Justices reject “rigid” rule punishing omissions by bankrupt debtors

Yesterday’s decision in Keathley v. Buddy Ayers Construction squarely rejected a “rigid” rule adopted by the lower court to punish the failure of a debtor in bankruptcy to mention one of its assets to the court.

The case involves a bankrupt debtor who failed to disclose to the bankruptcy court the possibility that a car accident he was in after the bankruptcy filing might produce additional assets for his creditors. Under a rule of “judicial estoppel” in the lower courts, the lawsuit by Keathley (the bankrupt debtor) against the other driver was dismissed on the theory that Keathley improperly benefited in his bankruptcy by failing to call the accident to the attention of the bankruptcy court – although he disclosed it to his attorney. The idea is that because Keathley had a possible incentive to hide the incident – it might have produced money for his creditors if he disclosed it – he is conclusively presumed to have acted wrongfully when he did not disclose it.

Ketanji Brown Jackson’s opinion for a unanimous court is narrow and succinct. She characterizes judicial estoppel as “an ‘equitable doctrine’ ‘intended to protect the integrity of the judicial process’ … by ‘prohibiting parties from deliberately changing positions’” and explains that “courts that apply judicial estoppel to claims in the bankruptcy context view the debtor’s failure to disclose a particular claim as an ‘implicit representation’ that the claim does not exist.” Then, on that view, “when the debtor files a lawsuit based on that claim, he has taken inconsistent positions in the two judicial proceedings ‘by asserting in the civil lawsuit that he has a claim … while denying … in the bankruptcy proceeding that the claim exists.”

Jackson repeatedly emphasizes how little the court is deciding. For one thing, the parties do not dispute whether the debtor “has a continuing duty to disclose assets that arise after the initial filing of the bankruptcy,” and the justices thus “do not opine on whether such a duty exists.” Similarly, she notes that “this Court has never applied judicial context in the bankruptcy context,” and so “assume[s] without deciding that judicial estoppel can apply in the bankruptcy context and that ‘inadvertence or mistake’ can function as an exception to that application.”

The only thing the opinion resolves, then, is whether in the application of judicial estoppel it makes sense to conclusively presume that estoppel applies, and that a litigant cannot be forgiven on the grounds of “inadvertence or mistake,” if the litigant had any motive to hide the information. On that point, Jackson rejects the lower court’s “understanding of ‘inadvertence or mistake’ [a]s simultaneously too rigid and too broad.”

On the first point, she points to the lower court’s “failure to fully recognize that ‘judicial estoppel is an equitable doctrine.’” She points to earlier opinions stating that equity “eschews mechanical rules; it depends on flexibility” and that equitable inquiry should proceed “on a case-by-case basis.” As Jackson sees it, the lower court limits analysis to “only two circumstances”: “whether the debtor knew of the underlying ‘facts’ … and whether there was a potential motive to conceal the claim.” For Jackson, “[t]hat rigidity is out of step with equity,” and the lower court instead “should have examined the totality of the circumstances surrounding Keathley’s failure to report his personal-injury claims earlier.”

On the second point, she suggests that the lower court’s rule “is not only overly rigid; it is also overly broad,” as it “holds that an omission falls outside the exception any time a debtor … could potentially benefit from non-disclosure.” That makes little sense to her, because “a debtor will almost always hypothetically benefit from not revealing such a claim to his creditors.” In sum, such a “one-size-fits-all test” is “patently incompatible” with traditional equitable analysis, “which suggests that circumstances—and outcomes—may vary.”

In a brief concurrence, Justice Clarence Thomas, joined by Justice Neil Gorsuch, questions the doctrine of judicial estoppel altogether – going much farther than the majority’s ruling narrowing the doctrine from the breadth accepted by the court below.

Given that holding’s narrowness, Keathley is probably a good candidate for least significant decision of the term. It does resolve a circuit conflict, but it does not even establish that the doctrine applies in the bankruptcy context or, most importantly, whether debtors have an ongoing duty to disclose assets that accrue to them long after confirmation of a plan in bankruptcy. The lower courts have divided on those questions, which seem much more important than the issue resolved yesterday. Perhaps the most notable thing about it is that it buttresses the U.S. Court of Appeals for the 5th Circuit’s lead as the most-reversed circuit at the Supreme Court this term.