“STAYING” AWAY FROM CONTEMPT SANCTIONS
Suppose you find yourself in this situation. You’ve been involved in litigation for months against a party you believe defrauded you out of thousands of dollars. After protracted legal proceedings, your judge finally sets a trial date. You are finally going to have your day in court against this person.
But shortly before you go to trial, you receive a tip that your defendant has filed for bankruptcy. And not only that, but you also find out that this person filed for bankruptcy a couple of years ago, in the middle of your case, and did not tell you or your judge. And not only that, but you also find out that the person received a discharge (cancellation of all pre-bankruptcy unsecured debt), and that the trustee determined that the person had no assets. The bankruptcy case is CLOSED.
No problem. You think that, because you have a trial date, all you have to do is go before your state court judge and plead your case for fraud. Surely, your state court judge can grant you relief, and force this fraudulent, thieving defendant to pay you your damages.
What could possibly go wrong? Unfortunately, a lot.
Because the case has closed, there is no more “automatic stay” of 11 USC Sec. 362. There is, however, a “discharge injunction” 11 USC Sec. 524(a), which means that creditors are barred from attempting to collect discharged debts.
Furthermore, the Bankruptcy Court has exclusive jurisdiction over the question of whether these discharged debts are related to fraud. 11 USC Sec. 524 (a)(2), (4) & (6); Grogan v. Garner, 498 U.S. 279, 284 n. 10, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); Aldrich v. Imbrogno (In re Aldrich), 34 B.R. 776, 779 (9th Cir. B.A.P.1983), cited in Ackerman v. Eber (In re Eber) 687 F.3d 1123 (9th Cir. 2012).
Based on these authorities, you will likely seek to file a dischargeability complaint under 11 USC Sec. 524 (a)(2), (4) or (6), in the Bankruptcy Court; or an action to revoke the discharge under 11 USC Sec. 727 (d), for example, if there are multiple false statements or multiple examples of deception in the defendant/debtor’s bankruptcy papers, such that it appears that the discharge itself was obtained through fraud.
Additionally, the US Supreme Court has ruled that if the Plaintiff or Plaintiff’s attorney is well-versed in bankruptcy law, the failure to observe the discharge injunction (in this case, failure to seek a ruling on fraud in the bankruptcy court) is considered much more knowing and culpable. Taggart v. Lorenzen, 139 S. Ct. 1795 (2019) [Slip Opinion, p. 7]. In other words, to paraphrase a line from Michael Mann’s film, The Insider, “The more you know, the worse (the contempt sanction) gets.”
The point is that you want your client to have the maximum ability to seek a ruling on the defendant’s alleged fraud in State Court. This, however, must await a ruling from the Bankruptcy Court in this regard, and any attempt to circumvent the Bankruptcy Court could easily backfire and be very costly.
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!!
San Diego County Debtor Filed Bankruptcy Petition in 2021. Bankruptcy Court Held, and 9th Circuit Court of Appeals Agreed, that California’s $600K 2021 Homestead Exemption Applied in its Entirety. That Exemption is then Added to the Mortgage Balances and Other Liens on the Property, and Where, as Here, the Sum of Those Figures Exceeds the Value of the Real Estate, the Debtor May Avoid the Trustee’s Claims. Debtor was Not Limited to the Statutory Exemption Amount at the Time the Lien was Incurred (2014).
Barclay [US Trustee] v. Boskoski [Debtor] (9th Circuit, 2022) 52 F.4th 1172;
Argued and Submitted 9/23/2022, at Pasadena, California.
Opinion Issued 11/14/2022.
On August 24, 2022, President Joe Biden announced a proposed plan, through the Department of Education, to forgive a portion of student loan debt owed by millions of Americans. The plan proposed to allow cancellation of up to $10,000 for certain loan recipients, and up to $20,000 for Pell Grant recipients. This forgiveness would be given only to holders of federal loans, and would not guarantee full cancellation of all debt owed by every borrower, such as those who owe more than $20,000 in Pell grants. The program also does not apply to those whose loans come from private lenders, such as Sallie Mae.
As of this writing, over 26 million borrowers have applied for relief, and the Biden Administration has approved certain applicants for relief. But no loan relief has been granted.
No relief has been granted because several Republican Attorneys General, from Nebraska, Missouri, Kansas, Iowa, Arkansas, and South Carolina, sued to stop the program (Eastern District of Missouri, Case No. 4:22CV1040, filed 9/29/2022). Briefly, the States claimed that the loan relief would harm them financially, based on lost loan repayments (the States apparently did not discuss how they might benefit from increased tax payments if the borrowers were not tied to low-wage jobs to make their current payments; nor did the States discuss how much more money they would receive through the federal infrastructure bill).
Eastern District of Missouri Judge Autrey threw the case out, based on lack of “standing” (i.e., lack of an actual harm that the States had suffered), but the 8th Circuit Court of Appeals, which oversees several Midwestern states, placed this loan relief program on hold, pursuant to an injunction. State of Missouri, et al. v. Joseph R. Biden, etc., et al., Case No. 22-3179, published 11/14/22
Unfortunately, the 8th Circuit’s logic, particularly on the issue of immediate, actual harm (“standing”) appears disingenuous, and suggests a political motive behind the decision. For example, the 8th Circuit ruled that the state of Missouri has standing, because a loan fund created by the state of Missouri would potentially lose money if some of the loans granted through that fund were reduced or forgiven. That no relief has yet been granted means that no funds have yet been lost. And thus the state of Missouri has no standing. Lujan v. Defenders of Wildlife (1992) 504 US 555, 575-578 [opinion of Scalia, J].
Even more worrisome is the court’s assertion that because a federal decision causes a state to lose money, the state can sue to stop that program. Taken to its logical extreme, if the federal government decides from year to year to spend less money on highway repair for roads in Ohio than in Kansas, Ohio can sue and stop the program. Or if, year to year, the federal government decides to grant more funds for cancer research to universities in Minnesota than in California, California can sue to stop the program. This is the sort of chaos that Scalia warned against; the courts would assume day to day authority over the acts of a co-equal branch of government. Lujan v. Defenders of Wildlife (1992) 504 US at 577.
In other words, the 8th Circuit Court’s reasoning leads to chaos, and no federal spending program could ever be approved, because by definition, some agency, state, or individual will receive less money than another.
Additionally, how these States might benefit eventually from the improved financial health of borrowers apparently played no role in the 8th Circuit’s decision.
The Biden Administration has asked the US Supreme Court to intervene and overturn the 8th Circuit. (SCOTUS Blog, 11/18/2022) However, given the Court’s extreme conservative nature, as well as its willingness to disregard long-established precedent, a favorable ruling is not assured.
During the years of the Financial Crash (2007-2012), one could read in the press about something called “predatory lending,” or “lending discrimination,” or “disparate treatment,” or “disparate impact.” These concepts and legal doctrines were important because they spoke to the fact that persons of color were treated deceptively or unfairly, or tended to receive subprime loans, or loans that they could not repay, or were preyed upon by certain lenders. The end result was that minority borrowers were much more likely to have their homes foreclosed upon than were Caucasian borrowers.
Central to the effects of the Financial Crash upon minority borrowers, in particular, was the belief among certain lenders that they could do whatever they wanted with regard to minority borrowers.
A recent ruling from Pennsylvania points to the continued need for vigilance with regard to lending discrimination. The US Department of Justice and the Consumer Financial Protection Bureau sued Trident Mortgage for redlining practices against borrowers of color in the Philadelphia area. Consumer Financial Protection Bureau v. Trident Mortgage Company LP, Case No. 2:22-cv-02936, U.S. District Court for the Eastern District of Pennsylvania.
In its press release of July 27, 2022, announcing the settlement with Trident Mortgage, the Department of Justice stated that:
“Redlining is an illegal practice in which lenders avoid providing credit services to individuals living in communities of color because of the race, color, or national origin of residents of those communities. The complaint in federal court today alleges that from at least 2015 to 2019, Trident failed to provide mortgage lending services to neighborhoods of color in the Philadelphia Metropolitan area, that its offices were concentrated in majority-white neighborhoods, and that its loan officers did not serve the credit needs of neighborhoods of color. The complaint also alleges that loan officers and other employees sent and received work e-mails containing racial slurs and referring to communities of color as ‘ghetto.’ ”
The director of the Consumer Financial Protection Bureau, Rohit Chopra, stated the importance of fighting discrimination, when he said, in connection with the Trident settlement, “With housing costs so high, it is critical that illegal discrimination does not put homeownership even further out of reach.”
The Department of Justice, in commenting on the consent order, stated that the Truth in Lending Laws and other anti-discrimination laws must continue to be enforced. 15 USC §§1601, et seq (Truth in Lending Act); 15 USC §1691 (Equal Credit Opportunity Act); 15 USC §1681 et seq. (Fair Credit Reporting Act). Courts will have an important role, looking to the letter of the anti-discrimination laws, their intent, and to the reality on the ground, rather than finding excuses to look the other way, and blame the victim, simply because confronting reality may be uncomfortable or inconvenient.
Warning: These Posts Does Not Constitute Legal Advice; Please Consult An Attorney