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Judicial Estoppel Doctrine Defeats Ex-Convict’s Standing to Bring Shareholder Derivative Action Based on Failure to Disclose Alleged Stock Interest to Probation Authorities at Time of Sentencing

Posted in Derivative Actions, Standing

The doctrine of judicial estoppel in general prevents a party who asserts a factual position in one legal proceeding from taking an inconsistent position in subsequent litigation.  Judicial estoppel occasionally comes into play in shareholder disputes when the complaining party’s status as a shareholder, and thus his or her standing to sue, is challenged based on the failure to disclose the stock interest in prior legal proceedings.

For example, last year I wrote about a case called Light v. Boussi in which the court dismissed a corporate dissolution proceeding brought by a putative 50% shareholder due to his failure to list the shares as an asset in his prior bankruptcy proceeding.  A recent decision by Suffolk County Commercial Division Justice Emily Pines provides another example, this time involving a shareholder’s derivative action in which the plaintiff failed to disclose his alleged stock interest at the time of his sentencing in prior criminal proceedings.  Watkins v. J C Land Development, Ltd., Short Form Order, Index No. 30679-08 (Sup Ct Suffolk County June 19, 2009).

The plaintiff, William “Chip” Watkins, filed a shareholder’s derivative action in 2007 alleging that he owned a 50% stock interest in a real estate company called J C Land Development, Ltd. (“JCLD”) formed on March 25, 1999.  Watkins alleged that he invested $600,000 in JCLD including $130,000 in start-up cash.  Watkins claimed that the other 50% shareholder, John Cenci, and another co-defendant as “agent” subsequently diverted ownership of JCLD’s real properties by placing title in their own names for “no adequate consideration”.  The suit asked to set aside the allegedly improper transactions and to have the title to the real properties transferred to the corporation.   

Cenci’s answer to the complaint asserted that he was the sole shareholder of JCLD.  He also counterclaimed against Watkins for $600,000 allegedly owing on the sale of a property developed by JCLD and sold to Watkins.

Watkins, however, had a bigger problem.  The same year he and Cenci allegedly formed JCLD, Watkins pleaded guilty to federal narcotics charges.  At the time of his guilty plea on March 5, 1999 — only 20 days before the formation of JCLD – SDNY District Judge Rakoff stated that “no fine will be imposed because the Court made a finding that, in his present circumstances and in the foreseeable future, [Watkins] will not be able to pay any material fine.” 

Based on the discrepancy between that statement and Watkins’ allegations in his derivative action, Cenci applied to Judge Rakoff for disclosure of Watkins’ sealed Presentence Report (“PSR”).  Over Watkins’ opposition, Judge Rakoff ordered partial disclosure of the PSR which reflected Watkins’ omission of any disclosure to the Probation Department of his alleged, contemporaneous interest in JCLD.  Here’s what Judge Rakoff said in his June 2009 order, as quoted in Justice Pines’ decision:

Throughout all proceedings before this Court, [Watkins] was represented by court-appointed counsel, based on his representations to the Court that he was financially unable to employ counsel himself. . . . In the New York action and dissolution [sic] proceeding, however, [Watkins] alleges that on or about March 25, 1999, i.e., twenty days after [Watkins] pleaded guilty before this Court, he and [Cenci] formed a real estate development company, and that, beginning a month after being incarcerated, [Watkins] invested approximately $600,000 in that corporation. . . . After pleading guilty, [Watkins] provided certain information to the probation department concerning his finances for use in his PSR.  At [Watkins'] sentencing hearing, the Court adopted the factual findings of the PSR, . . . and, as noted, declined to impose any fine based on its determination concerning [Watkins'] inability to pay.

Justice Pines’ decision also notes that, under the applicable Sentencing Guidelines, the federal court was required to impose a fine unless the defendant establishes both his inability to pay and the likelihood that such inability will continue.

Cenci argued that the statements made by Watkins and relied upon by Judge Rakoff at his sentencing judicially estopped Watkins from asserting his stock ownership in JCLD in the state court derivative action.  Watkins argued that there was no evidence of any on-the-record statement by Watkins regarding his financial situation and that there were many reasons for the sentencing including Watkins’ personal family situation at the time of sentencing.

Justice Pines agreed with Cenci and granted summary judgment dismissing the action.  Her decision summarizes the doctrine of judicial estoppel as follows:

The well recognized doctrine of judicial estoppel is designed to protect the integrity of the court system as a whole by prohibiting deliberate alteration of a stated position before the same or different courts in order to obtain favorable treatment.  The doctrine prohibits a party who, having obtained a favorable ruling based upon an asserted position, seeks to alter the position simply because the litigant’s interests have changed.  [Citations omitted.]

Justice Pines concluded that Watkins failed to raise any genuine issue of material fact in response to Cenci’s prima facie showing of entitlement to summary judgment based on judicial estoppel.  Here’s what she wrote:

Applying the doctrine set forth above, and Judge Rakoff’s statements in his Order and the released portions of the PSR, the Court cannot imagine a more apt scenario for application of the doctrine of judicial estoppel.  The Federal Court specifically relied on Watkins’ assertions of penury in declining to impose an otherwise mandatory fine in connection with Watkins’ pleas of guilty to the crime of conspiracy to violate the federal narcotics laws.  Thus, Watkins obtained a judgment in his favor based upon his statements, including those declaring the lack of assets.  The same litigant will not be permitted to utilize the State Court system to litigate his claims to real property or accountings based on funds he now states he began transferring at the precise time of his contradictory statements to probation, relied upon by a federal judge.  Plaintiff has not raised any issue [of] fact, and indeed cannot do so, when faced with the statements of the sentencing judge, and the admissions contained in the PSR.

As Watkins illustrates, the doctrine of judicial estoppel obviates the court’s determination of the plaintiff’s asserted stock ownership rights.  In theory — and I’m not referring here to the Watkins case — the “other” shareholders could reap a windfall if, in fact, the plaintiff acquired an ownership interest but then, for whatever reason, he or she concealed it in bankruptcy or criminal proceedings.  But such forfeiture is the price exacted by the doctrine, in the greater interest of ensuring the integrity of judicial proceedings. 

 Note:  Farrell Fritz, P.C. represented one of the co-defendants in the Watkins case.

  • Ron Smith

    What happens to Mr. Watkins ongoing? Does he have issues with the probation department or the court for lying about his assets?