Fraud Claims: Don’t Throw Good Money After Bad

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Nobody likes wasting money, especially on legal fees.  Clients don’t like it.  And courts don’t like it.  As Judge Shannon admonished in a recent opinion:

The Court has previously expressed and now reiterates its profound concerns with respect to the dissipation of monies otherwise available for distribution to stakeholders being burned up in litigation of dubious merit and questionable collectability.

The best outcome for everyone, of course, is to avoid pursuing questionable litigation in the first place.

My colleague, John Bird, has written two articles illustrating some of the challenges and considerations that lawyers and clients should take into account when pursuing fraud claims.

Motion to Dismiss Second Amended Complaint – Another AgFeed Opinion

Opinion in AgFeed USA – Another (Mostly) Successful Motion to Dismiss

Simply put, the Delaware Bankruptcy Court, like other courts across the country, takes a hard look at fraud allegations and requires them to comply with elevated pleading standards under the Federal Rules of Civil Procedure.

To avoid spending money litigating claims that may be dismissed, it is important to take a hard, objective look at the fraud allegations in your complaint to make sure that they are based on particular, specific factual allegations (e.g., the who, what, when, where and how of the fraud, including the time, place, and content of alleged misrepresentations) and not just conclusory statements.  For example:

Very Bad: The defendant induced plaintiffs to invest in his business.

Bad: Throughout 2007, the defendant strongly encouraged Larry, Curley and Moe to continue investing by making statements such as “stay with the business.”

Better: On July 4, 2007, Larry, Curley and Moe received a letter signed by defendant and delivered to their offices in Miami, Florida soliciting a $1 million investment in defendant’s spray-on hair business and stating that the business had been valued at $10 billion by New York Investment Bank, LLP.

This requires that you conduct a pre-complaint investigation in sufficient depth to make sure that your allegations of fraud are supported by facts rather than being merely defamatory and extortionate.  (To make sure your analysis is completely objective, it may be a good idea to have a fresh set of eyes review the complaint before it is finalized.)

Without the necessary preparation, you may just find yourself throwing good money after bad.

Mette H. Kurth

When is a Settlement Not a Settlement? When It Is an Asset Sale.

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For business people, whether you are settling a dispute or selling an asset may seem obvious. But for lawyers, the distinction can be surprisingly tricky, and it has serious ramification for our clients.

The confusion arises because the Bankruptcy Code allows you to either sell or settle a claim that a debtor has against someone else. What happens if the trustee settles a claim against a defendant in exchange for a cash payment, and a creditor objects because it believes the claim is worth more than is being paid? What if a trustee wants to sell claims that the debtor has against third parties? Whether these transactions are treated as settlements or sales matters quite a bit.

When selling an asset under Bankruptcy Code section 363, you must demonstrate that you have maximized the asset’s value. To settle a claim, the bar is much lower. Bankruptcy Rule 9019 requires that you show that the settlement is fair and equitable, which generally means that it does not fall below the “lowest point in the range of reasonableness.” Moreover, you cannot appeal a bankruptcy sale to a good faith purchaser unless you obtain a stay. (This is meant to encourage bidding in bankruptcy sales by protecting good faith purchasers). A settlement, in contrast, can be appealed without a stay.

The Ninth Circuit Court of Appeals recently adopted the BAP’s earlier reasoning in Mickey Thompson (decided in 2003) and the reasoning of the Fifth and Third Circuits, holding that a bankruptcy court has the discretion to apply the more stringent standards and procedures for sales to a settlement agreement in order to maximize value.

In Adeli v. Barclay, the bankruptcy trustee had entered into a settlement agreement with a creditor under which the creditor would purchase the estate’s claims against it in exchange for both cash and a waiver of the creditor’s claims against the estate. The trustee filed a motion to approve the settlement under Rule 9019 and presented evidence regarding the settlement’s reasonableness. It also noticed the matter as a sale subject to overbidding under Section 363. Nobody submitted an overbid. The debtor then appealed the settlement to the district court—but without seeking a stay pending appeal. The Ninth Circuit concluded that, because the bankruptcy court determined that the creditor/buyer was a good faith purchaser of the potential claims, and the debtor did not seek a stay pending appeal, the appeal was moot under Bankruptcy Code section 363(m) and was properly dismissed.

While the Ninth Circuit’s decision adopted Mickey Thompson’s reasoning and does not appear to significantly change current practice, it does serve as a stark reminder of the very real differences between sale and settlement procedures. Meanwhile, its time for the lawyers to update their form files to replace references to Mickey Thompson with a citation to Adeli v. Barclay.

Adeli v. Barclay (In re Berkeley Delaware Court, LLC), No. 14-55854 *10 (9th Cir. August 23, 2016). Download in PDF

Mette H. Kurth