Bankruptcy Omission Led to Estoppel

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Bankruptcy Omission Led to Estoppel

Chicago Daily Law Bulletin
July 21, 2008

by MARK D. DEBOFSKY

A recent district court ruling in Texas offers a cautionary tale to practitioners. Acuna v. Connecticut General Life Ins.Co., 2008 U.S.Dist.LEXIS 51136 (E.D.Texas May 28, 2008), involved an anesthesiologist who suffered from a severe ocular disorder that forced her to stop working and pursue a claim for disability benefits in 2003.

The insurer denied the claim, though, and the plaintiff followed up with a demand for a $200,000 claim settlement in 2004, threatening suit if the claim was not settled within 60 days. Shortly after making the demand, Dr. Edna G. Acuna filed a voluntary petition for bankruptcy with her husband, but she failed to list her disability claim on the bankruptcy schedules, either under Schedule B, which calls for a listing of contingent and unliquidated claims, or under Schedule C, which lists property claimed to be exempt.

Before being granted a discharge in bankruptcy, Acuna filed suit against her insurer. Later, after a discharge was granted, the insurer raised the issue of the bankruptcy in the insurance litigation, claiming that principles of judicial estoppel barred Acuna from pursuing her disability claim. The court explained that ''[j]udicial estoppel is a common law doctrine that prevents a party from assuming inconsistent positions in litigation.'' Superior Crewboats Inc. v. Primary P&I Underwriters (In re Superior Crewboats Inc. ), 374 F.3d 330, 334 (5th Cir. 2004).

The court added, ''A three-part test has been devised, wherein a Court must find that (1) the party's position is 'clearly inconsistent with the previous one'; (2) 'the court must have accepted the previous position'; and (3) 'the non-disclosure must not have been inadvertent.' Superior Crewboats, 374 F.3d at 335.''

The insurer asserted that the failure to disclose the bankruptcy claim barred the action to recover disability benefits and that all three parts of the judicial estoppel test were met. The insurance company claimed that Acuna's failure to disclose the claim in the bankruptcy action was inconsistent with her suit to recover disability benefits, that a discharge was granted based on the non-disclosure, and that there was no inadvertent failure to disclose because a demand for a policy recovery had been made just prior to the bankruptcy filing. The insurer also maintained that the plaintiff lacked standing to bring suit because the claim for disability benefits would have become property of the bankruptcy estate. Although the defendants conceded that disability benefits are potentially exempt under both the Bankruptcy Code and Texas law (citing 11 U.S.C. section 522(d)(10)(C); Tex. Ins. Code section 1108.051(b)(2)), they argued that the potential exemption nonetheless does not excuse a failure to disclose the asset to allow a creditor to object.

The plaintiff pointed out that she had amended her schedules and that the disability insurer was ''seeking a windfall by having to avoid its contractual obligation to pay the disability income benefits.'' She added that the insurance company had unclean hands since the bankruptcy was forced by her inability to work and the unjustified refusal to pay disability benefits exacerbated her financial distress.

The court sided with the insurance company. On the first element of the three part test, the court found an inconsistency because the failure to schedule the disability insurance claim was ''tantamount to a representation that no such claim existed.'' The court obviously adopted the debtor's position by granting a full discharge, and the inadvertence requirement could only be met if the debtor had no knowledge of the claim which was obviously not the case here.

What obviously swayed the court, though, was that a suit was filed against Acuna for fraudulently conveying real property to avoid creditors' claims.

Thus, the court determined: ''Here, the Plaintiff clearly knew how to claim exemptions and was even caught attempting to fraudulently convey real estate property. The bankruptcy proceedings have resulted in a discharge for Plaintiff and her husband, while allowing her to pursue her claims in this court. This is the kind of activity that judicial estoppel was designed to prevent.''

Nor did the court accept the plaintiff's argument that the non-disclosure was irrelevant because the claim would have been exempt since property is not exempt until it is found to be exempt by the bankruptcy court.

This was an obviously harsh result, but one that should serve as a warning to plaintiff lawyers that they need to inquire of their clients as to whether a bankruptcy is pending - and to caution clients that if they consider filing bankruptcy during the course of their disability insurance claim and litigation that they make full disclosure and seek the bankruptcy trustee's permission to pursue the disability insurance claim.

Attorneys who defend insurers will also pay close attention to this case and issue discovery or conduct an investigation to determine whether the insured filed for bankruptcy and scheduled the disability benefit claim, which may be a means of avoiding even a meritorious claim if the disability claim was not disclosed.

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