Disclosing an Asset in the Wrong Place Won’t Invoke Judicial Estoppel, Circuit Says

If a pro se chapter 7 debtor lists a lawsuit on his schedule of financial affairs, but fails to list the lawsuit among his assets on Schedule B, the Second Circuit ruled that the court should not apply judicial estoppel to dismiss the lawsuit when the debtor also disclosed the existence of the claim to the chapter 7 trustee and the bankruptcy court.

The Incorrectly Listed Lawsuit

The debtor filed a whistleblower claim in district court in New York against a former employer. Two years later, he filed a chapter 7 petition pro se in New Jersey.

On Schedule B, he did not list the lawsuit among his personal property assets. At the time, the official form did not specifically ask for lawsuits and claims. In 2015, the official form was modified to call for listing “all suits.”

However, the debtor did list the lawsuit on his statement of financial affairs, or SOFA, where he provided the caption, the docket number, and a terse description of the claim. At the subsequent meeting of creditors, the debtor mentioned the suit to the chapter 7 trustee. In addition, the suit was discussed in bankruptcy court, where it was the subject of motion practice several times.

Initially, the trustee decided to prosecute the suit on behalf of the estate. When it became clear there would be no immediate settlement, the trustee made an agreement with the debtor allowing him to continue the suit in the debtor’s name. However, the arrangement required the debtor to pay allowed claims in full. The trustee did not have the bankruptcy court approve the agreement. After the court granted the debtor’s discharge, he paid his creditors in full, to the tune of about $50,000.

The procedural history regarding the interactions between the bankruptcy court and the district court became exceptionally complex. Suffice it to say that the defendant filed a motion to dismiss based on judicial estoppel. The district court in New York granted the motion and dismissed the whistleblower suit. The debtor appealed.

The Reversal in the Circuit

Although the application of judicial estoppel is discretionary and the district judge made seemingly ironclad findings of fact, the debtor nevertheless won a reversal in the Second Circuit reinstating his suit.

In his May 8 opinion, the Second Circuit’s Judge Gerard E. Lynch was obliged to apply Third Circuit law because the law of the circuit in which the bankruptcy occurs determines the applicability of judicial estoppel. We recommend reading Judge Lynch’s opinion in full text for a detailed overview of judicial estoppel in both the Second and Third Circuits.

Applying the law to the facts of the case, Judge Lynch said that the invocation of judicial estoppel must be attributable to “intentional wrongdoing” in the Third Circuit. He quoted the Philadelphia-based appeals court for saying that the required intent for judicial estoppel cannot be inferred from the mere fact of nondisclosure. The sister circuit will not treat inadvertent or careless nondisclosures as equivalent to deliberate manipulation.

Since Third Circuit precedent supplied no “absolute answer” to the issue on appeal, Judge Lynch said that the outcome “depends upon the facts and circumstances of the case.”

Turning to the case at hand, Judge Lynch concluded that the district court misapplied the four-factor test. He said the lower court “clearly erred” in ruling that the debtor’s positions were “clearly inconsistent” and “erroneously interpreted” Third Circuit law by concluding that the failure to list the suit on Schedule B was, by itself, an assertion that the claim did not exist.

On the question of the bankruptcy court’s “adoption” of the nonexistence of the suit, Judge Lynch said the bankruptcy judge, to the contrary, had a “clear understanding” that the suit existed. The district court’s analysis of adoption, he said, was “erroneous” because the district judge could not say that the bankruptcy judge adopted the position that the “litigation did not exist.”

The finding of an unfair advantage was likewise “erroneous,” because gaining an advantage at the expense of creditors was “theoretical and speculative,” Judge Lynch said.

In the most memorable quotation in the opinion, Judge Lynch said that terminating a “potentially meritorious suit [] does not comport with judicial estoppel’s proper role” if the debtor is pursuing a “nonfrivolous claim” and there is only “speculative and hypothetical unfairness” to creditors who elected not to file small proofs of claim.

Finally, Judge Lynch did not find a sufficient impact on judicial integrity. As authority, the district court had improperly followed a reported opinion where there was no disclosure in the schedules or to the court until after the plaintiff filed a motion to dismiss.

Judge Lynch ended his opinion by analyzing authorities from other circuits. Most often, judicial estoppel was imposed when the debtor made no disclosure anywhere in the schedules and never told the trustee. He distinguished Marshall v. Honeywell Technology Systems Inc., 828 F.3d 923, 925 (D.C. Cir. 2016), where a divided panel of the D.C. Circuit invoked judicial estoppel because the debtor had made only oral disclosure. For ABI’s discussion of Marshall, click here.

Summary

Judge Lynch summarized and limited the holding as follows: When “a pro se debtor has listed his pending litigation on the SOFA, rather than the Schedule B . . . then disclosed it to the trustee and the bankruptcy court prior to discharge of his debt, and the trustee and the bankruptcy court were on sufficient notice to take steps to protect the creditors’ interests, the debtor is not estopped from pursuing that litigation by virtue of the doctrine of judicial estoppel.”