Although it is not alone in its financial woes, the bankruptcy filing of cryptocurrency giant FTX Trading, Ltd., has probably gotten the most attention of the cryptocurrency firms that are in deep financial distress (“the Crypto Winter”).
This article discusses the basic structure of the Chapter 11 bankruptcy filing, as well as some interesting questions that will arise in the administration of this case. This article is not intended to be an exhaustive discussion of Chapter 11 bankruptcy, nor an exhaustive recitation of everything that is going to happen in this FTX proceeding. There are likely to be many twists and turns, in bankruptcy court as well as criminal court.
FTX was founded in 2019 by Sam Bankman-Fried, who earlier founded a firm called Alameda Research. FTX was described in its Forbes magazine profile as follows:
One of the largest crypto trading exchanges in the world, it handles some 11% of the $2.4 trillion in derivatives traded each month. (It) raised $1.5 billion in private funding last year (2022), jolting its valuation from $1.2 billion to $25 billion.
However, as its obligations grew, and the cryptocurrency market began to contract, contracted, Bankman-Fried continue to live a lavish lifestyle, and FTX continued to recruit celebrity evangelists. Unfortunately, it appeared to more and more observers that FTX was nothing more than a Ponzi scheme. Fortune, December 3, 2022; The Guardian, December 17, 2022.
On November 11, 2011, FTX filed for bankruptcy protection in Delaware. Meanwhile, Bahamian authorities sought to exercise jurisdiction on that island and in New York. The Bahamian and US authorities have now agreed to have the case heard in the Delaware District of the United States Bankruptcy Court. FTX Trading Ltd., Case No. 22-11068 (JTD)
Additionally, in December 2022, Mr. Bankman-Fried was arrested in Nassau by the Royal Bahamas Police Force, and charged with wire fraud, securities fraud, money laundering, and other crimes. He was released on a $250 MM bond, and extradited to the United States.
One commentator compared Bankman-Fried to Bernie Madoff. Financial Historian Diana Henriques, quoted in The Guardian, 12/17/2022.
In late February 2023, a superseding indictment in the US charged Bankman-Fried with bank fraud, operating an unlicensed money transmitter, modified campaign-finance law violations, and conspiracy to make unlawful political contributions. Coindesk, February 23, 2023.
FTX and its founder face significant legal jeopardy.
Now back to bankruptcy. A chapter 11 bankruptcy differs from a chapter 7 business liquidation, in the sense that the Chapter 11 debtor is not going out of business. It is reorganizing its debts. For example, the Los Angeles Dodgers General Motors, and Delta Airlines, all went through Chapter 11, to reorganize their debts.
The purpose of the chapter 11 bankruptcy is to allow the management of the debtor company to continue to manage and operate the company, pursuant to strict supervision by the United States Trustee. Quarterly reports are generated to show revenue and expenses. The goal is to maximize assets available for the plan of reorganization. The company, now known as a “debtor in possession,” is not allowed to waste, or misuse assets.
Eventually, the company will propose a plan of reorganization to its creditors, the largest of which organize themselves into a creditor’s committee. The creditors committee and the debtor in possession will haggle over the details of the plan, for example, to cut the debt by 20-, 30-, or 40%, or to stretch the debt out over an additional number of years, or some combination of both debt reduction and new repayment terms. Elizabeth Warren & Jay L. Westbrook, “The Success of Chapter 11: A Challenge to the Critics,” 107 Mich. Law Review 603 (2009).
If the parties cannot agree on a plan of reorganization, then the court has to decide whether it will force the debtor in possession and creditors to come up with another plan, or whether it will cram the debtor plan down the throat of the creditors (known as a “cram down hearing”).
Additionally, the Chapter 11 debtor-in-possession, with certain important exceptions, is entitled to the cancellation (“discharge”) of certain debts after the plan of reorganization is approved. 11 USC Sec. 1141(d)(1)
The Bankman-Fried criminal charges, however, throw in a different wrinkle: if for example FTX was operating as an alter ego of its founder, and not following all corporate formalities, some creditors may argue that FTX was a fraudulent enterprise, and is not entitled to bankruptcy relief. 11 USC Sec. 523(a)(2)(4) & (a)(4) [debts involving fraud not dischargeable]; 523(a)(6) [debts related to malicious conduct not dischargeable]; 11 USC Sec. 523 (c). Or, in the alternative, certain types of claims may be brought against the company, such as those dealing with fraud, which are not resolved as part of the plan of reorganization. The recent conviction of the Trump Organization on fraud charges in New York City provides an example of a prosecution that could result in a non-dischargeable debt, and could saddle FTX with significant fines and penalties.
In other words, the criminal charges against Bankman-Fried, and the eventual evidence showing the relationship between him and the company, may have a lot to do with what type of relief FTX eventually receives from the bankruptcy court, even assuming a very business friendly Delaware bankruptcy judge.
WARNING: THIS POST DOES NOT CONSTITUTE LEGAL ADVICE!! PLEASE CONSULT AN ATTORNEY!!
In Lujan v. Defenders of Wildlife (1992) 504 US 555, 575-578, a very conservative jurist, Associate Justice Antonin Scalia, wrote the following:
“To permit Congress to convert the undifferentiated public interest in executive officers’ compliance with the law into an “individual right” vindicable in the courts is to permit Congress to transfer from the President to the courts the Chief Executive’s most important constitutional duty, to “take Care that the Laws be faithfully executed,” Art. II, § 3. It would enable the courts, with the permission of Congress, “to assume a position of authority over the governmental acts of another and co-equal department,” Massachusetts v. Mellon, 262 U. S., at 489, and to become” ‘virtually continuing monitors of the wisdom and soundness of Executive action.’ “
This was another way of saying that there are cases in which the court should not get involved, such as those involving the specific statutory actions of a co-equal branch of government (i.e., “non-justiciable” cases).
Consequently, even when Congress passes a law that has a public benefit, it does not automatically grant citizens a “private right of action” to block that law. Any citizen who disliked any law could ask the courts to prevent it from going into effect, which would lead to chaos.
The student loan forgiveness program announced by President Biden is on hold. And it may be an example of what Justice Scalia warned of in Lujan. The Supreme Court will be hearing arguments regarding the loan forgiveness program in a few weeks. (“Supreme Court Agrees to Decide on Biden’s Stalled Student Loan Forgiveness Plan, “Los Angeles Times, December 1, 2022). The arguments against the program, based on the 8th Circuit Court of Appeal decision, and another decision in Texas, raise the specter of placing the Supreme Court in the position of deciding on the appropriateness of day to day, or administrative actions by both Congress and the President.
In other words, the current student loan case invites the courts to get involved in non-justiciable cases. Albert, Lee A., “Justiciability and Theories of Judicial Review: A Remote Relationship,” 50 So.Cal. Law Review 1139, 1165-1166 (1977)
Pres. Biden and Education Sec’y Cardona base the program on the 2003 HEROES Act, which authorizes the Secretary to “waive or modify any statutory or regulatory provision applicable to the student financial assistance programs” if the Secretary “deems” such waivers or modifications “necessary to ensure” at least one of several enumerated purposes, including that borrowers are “not placed in a worse position financially” because of a national emergency. 20 U.S.C. § 1098bb(a)(1), (2)(A).”
The “national emergency” cited by Pres. Biden and Sec’y Cardona was the COVID pandemic, which began in 2020, and is far from over. “Tripledemic Update: RSV, Covid And Flu,” Forbes, December 13, 2022.
In the 8th circuit case, the state of Missouri claimed that it would be harmed by receiving less repayment revenue, should be loan forgiveness program go into effect. State of Nebraska, et al. v. Joseph R. Biden, Jr., et al., Case No. Case No. 22-3179.
This reasoning is problematic because: 1) No loans have been forgiven, so no money has been lost; 2) research shows that when borrowers are released from paycheck to paycheck jobs as a result of debt relief, those borrowers find better paying jobs, which would cause them to pay more in taxes to the state (Harvard Business School/Working Knowledge, “Forgiving Student Loan Debt Leads to Better Jobs, Stronger Consumers,” May 22, 2019); 3) the government has several different laws upon which they can rely for student loan relief [e.g., Higher Education Act (“HEA”), beginning at 20 US Code Sec. 1082; the Federal Family Education Loan Program, beginning at 20 USC 1071; the Federal Claims Collection Act, found beginning at 31 USC Sec. 3701, the Direct Loan Program of Title IV of the HEA, and federal regulations, such as 31 CFR 30.70 and 31 CFR 902.1 (a); see Open Letter to Sen. Elizabeth Warren, Legal Services Center of Harvard Law School, September 14, 2020]. For example, the HEA states that the Secretary of Education has the power “enforce, pay, compromise, waive, or release any right, title, claim, lien, or demand, however acquired, including any equity or any right of redemption.” 20 U.S.C. § 1082(a)(6) p. 3 (emphasis added);
And 4) striking down the program is exactly the type of mischief that Justice Scalia warned against in Lujan, as stated above.
Finally, if the quibble is with the HEROES Act as a basis for the program, shouldn’t the Supreme Court defer to the Executive, based on this undisputed alternative authority? Or, simply require the President to resubmit the program, citing to his alternative statutory authority rather than the HEROES Act, instead of gutting the program?
We may have an answer in June 2023.
THIS POST DOES NOT CONSTITUTE LEGAL ADVICE; PLEASE CONSULT AN ATTORNEY
When representing clients, attorneys rely on the words of the law (a “statute”) and ask the court to implement the plain, obvious meaning of its words. When it comes to federal statutes, however, it is easy to overlook the “comments” by Congressional committees that draft the statutes, or the agencies which implement them. Such comments can be critical in court. For example, a recent unanimous Court of Appeal used a statute’s agency staff comments to protect a consumer from a deceitful lender. In Gilliam v. Levine, Case No. 18-56373 (9th Circuit, 2020), the court recounts that the borrower obtained a loan as trustee for a family trust. The purpose of the loan was to make home repairs. The home itself was the sole asset of the trust. Another family member, who occupied the home, was the trust beneficiary. The borrower later discovered that the due date for the final loan payment was 1 year earlier than she had been led to believe. The borrower was alarmed, and sued to cancel (rescind) the loan under federal law, Truth in Lending Act (TILA), 15 U.S.C. § 1601, et seq., and the Real Estate Settlement Practices Act (RESPA), 12 U.S.C. § 2601. The borrower also asserted a claim under California’s Fair Lending Law [Rosenthal Act], 1788.1(b) of California’s Rosenthal Act, California Civil Code §§ 1788.1(b). The trial judge dismissed the lawsuit, because, according to that judge, the loan went to the trust, not to a person, and hence was not a consumer loan. The 9th Circuit Court of Appeal reversed the trial court, noting the federal Consumer Financial Protection Bureau’s Official Staff Commentary to Regulation Z (mortgage loans), which states that “[c]redit extended for consumer purposes to certain trusts is considered to be credit extended to a natural person rather than credit extended to an organization.” 12 C.F.R. pt.1026, Supp. 1, § 1026.3 Comment 3(a)-10. (And under California law, the trustee, not the trust, holds title to trust property – – Author) The “certain trusts,” which fall under the rubric of “natural persons,” included the trust in this case, which was formed for tax or estate planning purposes [which benefit people]. The trust in question was “primarily for personal, family, or household purposes.” 15 U.S.C. § 1602(i). The borrower was the aunt (as Trustee); the niece was the beneficiary; and the trust property was a private home. As a result, the loan was a “consumer credit transaction,” which was subject to the Fair Lending Laws. And the Comment makes the point: Look to the substance of the transaction. Here it was to benefit a consumer, not a company. 12 C.F.R. pt. 1026, Supp. 1, and § 1026.3 Comment 3(a)-10.i. Because this was a consumer loan, the Trustee had the right to rescind this deceptive loan. WARNING: THIS POST DOES NOT CONSTITUTE LEGAL ADVICE; PLEASE CONSULT AN ATTORNEY
Bankruptcy is a legal proceeding that liquidates (eliminates) the unsecured debts of the debtor (debts not backed by collateral). It is important to note, however, that the debtor may have a particular legal status, and that legal status is what determines which bankruptcy is used, or which entity is able to cancel its debt.
For example, if a corporation files for bankruptcy, and is properly formed and documented, then it may file for bankruptcy without the necessity of its owners also filing for bankruptcy. And the corporation’s unsecured debts may be eliminated or re-structured, depending on the particular type of relief applied for.
However, if both the corporation and the individual are equally liable on the debt, such as through a personal guarantee by the owner, then the filing of a bankruptcy petition for the corporation will not insulate the individual. The individual would also need to separately file for bankruptcy protection, if that is the type of relief sought.
The case of Alex Jones is a illustrative. Mr. Jones, through his media outlet, InfoWars, has become infamous for making the false claim that the mass shooting at the Sandy Hook Elementary School was some type of staged or phony incident. Several parents of children killed at Sandy Hook Elementary sued Mr. Jones and InfoWars for defamation, on the theory that by maintaining such a claim, Mr. Jones apparently implied that the grieving parents were lying about the deaths of their children.
For whatever reason, Mr. Jones did not contest the lawsuit, choosing instead to allow the court to take a default against him. Such an action, however, did not prevent the court from continuing its proceedings against Mr. Jones and his company or companies.
The court would eventually enter judgments for large sums of money in favor of the parents, both against Mr. Jones, and against some or all of his companies, including Infowars.
See, for example, cases collected by the First Amendment Watch at NYU: https://firstamendmentwatch.org/deep-dive/alex-jones-infowars-and-the-sandy-hook-defamation-suits/
Mr. Jones responded to being hit with these large judgments by filing a bankruptcy petition for Infowars. Bankruptcy of course means that no further action collection against the debtor’s personal unsecured debts, unless the debts (in Jones’s case, the judgments) relates to fraud, moral turpitude, or is otherwise considered non-dischargeable.
Setting aside the question of whether the judgments for defamation are connected to moral turpitude, where these false statements relate to the deaths of the plaintiff’s children, there appears to be a disconnect between the judgments and the bankruptcy filing by Mr. Jones. He declared bankruptcy for Infowars, but apparently not for himself personally. The judgments were against him personally, as well as against Infowars and other entities. In other words, if there is a judgment against Infowars, bankruptcy might have the effect of making the judgment uncollectible against Infowars, but the judgment against Jones himself would be unaffected.
A bankruptcy petition for Infowars is not the same as a bankruptcy for Alex Jones, because the individual and the company are separate, assuming that the company is created in a proper, recognized corporate form, such as a Corporation, LLC, or other distinct legal entity.
Mr. Jones cannot protect himself personally by filing a bankruptcy for Infowars. He would have to file bankruptcy for himself as well. It may be that he did not want to file bankruptcy for himself, and believed that somehow corporate bankruptcy would protect his personal fortune.This is not the case.
Thus, when an individual and corporation are both fully liable on the debt, corporate bankruptcy will not protect the individual. This occurs, for example, where an individual personally guarantees the debt of a company, or the corporation and the individual are jointly liable.
So apparently here in the case of Infowars, Infowars can be pursued for the Judgment, but in the absence of Infowars, Mr. Jones may also be pursued, unless he files for personal bankruptcy, and the bankruptcy court accepts the filing as appropriate, and not involving moral turpitude, or affected by some other disqualifying factor.
THIS POST DOES NOT CONSTITUTE LEGAL ADVICE, AND READING IT DOES NOT CREATE AN ATTORNEY CLIENT RELATIONSHIP. PLEASE CONSULT DIRECTLY WITH AN ATTORNEY FOR ANY LEGAL ADVICE!!
The primary purpose of the bankruptcy stay [11 USC Sec. 362] is to protect the debtor. (In re Fuel Oil Supply and Terminaling, Inc., 30 BR 360, 362 (Bankr.N.D.Tex.1983), cited in In re Globe Investment & Loan Co., Inc., 867 F.2d 556 (1989)). By stopping all collection actions against the debtor, the bankruptcy stay acts 1) as an injunction to preserve the estate, and 2) to prevent the creditors from trying to go around the bankruptcy process to collect. Once the debtor receive the discharge (11 USC Sec. 727), creditors are no longer able to collect the discharged debts. A creditor who, despite the discharge, seeks to collect a pre-bankruptcy debt, runs the risk of a contempt citation and punishment by the federal court. And so it was held recently by the US Supreme Court which held that a business dispute with the debtor, that had begun prior to the debtor’s filing for bankruptcy, was discharged by the bankruptcy, and no further collection activity would be allowed. Writing for a unanimous US Supreme Court, Associate Justice Breyer opined that the business creditors, who had initiated the lawsuit against the debtor (Mr. Taggart) had no reasonable basis to believe that the bankruptcy stay, and the subsequent discharge would not act to bar the continued litigation against the debtor. The debt was considered wiped away, and the creditors actions, seen objectively, were not only impermissible, but gave rise to contempt sanctions: “Under the fair ground of doubt standard, civil contempt therefore may be appropriate when the creditor violates a discharge order based on an objectively unreasonable understanding of the discharge order or the statutes that govern its scope.” Taggart v. Lorenzen, ___ U.S. ___, 139 S.Ct. 1795, 1801, 204 L.Ed.2d 129 (2019). The facts showed that the creditors had a working knowledge of the effects of bankruptcy law, and objectively should have realized that the pre-bankruptcy debt was no longer collectible. Therefore, the Supreme Court remanded the matter back to the 9th Circuit, to impose appropriate sanctions: “We conclude that the Court of Appeals erred in applying a subjective standard for civil contempt. Based on the traditional principles that govern civil contempt, the proper standard is an objective one. A court may hold a creditor in civil contempt for violating a discharge order where there is not a “fair ground of doubt” as to whether the creditor’s conduct might be lawful under the discharge order.” The Takeaway: Creditors Who Know that a Debtor has Filed for Bankruptcy Should Take No Action Against the Discharged Debtor, without First Having a Very Detailed, Careful Conversation with an Attorney, Lest Those Creditors End Up Held in Contempt!!