Contributed by Andrea Saavedra
Among equitable doctrines, the doctrine of equitable mootness — which essentially allows courts to dismiss appeals from bankruptcy confirmation or sale orders where, as a result of the plan going effective or the sale closing, granting the relief requested in the appeal would be inequitable — is well known. Indeed, in the Second Circuit, it is arguably among the most significant legal rules that provide certainty to parties to a corporate transaction in a bankruptcy case. The doctrine’s emphasis on the importance of finality to the successful operation of our federal bankruptcy system can be viewed as a pragmatic solution by the appellate courts to the otherwise uncertain, litigious, and time-sensitive nature of a bankruptcy case.
A perhaps lesser known — but equally powerful — equitable doctrine in the context of bankruptcy appeals is that of judicial estoppel. Judicial estoppel prevents a party from contradicting previous declarations made, or actions taken, during the same or a later proceeding if the change in position would adversely affect the proceeding or constitute a fraud on the court. The Supreme Court of the United States has explained that, while the “circumstances under which it can be invoked are likely not reducible to any general formulation or principle,” there are several factors that inform the decision whether to apply the doctrine in a particular case:
First, a party’s later position must be clearly inconsistent with its earlier position. Second, courts regularly inquire whether the party has succeeded in persuading a court to accept that party’s earlier position, so that judicial acceptance of an inconsistent position in a later proceeding would create the perception that either the first or the second court was misled. A third consideration is whether the party seeking to assert an inconsistent position would derive an unfair advantage or impose an unfair detriment on the opposing party if not estopped.
In “enumerating these factors,” the Supreme Court made clear that it did not intend to “establish inflexible prerequisites or an exhaustive formula for determining the applicability of judicial estoppel.” Accordingly, its application is highly sensitive to the facts of the particular case at issue.
In Adelphia Recovery Trust v. Goldman, Sachs & Co., et al., the Adelphia Recovery Trust (the plan-created litigation trust established for the benefit of the creditors of Adelphia Communications Corp. (“ACC”), the parent entity of the various Adelphia companies) appealed from the District Court’s dismissal on summary judgment of its fraudulent conveyance action against Goldman Sachs & Co. The facts underpinning the avoidance action arose from a multi-million margin loan that Goldman had extended to an entity owned by the Rigas family unconnected to Adelphia. The loan was secured by the entity’s ownership interests in certain ACC stock. As ACC’s stock price decreased following disclosure of the Rigas’ fraudulent concealment of debt in 2002, Goldman issued several margin calls to the Rigas-controlled entity. The trust alleged that the Rigases caused ACC to make cash payments of $63 million to cover these margin calls.
The District Court provided the trust with several opportunities to amend the complaint so as to properly identify which transfers were made by ACC and which were made by its debtor-subsidiaries. Absent clear allegations that the cash transferred to Goldman was property of the ACC bankruptcy estate, the District Court expressed concerns with the trust’s standing to pursue the avoidance action because it did not represent the Adelphia debtor-subsidiary creditors, who had been paid in full under the confirmed and consummated chapter 11 plan. Ultimately, the trust could not plead around the facts settled in the chapter 11 cases — that the payments to Goldman were made in the name of a subsidiary and that the debtors’ schedules of assets and supporting documentation for the chapter 11 plan identified the relevant account as property of the subsidiary. Accordingly, the District Court held that the trust lacked standing to pursue its avoidance claim against Goldman.
On appeal, the Second Circuit found that the revised ownership claim was inconsistent with what had been litigated and determined in the chapter 11 cases. Given the “importance to bankruptcy proceedings of determining with finality a debtor’s ownership of particular assets,” the Second Circuit affirmed the lower court’s ruling, relying upon the doctrine of judicial estoppel. The court noted that a central question in every bankruptcy is the determination of an estate’s res, and that both the Bankruptcy Code and the Bankruptcy Rules were designed to provide debtors and creditors with “ample periods of time within which to finalize asset ownership schedules and fashion a plan upon those schedules.” In the Adelphia chapter 11 cases, over four and a half years passed between commencement and confirmation of the plan and at no time did ACC or any other party attribute ownership of the account in dispute to ACC, even after a restatement of the debtors’ accounting records and amendments to their schedules of assets. Further, as the plan was not based on substantial consolidation of the debtors’ estates, there was not even a plausible argument that ownership interests had not been appropriately assigned under the confirmed and consummated chapter 11 plan.
Noting that it is “crucial, both for the sake of finality and the needs of debtors and creditors, that claims to ownership of various assets be determined in a bankruptcy proceeding,” the Second Circuit declined to issue a ruling “inconsistent with the factual underpinnings” of Adelphia’s chapter 11 plan. Indeed, despite potentially applicable precedent that would have permitted the parent-debtor to assert an ownership interest in the disputed account as a result of its purported control over the subsidiary entity, the court explained that:
A different ruling would threaten the integrity of the bankruptcy process by encouraging parties to alter their positions as to ownership of assets as they deem their litigation needs to change, leaving courts to unravel previously closed proceedings. Doing so would allow parties an opportunity to play fast and loose with the requirements of the bankruptcy process and inject an unacceptable level of uncertainty into its results — exactly the result that the doctrine of judicial estoppel is intended to avoid.
Accordingly, the Second Circuit’s application of judicial estoppel in Adelphia is grounded in the value of finality in the bankruptcy context, which is the same rationale that underpins the doctrine of equitable mootness. It will be interesting to see whether its popularity as a doctrine in the bankruptcy context will increase as a result of this decision. Further, the decision reminds parties to a restructuring to consider what impact their actions or non-actions in a bankruptcy case may have on future positions the parties may seek to take.