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(347)-508-9316THE LEGAL QUESTION AS TO SECTION 523(a)(19) OF THE BANKRUPTCY CODE
The question of whether debt under a settlement owed to the Securities Exchange Commission (“SEC”) by a Chapter 7 debtor can be contentious, complex and the subject of bankruptcy litigation over the issue of the dischargablilty of the SEC debt. How to properly interpret Bankruptcy Code Section 523(a)(19) is a controversial issue where there is a stipulation settling an SEC securities violation case for a fixed monetary amount, but as a condition of the settlement not finding of an SEC violation in the underlying case. The resulting consent decree and consent judgment based on the settlement often can contain the following language: “Without admitting or denying the allegations of the complaint (except as to jurisdiction, which the Defendant admits), Defendant hereby consents to the entry of the Final Judgment…”. And the Consent Judgment acknowledges that the defendant “consented to the entry of this Final Judgment without admitting or denying the allegations of the Complaint (except as to jurisdiction); [and}waived findings of fact and conclusions of law…”. Given that there was not a finding of fact or conclusion of law in many SEC settlements, are the settlements dischargeable under Section 523(a)(19)? This is a question because Section 523(a)(19) requires BOTH: (A) an SEC violation; and (B) a stipulation, order or judgment against the the defendant. Do we have an “SEC Violation” where there is a mere Stipulation which specifically contains NO findings of fact or conclusions of law as to a violation?
THE STATUTORY LEGAL STANDARD FOR SECTION 523(a)(19) OF THE BANKRUPTCY CODE
As reviewed by Judge Grossman in Long Island Invasive Surgery, P.C. v. Orslini (In re Orslini), 649 B.R. 427, 437-438 (Bankr. E.D.N.Y. 2023), “[t]he plaintiff has the burden of establishing an exception to discharge of a debt under § 523 by a preponderance of the evidence.” See also Grogan v. Garner, 498 U.S. 279, 289-90, 111 S. Ct. 654, 112 L. Ed. 2d 755 (1991); see also, e.g., Scheidelman v. Henderson (In re Henderson), 423 B.R. 598, 616 (Bankr. N.D.N.Y. 2010) (“Exceptions to discharge under § 523 must be . . . construed so as to give the maximum effect to the Code’s policy of providing honest but unfortunate debtors with a ‘fresh start.’” (citations omitted). Exceptions to discharge should be construed narrowly, “and genuine doubts should be resolved in favor of the Debtor.”
In re Hyman, 502 F.3d 61, 66 (2d Cir. 2007).
11 U.S.C. Section 523(a)(19) provides:
“(19) that— (A) is for— A discharge under section 727, 1141, 1192(**), 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—
(i) the violation of any of the Federal securities laws (as that term is defined in section 3(a)(47) of the Securities Exchange Act of 1934), any of the State securities laws, or any regulation or order issued under such Federal or State securities laws; or
(ii) common law fraud, deceit, or manipulation in connection with the purchase or sale of any security; and
(B) results, before, on, or after the date on which the petition was
filed, from— (i) any judgment, order, consent order, or decree entered in anyFederal or State judicial or administrative proceeding;
(ii) any settlement agreement entered into by the debtor; or
(iii) any court or administrative order for any damages, fine,penalty, citation, restitutionary payment, disgorgement payment,attorney fee, cost, or other payment owed by the debtor.
It is well established that a debt will not be determined to be nondischargeable under Section 523(a)(19) unless the Court finds that BOTH Section 523(a)(19)(A) and (B) have been satisfied, and that if and only if it is determined that a federal or state securities violation or common law fraud, deceit, or manipulation in connection with the purchase or sale of any security has occurred under Section 523(a)(19(A), then, and only then, can the court look to whether an exception to a discharge of a (i) judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding; (ii) any settlement agreement entered into by the debtor; or (iii) any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor has been shown. In Blake v. Fusco (In re Fusco), 641 B.R. 438, 455 (Bankr. E.D.N.Y. 2022), Bankruptcy Judge Strong explained:
Section 523(a)(19) makes a debt nondischargeable if two conditions are met. First, the debt must be for “the violation of any of the Federal securities laws. . ., any of the State securities laws, or any regulation or order issued under such Federal or State securities laws,” that is, a securities law violation, or it must be for “common law fraud, deceit, or manipulation in connection with the purchase or sale of any security,” that is, common law securities fraud. 11 U.S.C. § 523(a)(19)(A). Second, the debt must result from a “judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding,” a “settlement agreement entered into by the debtor,” or a “court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor” — that is, the debt results from a judgment, agreement or award. 11 U.S.C. § 523(a)(19)(B).
THE STATUTORY LEGAL STANDARD FOR SECTION 523(a)(19) OF THE BANKRUPTCY CODE
Courts agree that these requirements are distinct, and that BOTH must be satisfied in order for a debt to be nondischargeable. As one court observed, “Section 523(a)(19) explicitly requires both subsections (A) and (B) to be met.” In re Sklar, 626 B.R. at 768. That is, and as a threshold matter, to prevail on a Section 523(a)(19) claim, a plaintiff must establish both that the debt is for a securities law violation or common law securities fraud, and that the debt results from an appropriately memorialized judgment, agreement, or award. (emphasis supplied); see also, e.g., Schlosser v. Heinemann (In re Heinemann), Adversary Proceeding Case No. 19-09028, 2022 Bankr. LEXIS 3391 at *16-17 (Bankr. S.D.N.Y Dec. 2, 2022); Mollasgo v. Tills (In re Tills), 419 B.R. 444 (Bankr. S.D. Cal. 2009). Further, “[o]n a Section 523 exception to discharge action, ‘’the bankruptcy court does not litigate the underlying claim, but only whether such claim has already been established.’ In re Pujdak, 462 B.R. 560, 575 (Bankr. D.S.C. 2011) (quoting Faris v. Jafari (In re Jafari), 401 B.R. 494, 499 (Bankr. D. Colo. 2009)). Here, then, this Court’s’ only function’ is to determine whether the Award ‘has satisfied the requirements set forth’ in Section 523(a)(19). In re Pujdak, 462 B.R. at 576. Specifically, the only two considerations are whether ‘a determination of a securities violation or related fraud has been made” and whether “proof of entry of that order’ has been tendered. Wright v. Minardi (In re Minardi), 536 B.R. 171, 192 (Bankr. E.D. Tx. 2015)” Fusco, supra, 641 B.R. at 458. “The proper interpretation of § 523(a)(19), even as amended, requires that a tribunal other than the bankruptcy court determine the liability aspect — e.g., whether a federal or state securities violation or some type of related fraud has occurred. In re Collier, 497 B.R. 877, 902-03 (Bankr. E.D. Ark. 2013); Terek v. Bundy (In re Bundy), 468 B.R. 916 (Bankr. E.D. Wash. 2012).
Where there was no finding of fact or conclusion of law by the District Court that the debtor had committed a securities law violation and where, the District Court expressly refrains from determining liability or admission of any kind by the debtor for the allegations in the SEC’s complaint or the amended complaint, there is a question as to whether a Securities Violation had actually occurred to allow the operation of Section 523(a)(19). In Mollasgo v. Tills (In re Tills), 419 B.R. 444 (Bankr. S.D. Cal. 2009), the Court analyzed whether a debtor’s debt under a settlement agreement with a plaintiff creditor who had asserted pre-petition claims against defendant debtor, based on California securities law violations, common law fraud, and negligent misrepresentation in connection with the sale of a security, was nondischargeable under Code Section 523(a)(19). The Court found that it was dischargeable, stating:
“… in this case, the Settlement Agreement contains no discussion of the basis for non- dischargeability and, instead, contains a provision expressly stating that fault and liability are not conceded. The Court thus finds that the Settlement Agreement does not independently establish that Debtor committed securities violations and does not independently satisfy section 523(a)(19)(A).” Tills, 419 B.R. at 452-453. “Even if a settlement agreement is silent as to fault and liability, an argument could be made that the issues were necessarily decided based on the facts surrounding the settlement process. But here, no such argument is available as the Settlement Agreement expressly provides that fault and liability are not conceded.”
The Tills Court went on to observe:
“[i]f Congress wished to deviate so completely from the public policy favoring settlements it easily could have done so. Instead of referencing a ‘violation’ of securities law, Congress could have required non-dischargeability as to any settlement arising from a complaint alleging such violations. Given the strong public policy in favor of settlements, it is reasonable to assume that Congress would be completely clear if it intended to render it impossible to settle without resultant non- dischargeability. Thus, the Court concludes that Congress provided plaintiffs with a valuable tool in securities litigation, but also allowed the parties to avoid de facto non-dischargeability through settlement agreement language that expressly avoids any concession of fault or liability.”
Tills, 419 B.R. at 454.
THE CASELAW INTERPRETING SECTION 523(a)(19) OF THE BANKRUPTCY CODE
Likewise, in Allen v. Loughery (In re Loughery), No. 09-6380, 2010 Bankr. LEXIS 3810, 2010 WL 4642131, at *2-3 (Bankr. N.D. Ga. Oct. 12, 2010); the creditor filed a complaint in a federal district court, alleging violations of federal and state securities laws. 2010 Bankr. LEXIS 3810, 2010 WL 4642131, at *1. The parties settled and the creditor obtained a consent judgment against debtor. Id. The settlement agreement did not contain an admission of liability for securities violations. Id. The Bankruptcy Court held that “even though the Settlement Agreement satisfies the requirement of § 523(a)(19)(B), the terms of the Settlement Agreement itself do not establish as a matter of law that the debt results from the violation of the securities laws.” 2010 Bankr. LEXIS 3810 at *3. Similarly, in Barton v. Stalter (In re Stalter), 2012 Bankr. LEXIS 4444 at *12 (Bankr E.D. Mi. Sept. 25, 2012), the Court determined in reviewing a motion for summary judgment by a creditor that a consent judgment premised upon a violation of federal or state securities laws was not dischargeable under § 523(a)(19) as a matter of law. Stalter, 2012 Bankr. LEXIS 4444 at *2. The underlying complaint alleged a claim based on multiple grounds, including a violation of state securities law. 2012 Bankr. LEXIS 4444 at *2. The consent judgment was subject to the terms of the settlement agreement, which “reserved any admission of liability.” The Court denied summary judgment, stating “[t]his Court agrees with In re Tills decision, and its applicability to this case … .In this case, like in In re Tills, there was no determination of culpability by the state court and there was no admission of culpability by the Defendant in the Settlement Agreement or Consent Judgment.” See also In re Allison, 11-04728-8-SWH, 2012 Bankr. LEXIS 3983, 2012 WL 3775982 (Bankr. E.D. N.C. Aug. 29, 2012).
There was a contrary ruling in In re Gilley, 2013 WL 4460499 *3 (Bankr. M.D. N.C. 2013); Gilley v. SEC, No. 1:13-cv-916, 2014 WL 11497958 (M.D.N.C. June 3, 2014); aff’d per curiam sub nom, Gilley v. S.E.C., 590 Fed. Appx. 227 (4th Cir. Jan. 14, 2015), relied on by the SEC in not be followed by this Court. It is not controlling law in this Circuit, having been issued by the Fourth Circuit Court of Appeals. It is also distinguishable in that the Court in Gilley eliminated any doubt by noting that two years after the consent judgment at issue in Gilley, the SEC succeeded in obtaining summary judgment in the underlying action. Further, it is submitted that the interpretation of the law discussed in In re Gilley is unduly narrow-minded and restrictive, and that to follow this decision would ignore the very real considerations that debtors/defendants face in determining whether to enter into a knockdown, drag-out fight for years which will cost millions or instead, determine to settle what they consider to be unfounded allegations of securities fraud, in order to minimize and eliminate time, fees, and costs in litigating these issues with a government unit that has unlimited manpower, time and resources, especially where debtors/defendants expressly refrain from admitting the allegations of securities law violations in the settlement.
CONCLUSIONS AS TO SECTION 523(a)(19) OF THE BANKRUPTCY CODE
While there are are decisions that have not followed the plain statutory construction of Section 523(a)(19) and have ruled that a stipulation of settlement with the SEC is inherently non dischargeable, even where there are no findings of fact or conclusions of law, the more reasonable interpretation of Section 523(a)(19), requires that there be an explicit court finding or admission by the debtor that indeed there ACTUALLY WAS a violation, for the stipulation to be non dischargeable. However, where as here, there has been no admission or findings of fact that there REALY WAS a violation, a settlement stipulation which specifically avoids this conclusion, should not be assumed to be an admission of liability or a finding of liability that meets the requirements under Subsection (B) of Section 523(a)(19).
