Bankruptcy and Employment Defense Litigation

Transcription

1 Bankruptcy and Employment Defense Litigation Joseph C. Liburt ORRICK, HERRINGTON & SUTCLIFFE LLP 1000 MARSH ROAD MENLO PARK, CA (650) Jinnifer D Pitcher jpitcher@orrick.com ORRICK, HERRINGTON & SUTCLIFFE LLP 400 CAPITOL MALL SACRAMENTO, CA (916) BEIJING BERLIN DÜSSELDORF FRANKFURT HONG KONG LONDON LOS ANGELES MILAN MOSCOW NEW YORK PARIS PORTLAND ROME SACRAMENTO SAN FRANCISCO SEATTLE SHANGHAI SILICON VALLEY TOKYO WASHINGTON, D.C. OHSUSA:

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3 Copyright 2013, Orrick, Herrington & Sutcliffe LLP. All rights reserved. This paper is for informational use only and is not intended to constitute, and does not constitute, legal advice. OHSUSA:

4 I. INTRODUCTION Bankruptcy filings have tripled from 2007 to 2011 from 69,110 individual bankruptcies filed to 232,593. The likelihood that an employee who has sued his or her employer in a dispute has filed for bankruptcy has increased dramatically. If an employee has failed to disclose in the bankruptcy petition his or her claims against the employer, the employer has several strategies available to defeat, settle, or minimize the employee s claims. This paper provides a brief background of the bankruptcy framework and a summary of strategies for employers defending claims by employees who have filed for bankruptcy. A. Bankruptcy Code Framework The United States Constitution delegates to Congress the exclusive power to establish bankruptcy law. It has done so since the 1800s; the current law is known as the Bankruptcy Reform Act of 1978, as amended, commonly referred to as the Bankruptcy Code. 11 U.S.C. 101 et seq. The Bankruptcy Code is designed to achieve two objectives: (1) to ensure fair and orderly distribution of the debtor s assets (the estate) for the benefit of creditors, and (2) to provide an honest debtor with the ability to start over financially, i.e., to obtain a fresh start. A debtor s bankruptcy case is commenced by the filing of a petition under one of the chapters of the Bankruptcy Code. Individuals generally choose Chapter 7 or Chapter 13. In Chapter 7, the debtor s non-exempt assets are typically liquidated for the creditor s benefit. By contrast, a Chapter 13 bankruptcy generally involves a reorganization of the debtor s liabilities and the creation of a payment plan for the creditors benefit. Under either chapter, once a debtor files a petition for relief, a trustee is appointed to administer the debtor s estate. The proceeds of the estate are distributed to creditors in accordance with the rights and priorities established by the Bankruptcy Code. The debtor typically receives a discharge of claims against him or her, other than those that are exempted. 1 B. Debtor s Pre-Petition Causes of Action The debtor s estate is comprised of all legal and equitable interests of the debtor as of the commencement of the bankruptcy case. 11 U.S.C. 541(a). This includes any causes of action previously possessed by the debtor, whether or not a complaint has been filed. 2 These causes of action become the property of the bankruptcy estate once the debtor files the bankruptcy petition, even when the debtor fails to disclose a potential cause of action to the bankruptcy court or to the trustee. 1. Standing A Chapter 7 debtor may bring a cause of action only if the debtor can show either that the action did not become part of the estate or that the action was abandoned by the bankruptcy 1 Debtors may also claim that certain property is exempt from distribution to creditors under federal or state law. See 11 U.S.C. 522; see, e.g., Taylor v. Freeland & Kronz, 503 U.S. 638, 639 (1992) (debtor s employment discrimination lawsuit proceeds were exempt property). This paper does not discuss exemptions in detail, but counsel should be aware of the potential federal and state exemptions that may apply to debtors causes of action. 2 State law determines when the right of action arises.

5 trustee. See 11 U.S.C. 554 (trustee may abandon property that is burdensome to the estate or of inconsequential value; property not abandoned and not administered remains property of the estate). Accordingly, in a Chapter 7 filing, the debtor no longer has standing to pursue a cause of action which existed at the time the bankruptcy petition was filed, whether or not the cause of action has been disclosed. Courts are split, however, as to whether this is true lack of standing or merely a lack of prudential standing that can be cured by joining the bankruptcy trustee to the litigation. 3 See Fed. R. Civ. P. 17(a) ( An action must be prosecuted in the name of the real party in interest. ). Courts may also attempt to substitute the bankruptcy trustee as a proper party under Federal Rule of Civil Procedure 25. Indeed, in some individual non-class action cases, bankruptcy trustees have joined the litigation in earnest, prosecuting the claims more vigorously than the individual plaintiff would. Courts are also split as to whether a Chapter 13 debtor maintains standing to pursue a cause of action that existed at the time the petition was filed. See Donato v. Metro. Life Ins. Co., 230 B.R. 418, (N.D. Cal. 1999) (noting split of authority); see also Olick v. Parker & Parsley Petroleum Co., 145 F.3d 513, 515 (2nd Cir. 1998) (holding Chapter 13 debtors have standing to pursue claims when those claims belong to the bankruptcy estate); Maritime Elec. Co., Inc. v. United Jersey Bank, 959 F.2d 1194, 1209 n. 2 (3rd Cir. 1991) (same); Cable v. Ivy Tech State College, 200 F.3d 467, (7th Cir. 1999) (same); Smith v. Rockett, 522 F.3d 1080, 1081 (10th Cir. 2008) (same); Crosby v. Monroe County, 394 F.3d 1328, 1331 n. 2 (11th Cir. 2004) (same); accord 11 U.S.C. 1306(b) (providing that a Chapter 13 debtor remain[s] in possession of all property of the estate ). In order for an employer to argue lack of standing, the cause of action must have arisen prior to the debtor s seeking bankruptcy relief. The sequence of events is important. The key dates are the date the debtor s causes of action arose, the date the debtor filed the bankruptcy petition, the closing date of the bankruptcy case, and the filing date of the action. If, after the bankruptcy discharge, the debtor s causes of action are ongoing, the debtor may (depending on the circumstances) be able to regain standing, thus undercutting an employer s argument to the contrary. 2. Judicial Estoppel A debtor may be judicially estopped from asserting a cause of action that he or she failed to disclose in the bankruptcy case. Judicial estoppel prevents a party from gaining an unfair advantage in litigation by asserting a position inconsistent with the position the party asserted in a prior proceeding. The rationale is that the integrity of the bankruptcy system depends on full and honest disclosure by debtors of all their assets. Courts should not permit a debtor to obtain the relief afforded by the Bankruptcy Code, i.e., discharge of debts, if the debtor has represented that no claims exist, and then subsequently asserts those claims for his or her own benefit in a separate proceeding, hoping not to share the proceeds with his or her creditors. Because it is an equitable doctrine, courts have broad discretion to determine the circumstances in which judicial estoppel applies. Due to this broad discretion, courts decisions do not always (and frequently do not) reconcile with one another. On the whole, some factors that courts examine to determine whether judicial estoppel applies in the bankruptcy context are: 3 The distinction is paramount in federal court where jurisdiction is limited. See U.S. Const., Art. III. OHSUSA:

6 Culpability; whether debtor s failure to schedule assets was inadvertent, or similarly whether an innocent trustee is before the court. Compare Reed v. City of Arlington, 650 F.3d 571 (5th Cir. 2011) (en banc) (holding judicial estoppel did not bar bankruptcy trustee from pursuing former city employee's judgment against city) with Love v. Tyson Foods Inc., 677 F.3d 258 (5th Cir. 2012) (holding judicial estoppel barred plaintiff from pursuing EEO claims against employer that were not disclosed in his Chapter 13 bankruptcy proceeding). Timing; when the debtor disclosed the cause of action and whether the disclosure was only after the defendant-employer moved for dismissal. See, e.g., Burnes v. Pemco Aeroplex, Inc., 291 F.3d 1282, 1288 (11th Cir. 2002) ( Allowing [debtor] to back-up, reopen the bankruptcy case, and amend his bankruptcy filings, only after his omission has been challenged by an adversary, suggests that a debtor should consider disclosing potential assets only if he is caught concealing them. ). Chapter of relief. See 11 U.S.C. 1306(a) (Chapter 13 debtors, unlike Chapter 7 debtors, are specifically obligated to disclose property and earnings acquired after the commencement of the case). 4 Whether an administrative agency is involved. See, e.g., E.E.O.C. v. CRST Van Expedited, Inc., 679 F.3d 657, 681 (8th Cir. 2012) ( the district court abused its discretion in judicially estopping the EEOC from suing in its own name to correct any discriminatory employment practices that [defendant-employer] allegedly perpetrated against the [plaintiffs] ). Type of relief sought. See, e.g., Barger v. City of Cartersville, Ga., 348 F.3d 1289, 1297 (11th Cir. 2003) (applying judicial estoppel to bar claims for money damages but allowing claims for injunctive relief). Age, education, and sophistication of the debtor, including whether the debtor was represented by counsel or was proceeding pro per. 5 Each federal circuit has developed its own nuanced judicial estoppel factors. Additionally, state courts application of judicial estoppel may differ than federal courts and may be more favorable to debtors. See, e.g., Kelsey v. Waste Mgmt. of Alameda County, 76 Cal. App. 4th 590, 598 (1999) (setting forth California s standard for judicial estoppel; requiring 4 Judicial estoppel may appear an extreme remedy in a Chapter 13 proceeding where the bankruptcy court has flexibility to modify the debtor s payment plan. See, e.g., In re Studer, 237 B.R. 189, (Bankr. M.D. Fla. 1998) (modifying debtor s Chapter 13 repayment plan such that debtor s settlement proceeds were property of the estate and were subject to distribution to debtor s creditors). 5 A debtor s attorney who fails to disclose pre-petition causes of action in the bankruptcy petition may be subject to a malpractice action. See 11 U.S.C. 707 (a)(4)(d) ( The signature of an attorney on the petition shall constitute a certification that the attorney has no knowledge after an inquiry that the information in the schedules filed with such petition is incorrect. ).

7 positions to be totally inconsistent and that the first position was not taken as a result of ignorance, fraud, or mistake ). C. Practical Considerations 1. Discovery and Summary Judgment An employer who wishes to raise in employment litigation the employee/debtor s bankruptcy will likely need to file a motion for summary judgment rather than a motion to dismiss or motion for judgment on the pleadings, because the employer (and likely the employee/debtor) will need to introduce evidence outside of the complaint. 6 For example, those jurisdictions that require the debtor to show inadvertence or a good faith mistake in order to avoid judicial estoppel will allow evidence from the debtor. To rebut this evidence, defendantemployers should obtain the debtor s bankruptcy files, including a transcript or recording of the debtor s meeting of the creditors, which usually includes the debtor s testimony that the bankruptcy petition is accurate. 2. Reopening Closed Bankruptcy Cases While the defendant-employer s motion for summary judgment is pending, the plaintiff may move to re-open the bankruptcy proceedings. 7 See 11 U.S.C. 350(b) ( [a] case may be reopened in the court in which such case was closed to administer assets, to accord relief to the debtor, or for other cause. ); Fed. R. Bankr. P ( A case may be reopened on motion of the debtor or other party in interest pursuant to 350(b) of the Code. ). If the plaintiff re-opens the bankruptcy proceeding, the defendant-employer should contact the bankruptcy trustee and consider negotiating directly with the trustee (or the trustee s counsel) to buy the employee s claim against the employer. Because the trustee owns all of the employee s assets, including legal claims against the employer, it is the trustee who has the authority to negotiate and settle or sell the claims (subject to approval by the bankruptcy judge). Trustees may be more realistic and sophisticated than the debtor about the merits of the claim against the employer. Furthermore, trustees are under a duty to maximize recovery for the debtor s creditors, incentivizing them to settle in many cases. The benefit to this strategy is that the employer can potentially purchase the debtor s cause of action against it. If successful, the employer will own the cause of action, and can return to the civil proceeding and dismiss the claims against itself. This type of negotiation should be performed by experienced counsel who can address myriad issues that may arise in negotiations, including, for example, whether the causes of action are subject to an exemption, whether there are any tax issues, and whether the type of relief that the debtor has requested poses any obstacle to the purchase of the claims. Once the employer owns the claim, it can move to dismiss the claims against itself. Defendant-employers should 6 Some federal district courts and individual judges discourage successive motions for summary judgment or partial summary judgment, limiting defendant-employers to only one motion for summary judgment. 7 A defendant-employer should not rely on receiving notice of activity in the debtor s bankruptcy proceedings (since the defendant-employer is usually not a party) but instead should affirmatively check PACER at the outset of every case and monitor periodically in the event the plaintiff files for bankruptcy protection. OHSUSA:

8 remember that settlements with bankruptcy trustees require approval by the bankruptcy court, and notice to the creditors, with a period of time for any objections. 3. Alternative Forms of Relief If the defendant-employer is unsuccessful in dismissing, settling or buying the debtor s claims under the strategies above, it may request that the debtor s recovery be limited to the amount of the creditors claims. See, e.g., In re Williams, 310 B.R. 442, 444 (Bankr. N.D. Ala. 2004) ( [T]he Court will limit the trustee's recovery to the amount of the unsecured claims filed in this case, plus reasonable attorneys' fees, and reasonable expenses incurred by the trustee and special counsel to pursue the civil action and other administrative expenses in the case. ). Courts appear more apt to follow this approach if the debtor s conduct has been deceitful. In addition, there are criminal penalties for debtors and other individuals who perpetuate a fraud on the bankruptcy proceedings. It is a crime to knowingly and fraudulently conceal any property belonging to the estate of a debtor in a bankruptcy case. 18 U.S.C Class Actions Special considerations apply if the debtor-employee purports to bring a class action against the employer. Once the employer determines that a proposed class representative has filed for bankruptcy relief and that it has viable arguments for lack of standing and/or judicial estoppel, then the employer, in addition to the strategies above, may also move to decertify a class action on the grounds that the class representative is not adequate and that proposed class counsel is inadequate for not discovering the bankruptcy issue. While a bankruptcy trustee can often serve as the plaintiff in a single-plaintiff employment action, it is unlikely that a bankruptcy trustee can do so in a class action, due mainly to conflicting fiduciary obligations. While the trustee (wearing his/her bankruptcy trustee hat) has a fiduciary duty to maximize recovery for the debtor s creditors, the trustee (wearing his/her class representative hat) has a fiduciary duty to act in the best interests of the class members. These duties are highly likely to be inconsistent. Moreover, in the class action context, a bankruptcy trustee would have to meet the additional requirements of adequate representation under Federal Rule of Civil Procedure 23 or analogous state law procedure, or in a Fair Labor Standards Act case, showing that he or she is similarly situated to non-bankruptcy putative class members. A trustee with conflicting duties would be hard pressed to argue that he or she is an adequate representative or similarly situated. Furthermore, the trustee and plaintiff may have conflicting interests, for example if they dispute when the cause of action arose and therefore, whether, it belongs to the estate or not. II. CONCLUSION Defendant-employers should routinely check plaintiffs in litigation to see if they have filed for bankruptcy. If a plaintiff has filed for bankruptcy such that the plaintiff no longer owns his or her claims, the employer should evaluate the strategies above and be prepared to educate the judge and opposing counsel about the intersection of bankruptcy law and employment law.