Opinion
Nos. 93-486-CIV-T-24A and 94-635-CIV-T-24E
May 18, 1995
ORDER
These causes came before the Court for hearing on April 18, 1995, on appeals of the Securities and Exchange Commission from final orders of the Bankruptcy Court: (1) a final order entered on February 22, 1993, dismissing with prejudice a nondischargeability complaint filed by the Commission pursuant to Section 523(a)(2)(A) of the Bankruptcy Code, 11 U.S.C. § 523(a)(2)(A); and (2) a final order entered on February 24, 1993, denying the Commission's motion to intervene and be substituted as plaintiff in an adversary proceeding under Section 727 of the Bankruptcy Code, 11 U.S.C. § 727.
SECTION 523(a)(2)(A) APPEAL
This appeal involves the dismissal of the Commission's complaint in an adversary proceeding seeking a determination that a disgorgement judgment it holds against debtor Paul A. Bilzerian is nondischargeable under Section 523(a)(2)(A) as money obtained by fraud.
In order to place the substance of the rulings in context, a brief historical summary of the facts leading up to the orders is required. The Commission brought a civil law-enforcement action against Bilzerian on June 29, 1989, alleging that he had committed numerous securities law violations, including securities fraud, in connection with several attempted corporate takeovers during the 1980's. On April 18, 1991, Bilzerian was found by the District Court for the District of Columbia to have violated the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5; he was enjoined from further violations of the federal securities laws. SEC v. Bilzerian, [1991 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,875 (D.D.C. April 18, 1991), aff'd, 29 F.3d 689 (D.C. Cir. 1994). Thereafter, the District Court ordered him to disgorge more than $33 million in illegal profits plus interest. SEC v. Bilzerian, 814 F. Supp. 116 (D.D.C. 1993), aff'd, 29 F.3d 689 (D.C. Cir. 1994).
On August 5, 1991, Bilzerian filed a petition for relief under Chapter 11 of the Bankruptcy Code, converting the case shortly thereafter to a Chapter 7 liquidation. The Commission filed a proof of claim for disgorgement on February 24, 1992.
The Commission commenced this adversary proceeding on July 31, 1992, by filing a complaint seeking a determination that Bilzerian's disgorgement debt is nondischargeable under Section 523(a)(2)(A) as money obtained by fraud. The complaint alleged that Bilzerian fraudulently obtained money, in the form of illegal profits, by accumulating funds through secret profit sharing agreements, falsifying critical information in public filings, and making material misstatements in connection with tender offers. In response to the Commission's adversary complaint, Bilzerian filed a motion for judgment on the pleadings, arguing that the Commission lacked standing to bring the proceeding and alleging various defects in the complaint.
The Bankruptcy Court entered an order on February 16, 1993, granting Bilzerian's motion for judgment on the pleadings. SEC v. Bilzerian, 151 B.R. 954, 957-58 (Bankr.M.D.Fla.). The Bankruptcy Court held that the Commission had standing but that its allegation that Bilzerian received "illegal profits" by virtue of securities fraud is insufficient to state a claim for money obtained by fraud. The Commission was allowed to file an amended complaint within 30 days.
On February 22, 1993, the Bankruptcy Court entered another order dismissing the Commission's complaint with prejudice on the ground that the Commission lacks standing under Section 523(c) of the Code. SEC v. Bilzerian, 151 B.R. at 958-59. The Bankruptcy Court held that because defrauded investors could have brought a securities law fraud action in their own right, the Commission, unlike the Federal Trade Commission inIn Re: Austin, 138 B.R. 898 (N.D.III. 1992), lacked standing to bring the nondischargeability action.
Standing
Section 523(a)(2)(A) of the Bankruptcy Code provides that a debt for money that would otherwise be discharged in bankruptcy is not dischargeable "to the extent obtained by * * * false pretenses, a false representation, or actual fraud." Under Section 523(c)(1), an action under Section 523(a)(2) to prevent a discharge may be brought by "the creditor to whom such debt is owed." There are no further standing requirements under the statute. The disgorgement judgment rendered by the District Court in the Commission's civil action is a debt to the Commission. Therefore, in the opinion of this Court, the Securities and Exchange Commission is the creditor to whom the debt is owed and the Bankruptcy Court erred in denying the Securities and Exchange Commission standing under Section 523(c).
The Supreme Court has recognized a government agency's ability to enforce a debt as a creditor in a bankruptcy case even though the agency will not be the ultimate recipient of the money. Nathanson v. National Labor Relations Board, 344 U.S. 25 (1952). In that case Mr. Justice Douglas, speaking for the Court, said:
"We think the Board is a creditor as respects the back pay awards, within the meaning of the Bankruptcy Act. The Board is the public agent chosen by Congress to enforce the National Labor Relations Act. . . . A back pay order is a reparation order designed to vindicate the public policy of the statute by making the employees whole for losses suffered on account of an unfair labor practice. . . . Congress has made the Board the only party entitled to enforce the Act. A back pay order is a command to pay an amount owed the Board as agent for the injured employees. The Board is therefore a claimant in the amount of the back pay."
Footnotes and citations omitted.
The fact that the Securities and Exchange Act of 1934, Section 10, and Rule 10(b)5 promulgated by the Commission has been, as noted by the Bankruptcy Judge below, well established as permitting a private civil action, does not preclude the Securities and Exchange Commission from pursuing a disgorgement action. Disgorgement is a procedure also well established.
This Court disagrees with the distinction made by the Bankruptcy Court that the Commission lacks standing because private parties can bring damage actions under Section 10(b). See In re Maio, 176 B.R. 170, 171 (Bankr.S.D.Ind. 1994) ("a private right of action does not strip the Commission of standing to enforce the federal securities laws through nondischargeability actions").
In SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978), the Fifth Circuit Court of Appeals stated:
"The trial court acted properly within its equitable powers in ordering Pullman to disgorge the profits that he obtained by fraud. This restitution merely forces the defendant to give up to the trustee the amount by which he was unjustly enriched. . . . The purpose of disgorgement is not to compensate the victims of the fraud, but to deprive the wrongdoer of his ill-gotten gain. . . ."
Footnote and citations omitted.
SECTION 727 APPEAL
This appeal involves the Bankruptcy Court's denial of a motion by the Commission to intervene and be substituted as a party plaintiff in an adversary proceeding under Section 727 objecting to Bilzerian's general discharge.
The adversary proceeding had originally been brought on August 10, 1992, by another creditor, BiCoastal Corporation. BiCoastal's complaint alleged serious misconduct by Bilzerian in connection with the bankruptcy case and asked that his discharge be barred pursuant to Sections 727(a)(2)(A) and (B) and 727(a)(3)-(a)(6).
On November 3, 1993, BiCoastal and Bilzerian jointly moved and stipulated to the dismissal of the adversary proceeding. The Bankruptcy Court granted the motion on the condition that other creditors have the opportunity to intervene and be substituted as parties plaintiff.
On February 16, 1994, the Commission filed a motion to intervene and be substituted as a party plaintiff in the adversary proceeding. The Bankruptcy Court denied the Commission's motion on February 24, 1994 on the ground that the Commission does not have standing to intervene in the Section 727 complaint.
Bicoastal Corp. v. Bilzerian (In re: Bilzerian), 164 B.R. 688, 691 (Bankr.M.D.Fla. 1994): "As noted earlier, the Motion to Extend the Time filed by the SEC was not scheduled for hearing, but this Court is satisfied that it is appropriate to consider the matter, especially since counsel for the SEC was also present at the hearing on the Government's Motion to Intervene. Earlier in this case, the SEC filed a Complaint, adversary proceeding No. 92-605, pursuant to Section 523(a)(2)(A) seeking a determination that a debt allegedly owed by Bilzerian to the SEC is nondischargeable. On February 22, 1993, this Court entered an Order and dismissed the Complaint on the ground that the SEC had no standing to assert such a claim because the SEC is not a creditor of the Debtor. For this reason, this Court is satisfied that the SEC does not have standing to intervene in the Section 727 Complaint. Therefore, the request to extend the time to file a Motion to Intervene is academic."
At the same time the Bankruptcy Court denied the Commission's motion, it granted a motion of the United States to intervene on behalf of the Internal Revenue Service and be substituted as a party pursuant to Federal Rule of Bankruptcy Procedure 7041. Bicoastal Corp., 164 B.R. at 691. The Bankruptcy Court stated that Rule 7041 carried out the policy of bankruptcy law "to preserve the privilege of discharge to honest debtors only" by giving "other parties in interest * * * an opportunity to prosecute a complaint objecting to debtor's discharge initially filed by another creditor if the original plaintiff elected, for reasons of its own, e.g., lack of funds to pursue and prosecute the complaint, not to pursue prosecution." Id.
Thereafter, the Bankruptcy Court vacated and set aside its order granting the motion of the United States to intervene and be substituted as a party, finding that Rule 7041 did not apply. United States v. Bilzerian (In re Bilzerian), 172 B.R. 112 (Bankr.M.D.Fla. 1994). The Bankruptcy Court held that the purpose of Rule 7041 was only to assure that a dishonest debtor could not buy a discharge by offering to pay off the objecting creditor. Id. at 114. Because Bilzerian had submitted an affidavit stating that he had not paid anything to the initial party bringing the suit, the Bankruptcy Court held that Rule 7041 did not apply. Id.
Standing
The Bankruptcy Court's determination that the Commission lacked standing was in error. Section 727(c) provides that any creditor may bring a suit under Section 727. As the holder of a judgment of disgorgement, the Commission is a creditor with standing to object to Bilzerian's discharge under Section 727.
Rule 7041
The Bankruptcy Court's second decision on Rule 7041 construes its purposes too narrowly. While it is true that one of the purposes is to prevent collusion between the debtor and a creditor who brings a nondischargeability action under Section 727, the Rule also effectuates the general policy of the law to preserve the privilege of discharge to honest debtors only. Hage v. Joseph (In re Joseph), 121 B.R. 679, 681-82 (Bankr.N.D.N.Y. 1990); Russo v. Nicolosi (In re Nicolosi), 86 B.R. 882, 886-88 (Bankr.W.D.La. 1988). The Bankruptcy Court correctly construed Rule 7041 in its initial decision on this matter.
A plaintiff who brings an adversary proceeding objecting to a Chapter 7 debtor's discharge pursuant to Section 727 becomes, in effect, the trustee of the action which, if successful, benefits all creditors. In re Joseph, 121 B.R. at 682; In re Nicolosi, 86 B.R. at 888. In contrast, an adversary proceeding pursuant to Section 523 benefits only the creditor seeking discharge of its own debt. Id. In order to preserve the benefit of a Section 727 proceeding for all creditors, Rule 7041 allows other creditors to "step in the shoes" of the original creditor who brings a Section 727 action and later abandons it. Id.
Procedurally, the new creditor is substituted for the former creditor and is limited to the objections to discharge set forth in the original complaint. In re Joseph, 121 B.R. at 683. The Commission should be allowed to be substituted as a party pursuant to Rule 7041.
In accordance with the foregoing, it is hereby
ORDERED that the Orders of the Bankruptcy Court appealed from in this case are reversed and the case is remanded for further proceedings consistent with this Order. This order is not a ruling on the sufficiency of the complaint filed in the Section 523 proceeding, but is merely a ruling that the Securities and Exchange Commission has standing to be considered as a creditor. On remand, clarification is required by the Bankruptcy Judge as to his ruling on the sufficiency of the complaint issue. Also, this Order is not in any way a ruling on the merits of the nondischargeability issue, which is, of course, to be initially determined by the Bankruptcy Judge.
DONE AND ORDERED in Chambers at Orlando, Florida, this 18th day of May, 1995.