How Bankruptcy and the Doctrine of Judicial Estoppel Affect the Investigation and Litigation of Insurance Claims

September 30, 2011 | Appeals | Corporate | Insurance Coverage

Recently, our clients have seen an increase in insurance claims where an insured, who has previously filed for bankruptcy, subsequently sustains a first-party property loss and seeks indemnification for the loss. There are several important issues to consider when investigating claims of this nature, including whether the insured has fraudulently valued the insurance claim or the assets disclosed in the prior bankruptcy.

At the outset of any claim investigation, where the insured has previously filed for bankruptcy, it is important to obtain all of the insured’s bankruptcy filings, as they may contain admissions or omissions that limit or preclude recovery on the insurance claim. In this regard, it is essential to analyze the bankruptcy filings for a description of the insured’s assets and their values. Further, if the insured failed to disclose the existence of a pending lawsuit in the bankruptcy, he may lose standing to assert, or the ability to prosecute an action on the claim.

A debtor files for bankruptcy as a means of discharging debts and obligations and receiving a “fresh start.” The bankruptcy case is initiated by the debtor filing a bankruptcy petition, which includes schedules of assets and liabilities and a statement of financial affairs. The debtor must execute these documents under penalty of perjury, and is required to include a good faith estimate of the value of all of his assets. See 11 U.S.C. § 521(a)(1). Upon the bankruptcy filing, a trustee is appointed to administer the debtor’s estate and liquidate the debtor’s assets in order to pay creditors. The submission of the petition is required for the trustee to properly administer the debtor’s estate, and ultimately, for the debtor to receive a discharge of his debts. The intentional or unintentional undervaluing of the debtor’s assets, or the failure to disclose those assets in a bankruptcy petition, may limit or preclude the debtor from recovery in a subsequent legal proceeding based upon the doctrine of judicial estoppel.

The doctrine of judicial estoppel holds that “where a party assumes a position in a legal proceeding and succeeds in maintaining that position, that party may not subsequently assume a contrary position because its interests have changed.” McIntosh Builders., Inc. v. Ball, 264 A.D.2d 869, 870, 695 N.Y.S.2d 196 (3d Dep’t 1999). Stated another way, “[a] litigant should not be permitted to lead a tribunal to find a fact one way and then attempt to convince a court in a different proceeding that the same fact should be found otherwise; the litigant should be bound by the prior stance that he or she clearly asserted.” Kilcer v. Niagara Mohawk Power Corp., 86 A.D.3d 682, 683, 926 N.Y.S.2d 224 (3d Dep’t 2011).

In order to assert a defense of judicial estoppel in connection with an insured’s prior bankruptcy filing, there must be a “final determination in the bankruptcy proceeding endorsing the party’s inconsistent position concerning his or her assets.” McIntosh Builders Inc., 264 A.D.2d at 870. The failure of a debtor to disclose all of his assets in a bankruptcy, as well as a debtor’s undervaluation of his assets may prevent recovery for the loss of those undisclosed or undervalued assets in a subsequent proceeding. See Kittner v. Eastern Mut. Ins. Co., 80 A.D.3d 843, 915 N.Y.S.2d 666 (3d Dep’t 2011); Popadyn v. Clark Constr. & Prop. Maintenance Servs., Inc., 49 A.D.3d 1335, 854 N.Y.S.2d 626 (4th Dep’t 2008).

With respect to insurance claims made after a debtor’s bankruptcy filing, the doctrine of judicial estoppel prevents an insured from taking a position, under oath, in a bankruptcy filing and later asserting a contrary or inconsistent position in a subsequent litigation over the denial of an insurance claim. By way of example, assume that an insured filed for bankruptcy in 2009 and indicated in his bankruptcy schedules that he owned only $3,500 in personal property. As such, the insured’s (debtor’s) bankruptcy estate was administrated based upon that premise, with his debts discharged. Assume further that the insured’s home subsequently sustained a fire loss and he made a claim to his insurer for loss of personal property in the amount of $150,000 (in contrast to the $3,500 value he swore to on his petition schedules), which claim was ultimately denied.

Setting aside the potentially significant issue of bankruptcy fraud, a court adjudicating a breach of contract action brought by the insured against the insurer over the denial of coverage would likely find that the insured is judicially estopped from asserting that he owned $150,000 worth of personal property. Because the insured previously affirmed in his bankruptcy case that his personal property was only worth $3,500, the insured’s damages on his personal property claim would either be limited to that amount, or possibly denied outright if the overvaluation constituted a material misrepresentation made in connection with the claim (e.g., as a part of a Sworn Statement in Proof of Loss or at an Examination Under Oath). Thus, the bankruptcy filings are important documents to analyze during the claim investigation stage as they could potentially limit or bar an insured’s personal property claim.

Additionally, a debtor is required to disclose all of his “property” in a bankruptcy. Litigation is considered property since it is a potential asset or liability of the debtor. Therefore, a debtor must disclose to the bankruptcy trustee any litigation in which he is a party, as well as any claims or causes of action he may have against any party, because it is the trustee of debtor’s estate who is solely vested with the right to prosecute the action for the benefit of creditors (unless the trustee abandons the “property” i.e., the litigation, back to the debtor). The failure to disclose litigation may preclude the debtor’s recovery in an action that is not disclosed in bankruptcy since all of the debtor’s claims constitute property of the bankruptcy estate. See Solovay v. Allure Home Improvements, 2011 NY Slip Op 31850U, *4, 2011 N.Y. Misc. LEXIS 3336 (Sup. Ct., Nassau Co., June 29, 2011) (“judicial estoppel prevents a party from prosecuting claims not disclosed in a bankruptcy proceeding that resulted in a party’s discharge”); Best v. MetLife Auto & Home Ins. Co., 7 Misc. 3d 242, 248, 793 N.Y.S.2d 682, 687 (Sup. Ct., Richmond Co. 2004) (“a debtor who fails to disclose a cause of action in bankruptcy, when required by the Bankruptcy Code … is barred following discharge or other substantive termination of the petition by the Bankruptcy Court from asserting capacity and standing to sue on any such cause of action not appropriately disclosed”). Thus, to the extent that an action was pending at the time of a debtor’s bankruptcy proceeding and had not been disclosed in the petition, the action may be subject to a motion to dismiss based on the insured’s lack of standing.

Therefore, where an insured has previously filed for bankruptcy, it is important to obtain the bankruptcy filings at the beginning of any claim investigation or litigation since the debtor’s petition may contain information that may limit or preclude future claims and causes of action.

 Reprinted with permssion. All rights reserved.

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