Reversing the bankruptcy court while expounding and expanding on the Supreme Court’s Cohen decision, District Judge Paul A. Engelmayer of New York ruled that a civil penalty imposed by the Federal Communications Commission for defrauding consumers is not discharged in a corporate debtor’s chapter 11 case under Section 1141(d)(6)(A).
In Cohen v. de la Cruz, 523 U.S. 213 (1998), the Supreme Court held that treble damages and attorneys’ fees imposed against a bankrupt landlord in favor of tenants under state law for actual fraud in charging excess rent were not dischargeable under Section 523(a)(2)(A), even though the treble damages were in excess of the actual damages sustained by the tenants.
The case before Judge Engelmayer was different from Cohen in that the government had not been defrauded, whereas the tenants in Cohen had been.
The Defrauded Customers and the Government Fine
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 over five years. By the time the debtor filed in chapter 11, 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 dischargeable under Section 1141(d)(6)(A). The bankruptcy judge ruled that the remaining fine was dischargeable. U.S. v. Fusion Connect Inc. (In re Fusion Connect Inc.), 617 B.R. 36 (Bankr. S.D.N.Y. June 9, 2020). To read ABI’s report, click here.
The government appealed and won in a September 2 opinion by Judge Engelmayer.
The Controlling Statutes
Two statutes were controlling: Sections 523(a)(2)(A) and 1141(d)(6)(A).
Section 523(a)(2)(A) bars discharge of a debt “obtained by . . . false pretenses, a false representation, or actual fraud,” but it applies only to individual debtors.
To prevent corporate debtors from filing in chapter 11 to discharge debts owing to the government for fraud, the so-called BAPCPA amendments in 2005 added Section 1141(d)(6)(A). Now, confirmation in chapter 11 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 . . . .”
The debtor had several arguments to say that the fine was dischargeable: No fraud was committed against the government; the debtor made no misrepresentations to the government; the victims of the fraud had been made whole; and the fine would not fall under the definition of a common law fraud.
Judge Engelmayer knocked down the arguments in his 27-page opinion.
Cohen Controls
Like the bankruptcy court, Judge Engelmayer began with Cohen, but unlike the bankruptcy court, he didn’t go much further.
He addressed two questions: Was the fine a “debt,” and was it “obtained by” fraud?
Judge Engelmayer said that “Cohen underscored the breadth of the debts that Section 523(a)(2)(A) exempts from discharge.” Regarding whether the treble damages were a “debt,” he quoted the Supreme Court for saying that treble damages and attorneys’ fees “fell within the scope of ‘any debt’” for money or property that was fraudulently obtained. Cohen, supra, 523 U.S. at 218.
Cohen also held that the treble damages and attorneys’ fees were “obtained by” fraud.
To define the broad scope of Section 523(a)(2)(A), Judge Engelmayer quoted the Supreme Court for saying that the section “prevents the discharge of all liability arising from fraud.” Id. at 215.
To plug a hole, Congress adopted Section 1141(d)(6)(A) seven years after Cohen. He said that Cohen’s “broad” construction of Section 523(a)(2)(A) “necessarily governs the construction of Section 1141(d)(6)(A).”
Focusing on Section 1141(d)(6)(A), Judge Engelmayer noted that Cohen involved non-compensatory treble damages and attorneys’ fees, while the appeal before him entailed non-compensatory civil penalties imposed by a governmental unit that was not a victim of fraud.
Following the direction shown by Cohen, Judge Engelmayer easily concluded that the civil fine was a debt resulting from money “obtained by fraud.” In that regard, he cited Cohen for saying that the debt itself need not be obtained by fraud, so long as it was traceable to fraud. Id. at 218-221.
Non-Statutory Arguments Fail
The debtor contended that the fine should be dischargeable because it did not contain the common law elements of fraud.
Judge Engelmayer countered by saying that the customers suffered from “actual fraud.”
Next, the debtor argued that the fraud was not directed against the government.
“Neither the statutory text nor the case law construing Section 523(a)(2)(A), however, requires that the common law elements of fraud must be met both as to the fraud and as to the creditor holding a debt arising from the fraud,” Judge Engelmayer said. He cited two bankruptcy courts for holding that judgments in favor of the government were nondischargeable when the common law elements of fraud were shown in fraud foisted on consumers.
To buttress his conclusion, Judge Engelmayer cited the Third and Eleventh Circuits for holding that disgorgement judgments obtained by the Securities and Exchange Commission were not discharged, although the fraud had not been directed against the SEC.
The debtor argued that dischargeability should be judged by Section 523(a)(7), which bars an individual from discharging fines and penalties assessed by the government that are not compensation for actual pecuniary loss. Since it was not an individual, the debtor contended that the debt should be discharged.
Judge Engelmayer disagreed. Some overlap happens in statutes, he said
Finally, Judge Engelmayer said that the debtor’s policy arguments were “unusually unpersuasive.” Allowing a corporate debtor “to shed a regulatory fraud penalty in this manner could invite mischief.” He reversed and remanded.
Reversing the bankruptcy court while expounding and expanding on the Supreme Court’s Cohen decision, District Judge Paul A. Engelmayer of New York ruled that a civil penalty imposed by the Federal Communications Commission for defrauding consumers is not discharged in a corporate debtor’s chapter 11 case under Section 1141(d)(6)(A).
In Cohen v. de la Cruz, 523 U.S. 213 (1998), the Supreme Court held that treble damages and attorneys’ fees imposed against a bankrupt landlord in favor of tenants under state law for actual fraud in charging excess rent were not dischargeable under Section 523(a)(2)(A), even though the treble damages were in excess of the actual damages sustained by the tenants.
The case before Judge Engelmayer was different from Cohen in that the government had not been defrauded, whereas the tenants in Cohen had been.