The U.S. Court of Appeals for the Second Circuit recently affirmed the dismissal of LIBOR-manipulation fraud claims brought by a group of hotel-related entities and their investor against a bank and two of its subsidiaries.

In so ruling, the Second Circuit held that:

(a) the borrower and related entities lacked standing to sue because they failed to list their potential claims in their bankruptcy case and the claims were barred by the doctrine of judicial estoppel; and

(b) the claims of the investor and guarantors were untimely and barred by the law of the case.

A copy of the opinion is available at:  Link to Opinion.

An Illinois limited liability company obtained a $66 million loan from a local bank to finance the purchase of hotels. The loan contained a formula, tied to the U.S. Dollar London Interbank Offered Rate (LIBOR), pursuant to which the borrower paid a net interest rate of approximately 4.8%.

Two years later, the borrower and affiliated guarantors filed bankruptcy in the United States Bankruptcy Court for the Eastern District of Texas, but their schedules failed to list any potential LIBOR-fraud claim as an asset. The bankruptcy court approved the debtors’ reorganization plan, which still did not disclose any claim against the bank, and the bankruptcy case was closed.

The bankrupt borrower, its corporate affiliates that guaranteed the loan, and an investor of the borrower then sued the bank, its parent and another subsidiary, in the United States District Court for the Southern District of New York, alleging that the banking defendants fraudulently induced the borrower to take out the loan, as the result of which the borrower was forced into bankruptcy.

The trial court dismissed the fraud claims against the lender because they were barred by the applicable statute of limitations, and dismissed the guarantors’ and investor’s claims “for failure to plead fraud with sufficient particularity.”

The plaintiffs appealed, and the Second Circuit previously reversed the judgment against the borrower, but affirmed the dismissal of the other plaintiffs’ claims.

On remand, the trial court dismissed the complaint, concluding that because the supposed LIBOR-fraud claim was not listed as an asset in the bankruptcy case, the plaintiffs lacked standing to sue or, alternatively, were judicially estopped. The trial court also denied the guarantors’ and investor’s motion to amend their complaint because “amendment would be untimely and barred by the law of the case.”

On appeal for the second time, the Second Circuit explained that “[t]he doctrine of judicial estoppel prevents a party from asserting a factual position in one legal proceeding that is contrary to a position that is successfully advanced in another proceeding … [and] will ‘prevent a party who failed to disclose a claim in bankruptcy proceedings from asserting that claim after emerging from bankruptcy.”

Although whether judicial estoppel applies depends on the specific facts presented, “[g]enerally, ‘judicial estoppel will apply if: [A] a party’s later position is ‘clearly inconsistent’ with its earlier position; [B] the party’s former position has been adopted in some way by the court in the earlier proceeding; and [C] the party asserting the two positions would derive an unfair advantage against the party seeking estoppel.’”

Addressing each element in turn, the Court first held that the bankrupt borrower “was required by Fifth Circuit law [where the bankruptcy was filed] to list its LIBOR claim before confirmation” because “[t]he Fifth Circuit has recognized ‘that the Bankruptcy Code and Rules impose upon bankruptcy debtors an express, affirmative duty to disclose all assets, including contingent and unliquidated claims.’” This means that “a debtor is required to disclose all potential causes of action.”

The borrower was on notice of its potential cause of action because numerous news articles had appeared reporting on LIBOR fraud and the parent of the bank had been sued for LIBOR manipulation by others before the bankruptcy plan was confirmed.

Because under Fifth Circuit bankruptcy precedent the plaintiff’s LIBOR-fraud claim was “a known cause of action” when the plan was confirmed, the bankrupt borrower’s “failure to list it in the schedule of assets is equivalent to a representation ‘that none exist[s].’”

Second, the Court found that “the bankruptcy court ‘adopted’ [the borrower’s] position that it had no LIBOR-fraud claim … when [it] confirmed the plan” because “’adoption’ in judicial estoppel ‘is usually fulfilled … when the bankruptcy court confirms a plan pursuant to which creditors release their claims against the debtor.’”

Third, even though under its precedent “we do not always require a showing of unfair advantage,” the Second Circuit found that “the showing had been made in this case” because the borrower’s “assertion of the claims now would allow it to enjoy an unfair advantage at the expense of its former creditors, who had a right to consider the claims during the bankruptcy proceeding.”

Finally, the Court affirmed the trial court’s denial of the guarantors’ and investor’s request to amend their complaint because they had not shown good cause after the deadline to amend in the trial court’s scheduling order had passed, as required by Federal Rule of Civil Procedure 16(b).

Accordingly, Second Circuit affirmed the trial court’s judgment.