DAVID E. GROCHOCINSKI, not individually, but solely in his capacity as the Chapter 7 Trustee for the bankruptcy estate of CMGT,
Nos. 10-2057, 11-1393 & 11-3597
In the United States Court of Appeals For the Seventh Circuit
Argued January 16, 2013—Decided June 21, 2013
Before BAUER and HAMILTON, Circuit Judges, and MILLER, District Judge.
Appeals from the United States District Court for the Northern District of Illinois, Eastern Division. No. 1:06-cv-05486—Virginia M. Kendall, Judge.
HAMILTON, Circuit Judge. The story of Rumpelstiltskin is about turning straw into gold. The legal malpractice case at the heart of these appeals presents a modern attempt to turn metaphorical straw into real gold. The district court rejected the effort, as do we.
This case originated in a contract dispute between CMGT, Inc. and Spehar Capital, a company CMGT hired to help it find financing. Spehar Capital sued CMGT over a dispute related to this agreement and eventually procured a $17 million default judgment against CMGT, which had no assets to pay it. Spehar Capital devised a plan to recоver on the judgment. Step one: force CMGT into bankruptcy. Step two: convince the bankruptcy trustee to bring a malpractice action against CMGT‘s law firm based on the theory that but for the law firm‘s negligence, Spehar Capital would never have obtained the default judgment. Step three: win the malpractice action or force a settlement for the nominal benefit of CMGT‘s bankruptcy estate. Step four: since Spehar Capital‘s claim on the bankruptcy estate dwarfs all others, Spehar Capital receives the lion‘s share of the payment to the bankruptcy estate. Result: Spehar Capital receives payment on the default judgment by convincing another court that the default judgment should never have been entered. A meritless default judgment would be transformed into a significant payout. Straw turns into gold.
We are now at step two. The bankruptcy trustee sued CMGT‘s law firm, known as Mayer Brown, the defendant here. The trustee claimed that Mayer Brown committed malpractice by failing to advise CMGT on the consequences of not settling its dispute with Spehar Capital and by failing to defend CMGT against Spehar Capital‘s suit. Mayer Brown moved to dismiss, arguing in part that this suit should be dismissed as a fraud on the court due to the inconsistency between the theory of the malpractice case and a recovery by Spehar Capital. The district court denied the motion to dismiss but granted discovery for the limited purpose of investigating the fraud on the court theory. Mayer Brown then moved for summary judgment, and the district court granted the motion, reasoning that the doctrine of judicial estoppel barred the inconsistencies in this suit, based on undisputed facts. We agree. If the trustee were to prevail in this suit, there would be a clear impression
I. Factual Background
A. CMGT
CMGT was formed in 1999 to provide management services to the health care industry. CMGT owned software that made it easier for companies to track employee absences. While CMGT appears to have had a promising business idea, it lacked the start-up capital needed to implement its plan on the desired scale.
CMGT agreed to have Ronald Given, a partner with Mayer Brown, guide it through the process of obtaining financing.1 The engagement letter provided that Mayer Brown would provide services “in connection with [CMGT‘s] initial capitalization, formative acquisition activities, and other related general corporate activities.” In exchange, CMGT agreed to pay Mayer Brown 1.5 times the firm‘s normal hourly rates, but would owe nothing unless and until CMGT secured over $1 million in financing. Mayer Brown also retained the right to terminate the agreement if unpaid legal fees exceeded $50,000 or if CMGT did not secure financing by May 2000. May 2000 came and went without financing, but Mayer Brown continued to provide legal services with the hope that financing would materialize.
In June 2001, CMGT also hired Spehar Capital to assist in the search for investors. Spehar Capital pairs com-panies seeking investors with venture capitalists seeking investments. For this service, Spehar Capital receives a finder‘s fee. Its founder is Gerard Spehar. The agreement between CMGT and Spehar Capital, as amended on September 30, 2002, provided that Spehar Capital would receive a success fee “immediately at the successful closing of a funding” with a firm introduced to CMGT by Spehar Capital or with whom CMGT approved Spehar Capital to hold discussions. The firms that met these conditions were identified in an Exhibit A that was attached to the contract and could be “amended only by written addendum.” Upon the closing of such a deal, CMGT was to pay Spehar Capital six percent of the capital raised. Spehar Capital was also to receive six percent of CMGT‘s common stock “[a]t such time as CMGT receives and accepts a Term Sheet or other commitment from an investor(s) for a minimum of $1,000,000,” and Spehar Capital was to have exclusive investment banking rights. In addition, after the closing of a successful financing transaction, Spehar Capital was to receive a total of $100,000 in consulting fees spread over twelve consecutive months.
B. The Trautner Deal
In 2003, CMGT still needed an investor. In July 2003, a CMGT shareholder named Charles Trautner proposed solving CMGT‘s financial woes with what we will call the “Trautner deal.” He proposed a spinoff transaction in which his investment group would form a new corporation that would purchase CMGT‘s assets for either $500,000 or 20 percent of the new corporation‘s stock. To make the two options equivalent from the perspective of CMGT‘s shareholders, the new corporation would receive an initial capitalization of at least $2.5 million. CMGT‘s president, Lou Franco, signed a non-binding letter of intent
But a dispute with Spehar Capital derailed the Trautner deal, and that dispute spawned the malpractice action now before us. The Trautner deal did not provide for any payment to Spehar Capital. CMGT, with the advice of Mayer Brown, had concluded that the deal was outside the scope of its contract with Spehar Capital. According to CMGT, because the deal was arranged through channels independent of Spehar Capital and because Trautner was not included in Exhibit A, Spehar Capital was not entitled to any payment. Spehar Capital, however, maintained that it was entitled to payment. Spehar Capital alleged that CMGT asked Spehar to participate in conversations about the deal with Trautner and that CMGT unreasonably refused to add Trautner tо the list on Exhibit A after Spehar Capital found out about the proposed Trautner deal on August 8, 2003.
Over the next month, Spehar Capital and CMGT were unable to reach any resolution, though the extent to which they engaged in settlement negotiations is disputed. Mayer Brown contends it is absurd to suggest CMGT could settle because CMGT had no money with which to settle or even to defend the litigation. The trustee contends that Spehar Capital wanted to settle and that CMGT could have offered to settle with a percentage of future financing proceeds.
The trustee also contends that Mayer Brown negligently failed to advise CMGT about the risk of not settling for the future of CMGT. As an example of this failure, the trustee points to an August 26, 2003 email in which the president of CMGT, based on advice from Mayer Brown, sent a letter to the shareholders conveying confidence that “any claims against the transaction will not succeed and, as a practical matter, the only substantive effect we will be facing is additional documentation complexity and a delay in the winding up of CMGT....”
According to the trustee, Mayer Brown failed to provide adequate advice to CMGT because the law firm had negotiated a “functionally equivalent” deal with Trautner that would have allowed Trautner essentially to assume CMGT‘s business without formally purchasing CMGT‘s assets from its shareholders. This alternative deal envisioned assigning CMGT‘s existing contracts to the new company formed by Trautner. CMGT would pay the new company for servicing CMGT‘s contracts, including its accrued legal fees owed to Mayer Brown, which would be paid on CMGT‘s behalf. In effect the deal would have given Trautner the benefit of the Trautner deal and Mayer Brown would have received payment of its fees without having to worry about Spehar Capital‘s claim. According to the trustee, however, this alternative deal was not in the interest of CMGT or its shareholders because CMGT would lose all of its revenue stream — the contracts that would be serviced by the new corporation.
C. The California Suit
On September 9, 2003, Spehar Capital followed through with its threat to sue, filing a complaint in a California state court. We refer to this action as “the California suit.” On September 12, the California court granted an ex parte temporary restraining order enjoining CMGT from closing the Trautner deal or any other deal whose terms did not comply with the CMGT-Spehar Capital agreement. Attorney Given of Mayer Brown forwarded the order to CMGT‘s president and shareholders. He informed them of the order and reminded them that Mayer
In November 2003, Spehar Capital amended its complaint in the California suit to include a claim for dam-ages. CMGT still did not appear, and the California court entered a default judgment in favor of Spehar Capital for $17,045,780 on March 18, 2004. This represented legal expenses, the $150,000 success fee, and the $100,000 management consulting fee that Spehar Capital claimed it should receive if it assisted with the successful closing of a financing deal. The vast bulk of the judgment was based on supposed values of $11,253,627 in stock compensation and $5,483,290 for the lost exclusive investment banking rights. The values of the stock compensation and investment banking rights were calculated based on the projected value of a speculative planned initial public offering in 2006 — a figure Spehar obtained from CMGT‘s promotional mаterials from several years earlier. At the prove-up hearing in California, Spehar testified to all of these damages.
This state court judgment is not subject to collateral attack in these proceedings. We are nevertheless troubled by aspects of the judgment that are relevant to our case. First, there was considerable tension between the injunctive relief and the damage award. The damage award rests on the premise that the Trautner deal would have closed. Recall, though, that the same court‘s injunction — issued ex parte at Spehar Capital‘s behest on claims of irreparable harm — enjoined the closing of the same Trautner deal, thus prohibiting CMGT from receiving the very funding that Spehar Capital claimed it had helped secure. Second, the valuation of the stock options and the investment banking rights based on a speculative IPO three years in the future is extraordinary, to put it mildly. At the time Spehar Capital sought the default judgment, CMGT was valued in thе red. It had just agreed to a deal in which it would sell its assets (without the liabilities) for a grand total of just $500,000. Yet according to Spehar Capital and the California court that entered the default judgment, the real value of CMGT was more than $180 million. This assumed that the tiny new company would have enjoyed truly meteoric success. Perhaps this is why the California judge said, upon entering the judgment, that he doubted Spehar Capital would ever collect because CMGT would “set [the Default Judgment] aside, walk away from the company or they will go bankrupt.” In other words, the judge who made the damages findings did not expect the judgment would ever be collected.
The judge was right, but may have underestimated Spehar Capital‘s creativity. The last of his predictions proved true. CMGT never paid the default judgment, and Spehar Capital forced CMGT into bankruptcy, filing an involuntary bankruptcy petition on August 25, 2004. On September 21, 2004, David Grochocinski was appointed to serve as the trustee. He did not move to vacаte the default judgment before the time to do so expired under California law.2 This brings us to the present litigation.
Shortly after Grochocinski was appointed trustee of CMGT‘s estate, Spehar Capital approached him about bringing a malpractice action against CMGT‘s attorneys, Given and the Mayer Brown firm. The bankrupt CMGT had essentially no assets, so Spehar Capital‘s only hope for recovering on the default judgment in the California suit was to convince the trustee to sue CMGT‘s lawyers for malpractice. Since the CMGT estate had no money to fund litigation, the trustee was unwilling to invest in litigation on behalf of the no-asset estate that would benefit only a single secured creditor — Spehar Capital. The trustee nevertheless encouraged Spehar to hire counsel to investigate whether a malpractice claim would be viable.
Eventually, Spehar Capital and the trustee entered into a post-petition financing agreement to help fund the investigation into the malpractice action and to ensure that CMGT‘s unsecured creditors would receive a fraction of any recovery. The agreement provided that Spehar Capital would advance the estate $5,000 for the costs of investigating the malpractice claim (an amount that could be increased to $18,500). If the estate recovered on the claim, Spehar Capital would receive, depending on the specific amount, approximately 80 to 90 percent of the net recovery after expenses (including the attorney‘s contingency fee).3 The agreement was accepted by the bankruptcy court on September 2, 2005, and no creditors exercised their right to object to its terms. After the agreement was made, Spehar Capital filed a proof of claim for a secured amount of $13,427,560 and an unsecured claim for $3,618,220.4
Spehar Capital then recommended to the trustee a lawyer specializing in malpractice
E. Procedural History
On August 23, 2005, the trustee, through counsel Joyce, filed this action in Illinois state court. The complaint contained two counts of malpractice that the trustee is still pursuing.5 Count I alleges that Mayer Brown negligently advised CMGT with respect to the consequences of Spehar Capital filing suit and that as a result, CMGT was unable to close the Trautner deal or any other financing deаl. If CMGT had closed a deal, the trustee alleges, it would have become a highly profitable company; instead, CMGT went bankrupt. Among other alleged failures, Mayer Brown supposedly failed to advise CMGT “that a very probable consequence of a lawsuit by [Spehar Capital], regardless of its merit, would be that CMGT would not receive funding from any source.” Count II alleges that Mayer Brown failed to defend CMGT adequately (or failed to make clear that it would not defend CMGT) against Spehar Capital‘s lawsuit and that as a result, CMGT sustained damages in the amount of the $17 million default judgment. Mayer Brown promptly removed to federal court under the bankruptcy removal statute,
Mayer Brown next moved to dismiss this unusual case, both for failure to state a claim and under the theory that the case was brought with “unclean hands” as part of a fraud on the court system orchestrated by Spehar Capital to secure a bogus default judgment and then collect it in bankruptcy through a meritless malpractice action. The district court denied the majority of Mayer Brown‘s motion. The court was initially not convinced by the fraud on the court theory because the trustee — not Spehar Capital — had brought the malpractice action, and because Mayer Brown did not present clear evidence that the trustee had perpetrated any fraud on the judicial system. Grochocinski v. Mayer Brown Rowe & Maw LLP, No. 06 C 5486, 2007 WL 1875995, at *3-4 (N.D. Ill. June 28, 2007). The court also found that the trustee pled a sufficient claim for malpractice under Count II and much of Count I.6
The district court granted summary judgment in favor of Mayer Brown. The district court did not apply the doctrine of unclean hands but instead relied on the doctrine of judicial estoppel, holding that it prevented the trustee from taking a position in this lawsuit inconsistent with Spehar Capital‘s position in the California suit. Acknowledging that the parties to this suit are different from the California suit, the district court found this was not a per se bar because judicial estoppel is “concerned solely with protecting the integrity of the courts, not the relationship between the parties to the prior litigation.” Id. at *10. The court found it appropriate to bind the trustee to Spehar Capital‘s prior conduct because the trustee “acted at all times as a proxy for the real party in this case, SC.” Id., citing Taylor v. Sturgell, 553 U.S. 880 (2008) (recognizing exception to rule against non-party preclusion for relitigation through proxy). The court then found that Spehar Capital‘s judgment in the California suit was inconsistent with the trustee‘s need to prove in the malpractice suit that Spehar Capital was never entitled to the judgment in the first place and that without this argument, the malpractice action failed as a matter of law. In two later proceedings, the district court denied Gerard Spehar‘s post-judgment motion to intervene and denied nearly all of Mayer Brown‘s motion for sanctions against the trustee and his lawyer Joyce. The trustee, Spehar, and Mayer Brown have all appealed. The appeals were consolidated and we have jurisdiction over еach as an appeal from a final judgment pursuant to
II. Summary Judgment in Favor of Mayer Brown
Summary judgment is appropriate if there are no genuine issues of material fact such that the moving party is entitled to judgment as a matter of law.
The application of judicial estoppel is “not reducible to any general formulation of principle,” though the inquiry is typically informed by several factors. New Hampshire v. Maine, 532 U.S. 742, 750 (2001) (quotation omitted). The Supreme Court has identified three considerations to help guide the inquiry: (1) whether “a party‘s later position must be clearly inconsistent with its earlier position;” (2) whether “the party has succeeded in persuading a court to aсcept 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 second court was misled;” and (3) 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.” Id. at 750-51 (quotations omitted). We have emphasized that these are not rigid requirements but “general guideposts that must be considered in the context of all the relevant equities in any given case.” In re Knight-Celotex, LLC, 695 F.3d at 722.
The trustee bases his appeal on a question of first impression: What showing is required to apply judicial estoppel to a litigant based on the litigation positions of someone else?7 The trustee argues that the district court erred in applying judicial estoppel by attributing to the estate Spehar Capital‘s previous litigation positions. According to thе trustee, estoppel based in part on the conduct of a non-party must comport with the exceptions to non-party preclusion identified in Taylor v. Sturgell, 553 U.S. 880 (2008), and the district court erred in concluding that one of these limited exceptions was met, at least as a matter of law on summary judgment. Mayer Brown responds that judicial estoppel is more flexible than the preclusion doctrines and can be applied regardless of whether the case meets an exception identified in Taylor.8
claim and issue preclusion identified in Taylor. Judicial estoppel is more flexible than the claim and issue preclusion doctrines that were the concern in Taylor. It is true that both the preclusion doctrines and judicial estoppel attempt to ensure consistent results across proceedings. E.g., Montana v. United States, 440 U.S. 147, 154 (1979) (noting that claim preclusion “fosters reliance on judicial action by minimizing the possibility of inconsistent decisions“). But judicial estoppel is concerned more generally with protecting the integrity of the courts from the appearance and reality of manipulative litigation conduct. See New Hampshire, 532 U.S. at 749-50 (collecting cases that “have uniformly recognized that [the doctrine‘s] purpose is to protect the integrity of the judicial process“) (quotations omitted). Judicial estoppel is a flexible equitable doctrine that is not “reducible to any general formulation of principle” and accordingly does not lend itself to rigid rules. Id. at 750. To protect the integrity of the judicial process, a court needs freedom to consider the equities of an entire case. Therefore it is appropriate for a court considering judicial estoppel effects of a non-party‘s conduct to engage in an equitable inquiry that turns on the specific circumstances of an individual case. With this in mind, we turn to the equities of this case.
The district court concluded that the unusual circumstances of this case made it equitable to treat the trustee and Spehar Capital as the same entity so that positions taken by Spehar Capital in the California suit would be attributed to the trustee for purposes of judicial estoppel. The court pointed to a wealth of undisputed evidence demonstrating the appropriateness of treating Spehar Capital and the trustee as one and the same for this purpose. Spehar Capital was instrumental in orchestrating both the bankruptcy and the filing of this suit. Spehar Capital forced CMGT into bankruptcy for the purpose of convincing the trustee to bring a malpractice action against CMGT‘s counsel. Once CMGT was in bankruptcy, Spehar Capital approached the trustee about bringing this suit. When the trustee was reluctant, Spehar Capital agreed to lend the trustee money to investigate the possible claim and to carve out a small portion of any recovery for the benefit of the unsecured creditors. Spehar Capital then recommended the attorney to bring the suit and frequently communicated with the attorney. And of course, Spehar Capital was set to receive the lion‘s share of any recovery. Together, all of these undisputed facts convinced the district court that it was appropriate to hold the trustee accountable for the positions taken by Spehar Capital in the California suit. Grochocinski, 2010 WL 1407256, at *14. Once Spehar Capital‘s conduct was considered, the district judge concluded that it would be inconsistent for the trustee to prevail in the malpractice case, for the benefit of Spehar Capital, on the theory that Spehar Capital never should have obtained the judgment in the California suit. And without this argument, the court concluded, the malpractice action failed as a matter of law.
The trustee also argues that judicial estoppel is inequitable here because it will unfairly prevent the innocent unsecured creditors from receiving any recovery. In other circumstances, this could be a serious concern, but it does not sway the equities in this case. Had it not been for Spehar Capital‘s insistence, this suit never would have been brought. Before Spehar contacted the trustee about bringing this action, the trustee was prepared to terminate the bankruptcy as a no-asset estate. If the trustee had followed that course, the unsecured creditors would have received no recovery as well. Since this suit would not have been brought but for Spehar Capital and the bulk of any recovery would wind up in its pockets, it was not an abuse оf discretion to conclude that foreclosing the unsecured creditors’ recovery did not tip the scales against the use of judicial estoppel. We affirm the grant of summary judgment in favor of Mayer Brown.
III. Intervention
Also before this court is Gerard Spehar‘s appeal of the denial of his motion to intervene pursuant to