Dischargeability, Criminal Behavior, & FTX Trading, Ltd.
A debtor in bankruptcy, whether individual, joint, or corporate, is/are looking to end his/her/its responsibility for pre-petition, unsecured debts. Those are debts that have no collateral. 11 USC Sec. 727, 1228 & 1328.
In bankruptcy parlance, the concept of ending a debt is a “discharge.” However, not all unsecured debts are “dischargeable.”
In other words, a discharge is not a discharge when the US Code says, “No.”
For example, the “discharge” and “dischargeability” will be front and center in the FTX Trading Ltd. bankruptcy proceedings in Delaware, Case No. 22-11068-JTD, in which the former CEO, Sam Bankman-Fried, will be a focus, not only as the brains behind the operation (he went to MIT), but also for his alleged criminal activity. There will likely be allegations that FTX itself was connected to Bankman-Fried’s alleged crimes.
The basic concepts of the discharge are described as follows:
The court’s determination that the debtor no longer owes the debt. The official cancellation or termination of the debt. In re Ybarra, 424 F.3d 1018, 1022 (9th Cir. 2005); see, US Bankruptcy Court for the District of New Jersey, “Glossary of Terms.”
The eligibility for the debt to be discharged. Typically, these consist of credit cards, hospital bills, and other unsecured promises to pay debts, which are considered dischargeable, with some notable exceptions. 11 U.S.C. §§ 727(b), 523(a).
There are certain categories of debts which cannot be discharged. That is because the debts are incurred for the benefit of another person, or are the result of other court proceedings, such as a verdict of fraud, certain criminal convictions, or other indications of fraudulent conduct. For example, debts which are attributed to fraudulent or malicious criminal conduct are not dischargeable. 11 U.S.C. §727(a), (b), and e.g., §523(a)(4) [fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny], (6) [willful and malicious injury by the debtor to another entity or to the property of another entity], (19), (20); In re Zelis, 66 F.3d 205, 209 (1995).
Additionally, for individuals, spousal support and child support are not dischargeable, for obvious reasons. The bankruptcy court does not want to end the parental or spousal support duties of the debtor. 11 USC Sec. 523 (a)(5).
As to FTX, Bankman-Fried was initially arrested in Nassau by the Royal Bahamas Police, 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. Additional criminal charges were levied against him in the US. CNN, “FTX founder Sam Bankman-Fried indicted on new criminal charges, including campaign finance violations,” February 23, 2023.
Consequently, the “exceptions to discharge” will be especially important in the FTX bankruptcy. For example, it seems likely that the US Government or multiple creditors will challenge the dischargeability of some or all of FTX’s debts through dischargeability complaints, based on 11 U.S.C. Sec. 727(a), (b), and the exceptions to discharge stated in 11 USC Sec. 523(a)(4), (6), (19), (20). In re Albert-Sheridan, 960 F.3d 1188 (9th Cir. 2020). The government and creditors will likely contend that FTX seeks a discharge connected to fraudulent or bad-faith criminal conduct.
The FTX bankruptcy, because the sum of money involved, (over $8 billion), will garner a lot of attention. Additionally, it should also generate opportunities for the Bankruptcy Court and the Court of Appeal to further explain how alleged criminal conduct will deny a discharge to an individual or corporate debtor.