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Gaming the System

Bankruptcy petitions may contain evidence of fraud and invoke judicial etoppel.

November 16, 2012 Photo
During the investigation of insurance claims, insurance company claims representatives and special investigators generally consider whether there is any evidence of fraud on the part of the insured. Fraud may exist when the insured has intentionally created the loss himself. It may also be found when an insured has suffered a valid loss but has committed fraud by misrepresenting either the quality or quantity of the damaged personal property. Under either scenario, a review of an insured’s bankruptcy petition is warranted because it may contain a plethora of fraud evidence that might be used to deny a claim based on the concealment and fraud provision of the insurance policy or the application of the doctrine of judicial estoppel.

Under the U.S. Bankruptcy Code, a debtor is required to disclose all assets and liabilities when filing a Chapter 7 bankruptcy proceeding. Section 521(1) of the Bankruptcy Code, entitled “Debtor’s duties,” reads: “The debtor shall…file a list of creditors, and unless the court orders otherwise, a schedule of assets and liabilities, a schedule of current income and current expenditures, and a statement of the debtor’s financial affairs….”

As addressed in In Re Coastal Plains, the Bankruptcy Code and Federal Rules of Bankruptcy Procedure “impose upon the bankruptcy debtors an express, affirmative duty to disclose all assets, including contingent and liquidated claims.” In Hamilton v. State Farm Fire & Cas. Co., it was noted that a debtor’s duty to disclose has been held not to cease simply when the debtor files his schedules with the bankruptcy court “but instead continues for the duration of the bankruptcy proceeding.”

When reviewing an insured’s bankruptcy petition, an insurer should consider four points: whether the insured had a financial motive to falsify a claim; whether the insured had the financial means to purchase an item allegedly stolen or lost; whether the insured has omitted from the petition the very item that is the basis for the claim; and whether the insured has misrepresented the value of the item at a substantially lower value than represented in the claim. If in the bankruptcy petition the insured has omitted the item involved in the claim or misrepresented the item at a lower value, the insured may be prevented from recovering under the policy based on the application of the doctrine of judicial estoppel, in addition to any policy exclusions for fraud and concealment.

The doctrine of judicial estoppel prevents a party from asserting a claim in a legal proceeding that is inconsistent with a claim made in a previous proceeding. The doctrine was born out of the courts’ search for a way to deal with debtors who failed to schedule assets or misrepresented the value of assets and financial affairs.

In New Hampshire v. Maine, the U.S. Supreme Court identified three factors to aid courts in deciding whether to apply the doctrine:

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. Third, courts ask 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.

As in Chicon v. Carter, applying these factors to an insurance claim may result in a court’s application of its equitable discretion to judicially estop an insured from asserting an insurable interest in the property of a pending claim because their “failure to reveal assets…operates as a denial that such assets exist, deprives the bankruptcy court of the full information it needs to evaluate and rule upon a bankruptcy petition, and deprives creditors of resources that may satisfy unpaid obligations.”

It appears that a majority of the courts across the nation have followed the Supreme Court’s determination regarding the application of the doctrine, e.g., IBF Participating Income Fund v. Dillard-Winecroff, LLC; U.S. Fidelity & Guaranty Co. v. Treadwell Corp. (applying Pennsylvania law); Guzman v. Alvares (recognizing but not favoring the doctrine); Whitacre Partnership v. Biosignia, Inc. (applying the doctrine even if intent to deceive is not present); Consolidated Stores, Inc. v. Gargis; and Blumberg v. USAA Cas. Ins. Co.

In Georgia, the doctrine of judicial estoppel was applied specially in Battle v. Liberty Mutual Fire Insurance Co. to uphold the denial of an insured’s claim for fire damage to a property that was not listed in a prior bankruptcy petition. The evidence established that the insured failed to disclose his interest in the residence. The bankruptcy court subsequently discharged the insured’s debts. Several years later, the insured filed a claim for fire damage to that same home suing Liberty Mutual and another insurance carrier, both of whom refused to pay his claim. The trial court granted summary judgment in favor of the insurance companies on the basis of judicial estoppel and barred the insured’s recovery under the policy. 

The Georgia Court of Appeals upheld judgment in the insurers’ favor, holding that “the primary purpose of judicial estoppel being to protect the integrity of the judicial process, we agree that when a debtor fails to list a property in a bankruptcy proceeding that results in no money being paid to his unsecured creditors, he cannot subsequently obtain reimbursement of a damage claim for that same property.” The court specifically rejected the insured’s argument that a party raising the defense of judicial estoppel must show that it was directly affected by its opposing party’s prior inconsistent successful position. According to the Georgia court, there is no requirement that an insurer show that it relied on the representations in a debtor’s bankruptcy or was otherwise prejudiced in order to invoke the doctrine of judicial estoppel.

Property value inconsistencies between bankruptcy cases and insurance claims and the application of judicial estoppel have been addressed by some courts. In Smith v. Allstate Ins. Co., 2006 U.S. Dist. LEXIS 93998 (S.D. Ohio 2006), judicial estoppel applied notwithstanding the insureds’ attempted distinction between market values on their bankruptcy petition and replacement costs on their insurance claim. In Smith v. Fireman’s Fund Ins. Co., 1994 U.S. App. LEXIS 423 (6th Cir. 1994), the court affirmed judicial estoppel based on inconsistent positions regarding the value of furniture and numerous other belongings between the bankruptcy petition and insurance claim. And in Fidelity National Ins. Co. v. Jamison-Means, proof of loss valued a property in excess of $40,000 compared with the bankruptcy petition value of $2,300.

In Smith v. Fireman’s Fund Ins. Co., the district court found that the plaintiffs were judicially estopped from recovering any proceeds for property they claimed to have purchased prior to their bankruptcy that they failed to disclose. On appeal, the 6th Circuit affirmed the ruling of the district court in favor of the insurance company and agreed that the plaintiffs were inconsistent regarding the value of their personal property, as the amount listed in bankruptcy and claimed in the loss differed by more than $17,000. It stated that the “inconsistent positions indicate that plaintiffs must be judicially estopped from claiming recovery under the insurance policy for any items they failed to disclose in the bankruptcy proceeding.” The plaintiffs argued that the district court improperly applied the doctrine. However, the 6th District specified, “The judicial estoppel doctrine protects the integrity of the judicial process by preventing a party from taking a position inconsistent with one successfully and unequivocally asserted by the same party in a prior proceeding. The purpose of the doctrine is to protect the courts ‘from the perversion of judicial machinery.’”

Based on Smith v. Fireman’s Fund Ins. Co., insurers should consider the difference between the two values represented by insureds in their bankruptcy petitions and insurance claims. It may be that the variance is too great to be reconciled solely on any alleged difference in the valuation method used, and, therefore, the doctrine of judicial estoppel should be applied.

Under the doctrine, the insurer need only show that the insured took a position with regard to property in a bankruptcy court or another previous litigation that is inconsistent with the current claim filed with the insurer. If the insured obtained a discharge of his debts or otherwise obtained protection from his creditors, an insurer can argue that judicial estoppel should apply because allowing the insured to then seek payment for damages to property that was not identified for his creditors is an inconsistent position from which the insured would derive an unfair advantage.   

Karen Karabinos is a partner with Drew Eckl & Farnham. She has been a CLM Member since 2010 and can be reached at KarabinosK@deflaw.com.

About The Authors
Karen Karabinos

Karen Karabinos is a partner with Drew Eckl & Farnham, LLP.  karabinosk@deflaw.com

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CLM’s Insurance Fraud Committee identifies, analyzes, and offers education on emerging fraud schemes and tactics; monitors and reports on developments in case law, state fraud statutes and applicable regulations; collaborates with other anti-fraud industry organizations and associations; and seeks to provide amicus support in matters of importance in the fight against insurance fraud.

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