Appellate Court Holds FCC Penalty Claim Survives Chapter 11 Corporate Debtor's Discharge

A Chapter 11 corporate debtor's monetary penalty obligation owed to the Federal Communication Commission (FCC), resulting from "fraud on consumers," survived the debtor's reorganization plan discharge, even when the FCC "was not a victim of the fraud," held the U.S. District Court for the Southern District of New York on Sept. 2, 2021. In re Fusion Connect, Inc., 2021 WL 3932346, 1 (S.D.N.Y. Sept. 2, 2021). On appeal, the court reversed the bankruptcy court's dismissal of the Government's non-dischargeability complaint under Bankruptcy Code (Code) §1146(d)(6), explaining that the fraud exception to dischargeability reaches debts owed to "creditors who were not themselves defrauded," such as the Government here. Id., at 2. According to the court, the bankruptcy court had confirmed the debtor's reorganization plan with a broad discharge (i.e., release) of pre-bankruptcy debt, but the plan confirmation order put "stakeholders … on notice that [the FCC Penalty] could attach to the newly constituted [reorganized] entity," when its terms made the dischargeability of that liability "an open issue." Id., at 12.

Relevance

The Fusion decision is important. A corporate debtor seeking chapter 11 reorganization relief ordinarily wants to clean up its balance sheet by eliminating unsecured liabilities with a discharge provision in a reorganization plan, permanently barring creditors from enforcing their pre-bankruptcy claims. When the bankruptcy court confirms the plan, the discharge will be a key part of the confirmation order. As the Third Circuit recently stressed in a similar context, "debtors [must] know their liabilities [in order to] implement a viable plan to obtain a fresh start." Ellis v. Westinghouse Electric Co., LLC, 2021 WL 3852612, 7 (3d Cir. Aug. 30, 2021). According to the Third Circuit, though, "the debtor's interest in a fresh start is not absolute, as the Bankruptcy Code tries to strike the 'delicate balance between the competing interests of creditors pursuing their claims and debtors in obtaining a fresh start and finality.'" Id., at 4, (citation omitted).

Facts

The debtor's predecessor's (B) had been engaged in defrauding consumers "for years." WL 3932346 at 1. As a result, B entered into a consent decree with the FCC in 2016, acknowledging its fraud, agreeing to issue refunds to consumers and to pay a "$4.2 million civil penalty to the United States (the FCC Penalty) in equal monthly installments over five years…. By its terms the consent decree bound [B's] successors, assigns, and transferees." Id. B later paid $1.2 million in refunds and credits to consumers and began paying the FCC Penalty. Id. 2. During 2018, however, Fusion, the debtor here, had merged with B's parent company, leaving "Fusion as the owner of [B's] business, and responsible for the outstanding FCC Penalty." Id.