeal from the U.S. District Court for the Southern District of Texas. It held that neither an adversary proceeding litigated by the parties in Asarco’s chapter 11 case, nor its failure to disclose its partnership-interest claim to the bankruptcy court, prevented Asarco’s post-bankruptcy claim to cure and reinstate its partnership interest with Montana Resources.[1]  The ruling presents an interesting and important application of the judicial estoppel and res judicata doctrines in the bankruptcy context.

Asarco and Montana Resources were partners in a copper mine.[2]  When Asarco failed to pay five consecutive cash calls that were required by the partnership agreement (totaling more than $5 million), Montana Resources covered the same.[3]  In so doing, Montana Resources diluted Asarco’s interest in the partnership from 49.9 percent to 0 percent.[4]  Shortly thereafter, Asarco and its affiliates filed for chapter 11.[5]

Montana Resources filed proofs of claim in the bankruptcy case seeking to recover proportional liabilities incurred by the partnership prior to the bankruptcy filing. Asarco then filed an adversary proceeding against Montana Resources asserting fraudulent transfer, breach of contract and improper expulsion related to the dilution of Asarco’s partnership interest.[6]  Asarco’s adversary complaint also alleged that under the partnership agreement, it had a right to cure and reinstate its interest in the partnership with Montana Resources,[7] and it sought declaratory relief on this claim.[8] As the adversary proceeding unfolded, Asarco dropped its declaratory relief claim without prejudice, and the remaining claims were dismissed with prejudice by an agreement of the parties.[9]  The bankruptcy case concluded with a plan offering full payment to all creditors.[10]

Two years after confirmation, Asarco sought to reinstate its partnership interest with Montana Resources, tendering the full cure amount and notifying Montana Resources that action would follow if it did not accept the cure and reinstate Asarco’s partnership interest.[11]  Montana Resources rebuffed the tender, and Asarco filed suit.[12]  Asarco’s complaint alleged, among other things, that Montana Resources breached the partnership agreement by refusing to accept the cure tender.[13]  Montana Resources quickly filed a motion to dismiss based on Asarco’s lack of standing to prosecute a claim post-bankruptcy, judicial estoppel and res judicata.[14]  The district court ruled that “all undisclosed claims that existed during the bankruptcy or ... were not specifically post-bankruptcy were barred on standing, estoppel or res judicata grounds.”[15]  However, the district court also found that none of these doctrines barred Asarco’s breach-of-contract claim that “arose from the post-bankruptcy tender and demand for reinstatement.”[16]  Specifically, the district court held that Montana Resources’ judicial estoppel and standing arguments failed because the breach-of-contract claim did not exist during bankruptcy since the cure tender and a demand for reinstatement had not yet occurred.[17]  The court further ruled that the breach-of-contract claim was a “new claim” that was not related to the other claims in the bankruptcy case, and that Asarco’s dropped request for declaratory relief during the adversary proceeding did not have a preclusive effect.[18]  After the district court certified its rulings on judicial estoppel and res judicata, Montana Resources successfully petitioned for an interlocutory appeal to the Fifth Circuit, challenging the district court’s refusal to dismiss the case.[19]

The Fifth Circuit Court of Appeals first addressed Montana Resources’ claim-preclusion argument asserting that because Asarco could have — but failed to — bring its breach-of-contract claim alleging failure to accept cure and reinstate during the adversary proceeding, it is now barred under the res judicata doctrine.[20]  Reviewing the issue de novo, the court began its analysis by noting that in the adversary proceeding, Asarco did seek declaratory judgment on the issue of whether the partnership agreement afforded Asarco the right to cure the defaulted payments and reinstate its diluted partnership interest.[21]  However, the court held that res judicata did not apply because Asarco voluntarily dismissed this claim before obtaining a ruling.[22]  The court analyzed the case law on res judicata relevant to claims for declaratory relief as opposed to claims seeking coercive relief,[23]  and held that the declaratory judgment claim asserted and then dismissed in the adversary proceeding did not have preclusive effect on Asarco’s breach-of-contract claim because the claim did not arise from the same set of facts and circumstances, as it depended on events that took place after the bankruptcy case — namely, the tender for cure and reinstatement, and Montana Resource’s rejection of the same.[24]

Regarding its judicial estoppel claim, Montana Resources argued that Asarco failed to explicitly disclose a partnership interest or a right to reinstatement in its bankruptcy case.[25]  Conceding the same, the court emphasized that the “purpose of the disclosure requirement is to protect creditors as it maximizes the estate to ensure that creditors are paid as fully as possible.”[26]  On this approach, the court noted that all creditors of the bankruptcy were paid in full.[27]  Moreover, and as the Fifth Circuit has not adopted any firm rules regarding the amount of disclosure required for the application of judicial estoppel, the court observed that the trustee was undoubtedly aware of the partnership contract because it filed the adversary proceeding with claims derived from the partnership agreement.[28]  The Fifth Circuit went on to rule that, although scant, this disclosure of interest was sufficient and the lower court’s ruling on the same was within its discretion.[29]

The court’s decision in Asarco LLC v. Montana Resources Inc. affirmed the district court’s ruling that the doctrines of res judicata and collateral estoppel would not present an obstacle to Asarco’s suit for post-bankruptcy cure and reinstatement. As such, the Fifth Circuit’s decision joins its prior decisions interpreting the res judicata and collateral estoppel doctrines, and defining their impacts on bankruptcy cases.[30]