In an area where the courts are divided, Bankruptcy Judge Stuart M. Bernstein of Manhattan ruled that a civil penalty owing by a corporate debtor to a federal agency for defrauding consumers is dischargeable under Section 1141(d)(6)(A).
The debtor was a telecommunications provider that entered into a consent decree with the Federal Communications Commission before bankruptcy. The debtor had made misrepresentations to consumers in marketing calls and placed unauthorized charges on customers’ bills.
The consent decree called for the debtor to issue $1.9 million in refunds to customers and pay a $4.2 million civil penalty to the FCC. By the time of its bankruptcy, the debtor had paid its customers, but not $2.1 million of the fine to the FCC.
The government filed an adversary proceeding to declare that the $2.1 million remaining to be paid on the civil fine was not discharged under Section 1141(d)(6)(A). In his 15-page opinion on July 9, Judge Bernstein decided that the remaining fine was dischargeable.
Until 2005, Judge Bernstein explained, all otherwise nondischargeable debts under Section 523(a) owing by a corporate debtor were discharged on plan confirmation by Section 1141. The so-called BAPCPA amendments added Section 1141(d)(6)(A), which says that confirmation does not discharge a corporate debtor from “any debt . . . of a kind specified in paragraph (2)(A) or (2)(B) of section 523(a) that is owed to a domestic governmental unit . . . .”
Of pertinence to the case at hand, Section 523(a)(2)(A) bars discharge of a debt “obtained by . . . false pretenses, a false representation, or actual fraud . . . .” Naturally, the government argued that the civil penalty, stemming from the debtor’s actual fraud, was nondischargeable under Sections 1141(d)(6)(A) and 523(a)(2)(A).
Judge Bernstein interpreted Supreme Court authority in the general area. He began with Cohen v. de la Cruz, 523 U.S. 213 (1998), where the Supreme Court held that treble damages for actual fraud are nondischargeable along with the creditor’s actual damages.
When the government itself is a victim of fraud, Judge Bernstein said that the government’s noncompensatory damages would be nondischargeable under Section 523(a)(2)(A) in view of Cohen. He also parsed Husky International Electronics Inc. v. Ritz, 136 S. Ct. 1581 (2016), where the Supreme Court read Section 523(a)(2)(A) broadly to encompass actual fraud where there was no misrepresentation. To read ABI’s report on Husky, click here.
Pointing in the other direction, Judge Bernstein took counsel from Field v. Mans, 516 U.S. 59 (1995). The Supreme Court held that there must be reasonable reliance for nondischargeability resulting from actual fraud, even though a reliance requirement is not contained in the language of Section 523(a)(2)(A). (Query: Does Husky undercut Field?]
Judge Bernstein said that “[s]ome courts have extended Cohen beyond the victims of the fraud to any non-compensatory award in favor of a governmental unit that arose from a fraud perpetrated on a third party.” The courts that he cited included the Eleventh Circuit in SEC v. Bilzerian (In re Bilzerian), 153 F.3d 1278 (11th Cir. 1998).
However, Judge Bernstein decided to follow a decision this year where a district court in Delaware held that fines for violating environmental regulations are dischargeable in a corporate debtor’s chapter 11 reorganization. South Coast Air Quality Management District v. Exide Technologies (In re Exide Technologies), 613 B.R. 79 (D. Del. March 24, 2020). To read ABI’s report on Exide, click here.
Exide is not squarely on point, however, because the Delaware case did not involve money or property obtained by actual fraud, like the case before Judge Bernstein. Since Exide involved fines for environmental pollution, the Delaware court decided that the fines were dischargeable because they fell within Section 523(a)(7), under which debts of this kind are dischargeable by corporate debtors in chapter 11. That section covers fines or penalties owing to the government that are not “compensation for actual pecuniary loss.”
Judge Bernstein “agree[d] with the reasoning of Exide” by concluding that Section 523(a)(6) “does not reach the FCC Penalty.” Picking up where Field and Husky left off, he said that actual fraud “is tethered to the common law concept of fraud.”
The government, Judge Bernstein said, advocated for a rule where government fines for actual fraud would be nondischargeable in “the absence of a misrepresentation to the FCC, an intent to deceive or induce reliance by the FCC, actual reliance by the FCC, and any pecuniary loss suffered by the FCC.”
Judge Bernstein described the FCC penalty as “a statutory claim arising from a fraud perpetrated on another and not a common law fraud claim that seeks to recover for the FCC’s own injury.” In Cohen and Husky, he said, the plaintiffs were the victims of the fraud, and “neither decision extends the notion of common law fraud to someone who has not been defrauded and has not suffered a pecuniary loss.”
In an area where the courts are divided, Bankruptcy Judge Stuart M. Bernstein of Manhattan ruled that a civil penalty owing by a corporate debtor to a federal agency for defrauding consumers is dischargeable under Section 1141(d)(6)(A).
The debtor was a telecommunications provider that entered into a consent decree with the Federal Communications Commission before bankruptcy. The debtor had made misrepresentations to consumers in marketing calls and placed unauthorized charges on customers’ bills.
The consent decree called for the debtor to issue $1.9 million in refunds to customers and pay a $4.2 million civil penalty to the FCC. By the time of its bankruptcy, the debtor had paid its customers, but not $2.1 million of the fine to the FCC.
The government filed an adversary proceeding to declare that the $2.1 million remaining to be paid on the civil fine was not discharged under Section 1141(d)(6)(A). In his 15-page opinion on July 9, Judge Bernstein decided that the remaining fine was dischargeable.
Until 2005, Judge Bernstein explained, all otherwise nondischargeable debts under Section 523(a) owing by a corporate debtor were discharged on plan confirmation by Section 1141. The so-called BAPCPA amendments added Section 1141(d)(6)(A), which says that confirmation does not discharge a corporate debtor from “any debt . . . of a kind specified in paragraph (2)(A) or (2)(B) of section 523(a) that is owed to a domestic governmental unit . . . .”
Of pertinence to the case at hand, Section 523(a)(2)(A) bars discharge of a debt “obtained by . . . false pretenses, a false representation, or actual fraud . . . .” Naturally, the government argued that the civil penalty, stemming from the debtor’s actual fraud, was nondischargeable under Sections 1141(d)(6)(A) and 523(a)(2)(A).
Judge Bernstein interpreted Supreme Court authority in the general area. He began with Cohen v. de la Cruz, 523 U.S. 213 (1998), where the Supreme Court held that treble damages for actual fraud are nondischargeable along with the creditor’s actual damages.