Granting a motion for panel rehearing, the Fifth Circuit held for a second time, again by a 2/1 vote, that third parties who paid more than $130 million to the receiver in the R. Allen Stanford Ponzi scheme are entitled to an order barring creditors from suing on the creditors’ own claims.
The new opinion stands in contrast to the Fifth Circuit’s long-held ruling that bankruptcy courts lack power to grant nonconsensual, third-party releases in chapter 11 plans. See, e.g., Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584 F.3d 229, 251 (5th Cir. 2009).
As before, the dissenter in the Fifth Circuit would have held that the receivership court lacked subject matter jurisdiction to bar creditors from suing on their own claims.
Exactly where the Fifth Circuit stands on third-party releases, either in receiverships or in bankruptcy, may not be clear unless the appeals court hears the Stanford appeal en banc. As it now stands, a receiver in federal court in the Fifth Circuit has a shot at imposing a nonconsensual, third-party release, while a chapter 11 debtor or trustee does not.
The Stanford Ponzi Scheme and the Settlement
The Securities and Exchange Commission put Stanford International Bank into a federal receivership in Dallas after discovering that the business in reality was a Ponzi scheme where hundreds of defrauded investors lost some $5 billion. The receiver brought lawsuits generating recoveries for distribution to all creditors pro rata. Stanford himself is serving a 110-year prison sentence.
The receiver sued two insurance brokers who provided policies that were advertised as providing investors with complete protection against loss and assured investors that Stanford was running a legitimate business. As it turned out, the policies were almost as illusory as the Stanford business.
After years of litigation and discovery, the two brokers agreed to settle and pay the receiver more than $130 million. At the time, the brokers were also defendants in lawsuits in state court brought by defrauded Stanford investors complaining about the representations made to them. In return for paying $130 million, the brokers therefore insisted that the receivership court enter a bar order precluding investors from pursuing their own claims.
The Original Panel Split Opinion
The district court approved the settlement and the bar order. Objecting investors appealed. For himself and Circuit Judge James E. Graves, Jr., Circuit Judge Patrick E. Higginbotham upheld the settlement and the bar order in a July 22 opinion. Zacarias v. Stanford International Bank Ltd., 931 F.3d 382 (5th Cir. July 22, 2019).
Circuit Judge Don R. Willett dissented. While he said he appreciated the “settlement’s practical value,” the district court, in his view, “lacked jurisdiction to grant the bar orders.” For ABI’s report on the July opinion and dissent, click here.
In early August, the dissenting investors filed a petition for rehearing en banc. They contended that the majority opinion was inconsistent and irreconcilable with another Fifth Circuit opinion just weeks earlier, also arising from the Stanford Ponzi scheme. See SEC v. Stanford International Bank Ltd., 927 F.3d 830 (5th Cir. June 17, 2019). To read ABI’s discussion of the June decision, click here.
In the June opinion, a different panel of Fifth Circuit judges had held, among other things, that receivers do not have greater powers than bankruptcy trustees to settle claims and enter bar orders based on the receivership court’s in rem jurisdiction.
The two Stanford cases were distinguishable, but, of course, the question remains whether the distinction makes a difference.
In the June opinion, the Fifth Circuit set aside an injunction barring insureds from suing the insurance companies, which had settled with the receiver. The insureds who were barred from suing the insurers included former Stanford employees who had claims under the policies to cover defense costs and potential judgments. The insureds were also barred from having claims in the Stanford receivership. Were it not for the reversal in the Fifth Circuit, the former employees would have had no protection from claims against them.
The July opinion, in contrast, dealt with the claims of defrauded investors who could receive distributions, unlike the insureds in the earlier case.
The Revised Opinions
On rehearing, the same three-judge panel from July treated the en banc petition as a petition for panel rehearing and withdrew their earlier opinion. In its place, the majority published a more lengthy opinion.
Again writing for the majority, Judge Higginbotham reached the same result, this time focusing more on the differences in the two Stanford appeals. He trotted out more facts to show that the brokers were in cahoots with Stanford and allowed their representations to attract new investors. He also stressed how the estate’s claims were identical to those of the defrauded investors.
Judge Higginbotham conceded that the receivership “cannot reach claims that are independent and non-derivative and that do not involve assets claimed by the receivership.” On the other hand, he said the dissenting investors’ “claims are derivative of and dependent on the receiver’s claims, and their suits directly affect the receiver’s assets.”
Judge Higginbotham stressed that the dissenting investors’ claims competed with the receiver’s for the same dollars from the settling defendants. Analyzing the facts, he said that the objectors in the June Fifth Circuit opinion were additional insureds who were not “active co-conspirators” who were left with no ability to collect on their claims against the insurance companies.
Judge Willett again dissented, this time in a shorter, two-page opinion. Again, he shared “the majority’s appreciation for this settlement’s practical value.” In his view, the dissenting investors’ and the receiver’s claims were not identical. He emphasized how the settling brokers had made representations directly to the investors.
Because the objecting investors had “distinct” claims, Judge Willett concluded that the receivership court “lacked jurisdiction to adjudicate them, or to enjoin them.”
Judge Willett said he “would thus vacate the bar orders.”
Observations
Panel rehearing enabled the majority to sharpen their arguments. The brevity of Judge Willett’s dissent could be interpreted as a sign that he believes the Fifth Circuit will hear the case en banc.
Another petition for rehearing en banc seems likely. If rehearing is granted once more, the outcome will determine whether receivers in the Fifth Circuit can confer nonconsensual, third-party releases even though they are unavailable in chapter 11 plans.
In the new Stanford opinion, the majority and the dissent both framed the question around the existence or lack of subject matter jurisdiction. En banc, the Fifth Circuit should examine the jurisdictional, prudential or statutory basis for permitting or barring third-party releases.
In a similar bankruptcy case, there could be subject matter jurisdiction if the need for a third-party injunction fell within the bankruptcy court’s “related to” jurisdiction under 28 U.S.C. § 1334(b). In this writer’s view, there would be subject matter jurisdiction in bankruptcy, on the theory that there is a conceivable effect on the estate because (1) there might be no settlement without a third-party junction, and (2) the individual plaintiffs were pursuing claims that belonged to the bankrupt estate.
However, the presence of subject matter jurisdiction does not mean that a bankruptcy court is at liberty to impose a third-party injunction. There must also be a statutory basis giving the court power to grant the equivalent of a discharge to a nondebtor. In that regard, courts disagree on whether Section 524(e) precludes the issuance of third-party injunctions.
In an SEC receivership like Stanford, subject matter jurisdiction is equally broad. Under 15 U.S.C. §§ 77v(a) and 78aa(a), district courts have jurisdiction over “all suits in equity” to “enforce any liability or duty created by” the securities laws. Again, the existence of subject matter jurisdiction does not mean that a court can or should issue a nondebtor injunction. Assuming there is jurisdiction, the question then becomes: Do the securities laws confer statutory power for the issuance of a third-party injunction?
In this writer’s view, courts should analyze third-party injunctions in terms of statutory power. Even if there is power, a court may still believe as a prudential matter that such injunctions are inappropriate.
The lack of subject matter jurisdiction has another implication: If a third-party injunction is beyond a court’s subject matter jurisdiction, dismissal of an appeal for equitable mootness may not be available.
One final thought. The trustee cleaning up the Madoff Ponzi scheme has been successful in the Second Circuit in enjoining defrauded investors from suing on claims based on the same facts as claims belonging to the estate. In that sense, the Fifth and Second Circuit cases are identical. If the Fifth Circuit sits en banc and reverses, there will arguably be a split of circuits.
Granting a motion for panel rehearing, the Fifth Circuit held for a second time, again by a 2/1 vote, that third parties who paid more than $130 million to the receiver in the R. Allen Stanford Ponzi scheme are entitled to an order barring creditors from suing on the creditors’ own claims.
The new opinion stands in contrast to the Fifth Circuit’s long-held ruling that bankruptcy courts lack power to grant nonconsensual, third-party releases in chapter 11 plans. See, e.g., Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584 F.3d 229, 251 (5th Cir. 2009).
As before, the dissenter in the Fifth Circuit would have held that the receivership court lacked subject matter jurisdiction to bar creditors from suing on their own claims.
Exactly where the Fifth Circuit stands on third-party releases, either in receiverships or in bankruptcy, may not be clear unless the appeals court hears the Stanford appeal en banc. As it now stands, a receiver in federal court in the Fifth Circuit has a shot at imposing a nonconsensual, third-party release, while a chapter 11 debtor or trustee does not.
The Stanford Ponzi Scheme and the Settlement
The Securities and Exchange Commission put Stanford International Bank into a federal receivership in Dallas after discovering that the business in reality was a Ponzi scheme where hundreds of defrauded investors lost some $5 billion. The receiver brought lawsuits generating recoveries for distribution to all creditors pro rata. Stanford himself is serving a 110-year prison sentence.
The receiver sued two insurance brokers who provided policies that were advertised as providing investors with complete protection against loss and assured investors that Stanford was running a legitimate business. As it turned out, the policies were almost as illusory as the Stanford business.
After years of litigation and discovery, the two brokers agreed to settle and pay the receiver more than $130 million. At the time, the brokers were also defendants in lawsuits in state court brought by defrauded Stanford investors complaining about the representations made to them. In return for paying $130 million, the brokers therefore insisted that the receivership court enter a bar order precluding investors from pursuing their own claims.