Bankruptcy Judge Christopher Sontchi of Delaware wrote an opinion reminding us that the Supreme Court’s Grupo Mexicano decision from 1999 does not prohibit bankruptcy courts from freezing the assets of defendants accused of fraud.
The facts are difficult to ascertain because the complaint and other documents are sealed. It appears, however, that the defendants, without the corporate plaintiff’s knowledge or consent, allegedly applied for a “loan” on behalf of the plaintiff from the Small Business Administration under the Paycheck Protection Program.
Allegedly, the individual defendants transferred the loan proceeds to a corporate defendant they owned, then spent the money “for their own benefit,” Judge Sontchi said in his August 27 opinion.
The plaintiff filed an adversary proceeding and sought a preliminary injunction to freeze the defendants’ assets sufficient to assure recovery of $2.4 million in loans that the defendants “allegedly took from Plaintiff.”
To freeze the defendants’ assets, the plaintiff’s first hurdle was Grupo Mexicano de Desarrollo S.A. v. All. Bond Fund, Inc., 527 U.S. 308 (1999). In an opinion for himself and four other justices, Justice Antonin Scalia held that an injunction known in the U.K. as a Mareva injunction is not available in federal courts in the U.S.
The plaintiffs in Grupo Mexicano had a claim of about $81 million for breach of contract. They contended that the defendant was on the cusp of depleting its assets by paying creditors in Mexico but not U.S. noteholders. The federal district court granted a preliminary injunction freezing the defendants’ assets. The Second Circuit affirmed.
Justice Scalia reversed. The Judiciary Act of 1789, he said, only conferred upon federal courts the equity powers exercised by the High Court of Chancery in England at the time of the American Revolution.
Justice Scalia said that the type of relief granted by the district court “was unknown to traditional equity practice.” It was “instructive,” he said, that the English Court of Chancery first allowed the injunctive remedy in 1975 in Mareva Compania Naviera S.A. v. International Bulkcarriers S.A., 2 Lloyd’s Rep. 509. He said it is “indisputable that the English courts of equity did not actually exercise this power until 1975” and that it “was a dramatic departure from prior practice.”
Although Mareva injunctions are not permissible in contract actions, Justice Scalia left the door open for similar injunctions in cases where the plaintiff has “rights at law or in equity in the property of the debtor.”
Judge Sontchi ruled “that the Grupo Mexicano decision, holding that district courts cannot grant preliminary injunctions to freeze a defendant’s assets if a plaintiff had no legal claim to those assets, does not apply to bankruptcy courts in general or, more specifically, to fraudulent transfer actions in bankruptcy.” He cited cases holding that Grupo Mexicano does not apply when the plaintiff has equitable claims or has equitable claims in addition to legal claims, such as constructive trusts.
Having decided that Grupo Mexicano did not bar the plaintiff’s request for an asset freeze, Judge Sontchi applied Third Circuit authority. The “two most critical factors,” he said, are the reasonable probability of success and a more-likely-than-not irreparable injury absent the injunction.
The evidence prompted Judge Sontchi to find “a more than 50% likelihood that absent a preliminary injunction, the Defendants’ assets will dissipate and Plaintiff will not recover.” In that regard, he said that the individual defendants, among other things, “have a history of wrongful acts and have proven that they are capable of shuffling assets.”
Judge Sontchi granted a preliminary injunction freezing about $2.4 million of the defendants’ assets.
Bankruptcy Judge Christopher Sontchi of Delaware wrote an opinion reminding us that the Supreme Court’s Grupo Mexicano decision from 1999 does not prohibit bankruptcy courts from freezing the assets of defendants accused of fraud.
The facts are difficult to ascertain because the complaint and other documents are sealed. It appears, however, that the defendants, without the corporate plaintiff’s knowledge or consent, allegedly applied for a “loan” on behalf of the plaintiff from the Small Business Administration under the Paycheck Protection Program.
Allegedly, the individual defendants transferred the loan proceeds to a corporate defendant they owned, then spent the money “for their own benefit,” Judge Sontchi said in his August 27 opinion.