An adversary proceeding is a lawsuit filed separate from but related to a bankruptcy case. Such an action can be based on the various types of claims found in 11 U.S.C. § 523, including securities fraud. Currently, there is a split of authority (based on the statutory framework of 11 U.S.C. § 523) on whether a creditor must first obtain a finding outside of the bankruptcy court or enter into a settlement agreement with the debtor, before the creditor may file an adversary complaint based on securities fraud. This article will address the split of authority and will advocate for finding that the creditor must first obtain a finding or enter into a settlement agreement, before filing the adversary complaint.
11 U.S.C. § 523(a)(19) states that:
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt- * * *
(A) is for- (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 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.
11 U.S.C. § 523(a)(19) (emphasis added).
Given that subsections (a)(19)(A) and (a)(19)(B) of section 523 are conjoined with the conjunction word “and,” courts have held that two conditions must be satisfied: “first, the debt stems from a violation of securities laws or a fraud in connection with the purchase or sale of a security, and second, the debt is memorialized in a judicial or administrative order or settlement agreement,” other than in from a bankruptcy court. See, Bryant v. Clements (In re Clements), 570 B.R. 803, 808 (Bankr. W.D. Wis. 2017); McGraw v. Collier (In re Collier), 497 B.R. 877, 902 (Bankr. E.D. Ark. 2013); Dever v. Miller (In re Miller), Nos. 08-34558 HCD, 09-3029, 2010 Bankr. LEXIS 3622, at *6-12 (Bankr. N.D. Ind. Aug. 26, 2010); Faris v. Jafari (In re Jafari), 401 B.R. 494, 496 (Bankr. D. Colo. 2009).
Some courts have held that “the existence of a securities laws violation must be determine by a tribunal other than the bankruptcy court” and that allowing a bankruptcy court to decide liability for securities violations renders section 523(a)(19) superfluous. See, Terek v. Bundy (In re Bundy), 468 B.R. 916, 919 (Bankr. E.D. Wash. 2012). More specifically, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) amended section 523(a)(19) by adding to section 523(a)(19)(B) the phrase “before, on, or after the date on which the petition was filed.” By including that language in the statute, “[t]he 2005 amendments eliminated any requirement that a prepetition judgment exist before the section 523(a)(19) exception to discharge may be applied.” 4 Alan N. Resnick & Henry J. Sommer, Collier on Bankruptcy ¶ 523.27 at 523-130 (16th ed. 2010). The bankruptcy treatise summarized the approaches taken by courts when no prepetition decision had issued:
In those circumstances, some courts proceed to try the section 523(a)(19) claim . . . on the merits. Other courts have interpreted the requirement in subparagraph (B) of section 523(a)(19), that there be a judgment or settlement agreement, to reflect Congress’s intent that the liability determination under the common law or federal or state securities laws be made in a nonbankruptcy forum. Under this view, the bankruptcy court should decline to determine nondischargeability under section 523(a)(19) and abstain from deciding the issue or grant relief from the automatic stay and place the adversary proceeding in suspense while the parties litigate the merits of the creditor’s claim in the nonbankruptcy forum.
4 Collier on Bankruptcy, ¶ 523.27 at 523-131, 523-132 (footnote citations omitted).
“When a pre-bankruptcy judgment does not exist — that is, when a debtor files bankruptcy before the securities fraud litigation in another forum has been filed or concluded, — subparagraph (B) suggests that a debt based upon securities law violations still may be found nondischargeable in a bankruptcy court.” In re Miller, 2010 Bankr. LEXIS 3622, at *8. “However, subparagraph (B) also mandates that the debt result from a judicial or administrative decision or settlement agreement.” Id. (emphasis added) In re Jafari provides what one court found was “thoughtful analysis of this language,” In re Miller, 2010 Bankr. LEXIS 3622, at *8:
When the words “before, on, or after the date on which the petition was filed” were inserted by BAPCPA to eliminate the temporal requirement, it invited debate as to whether § 523(a)(19) now allows a bankruptcy court to render its own determination of liability for securities law violations or fraud or whether the liability determination must still be made outside of the bankruptcy court.
In re Jafari, 401 B.R. at 496.
Agreeing in part with In re Chan, 355 B.R. 494 (Bankr. E.D. Pa. 2006), the In re Jafari court determined that bankruptcy and non-bankruptcy courts share concurrent jurisdiction to determine the dischargeability of a § 523(a)(19) claim. Nevertheless,
whichever court makes the dischargeability determination, and regardless of when the liability determination is made, the court must find that both requirements of the statute have been satisfied. Thus, the issue is not which court decides dischargeability, nor when the liability decision occurs[;] it is a question of how the Subsection B requirement can be satisfied.
In re Jafari, 401 B.R. at 497.
The In re Jafari court, after comparing the language of § 523(a)(19) with other § 523 provisions and reviewing the legislative history, concluded that the securities fraud debt must be established in an order or agreement outside the bankruptcy case:
[A]bsent a settlement agreement or other consensual determination of liability, Subsection B evidences a conscious choice to have the liability determination occur outside of the bankruptcy forum, whether it occurs pre- or post-bankruptcy. Once liability has been imposed, then either a bankruptcy court or a non-bankruptcy court may determine the application of this nondischargeability statute.
In re Jafari, 401 B.R. at 499-500.
While there is a split of authority on the issue, see Ballard v. Thoennes (In re Thoennes), 536 B.R. 680, 697 n.35 (Bankr. D.S.C. 2015) (recognizing split of authority), several courts have found In re Jafari to be persuasive. See, e.g., In re Collier, 497 B.R. at 894 (adopting In re Jafari); In re Bundy, 468 B.R. at 921 (ruling that allowing a bankruptcy court to decide liability for securities violations renders section 523(a)(19)(B) superfluous); Anderson v. Anderson (In re Anderson), Nos. 10-20651-TLM, 10-07039-TLM, 2012 Bankr. LEXIS 3573, at *5-13 (Bankr. D. Idaho Aug. 1, 2012) (finding In re Jafari and In re Bundy “compelling” and adopting them); Voss v. Pujdak (In re Pujdak), 462 B.R. 560, 574 (Bankr. D.S.C. 2011) (stating nonbankruptcy tribunals must decide securities law violations); Cutcliff v. Reuter (In re Reuter), 427 B.R. 727, 760 (Bankr. W.D. Mo. 2010), aff’d, 443 B.R. 427 (B.A.P. 8th Cir. 2011), aff’d, 686 F.3d 511 (8th Cir. 2012) (stating in dicta that if the issue were before it, the court would likely agree with In re Jafari that a non-bankruptcy forum is required to determine liability under section 523(a)(19)(B)); In re Miller, 2010 Bankr. LEXIS 3622, at *6-12 (adopting In re Jafari).
“The better reasoned cases on this narrow issue conclude that interpreting § 523(a)(19) to allow a bankruptcy court to decide whether the requirement of § 523(a)(19)(A) have been met would render § 523(a)(19)(B) meaningless,” In re Bundy, 468 B.R. at 921, which is in conformity with Ninth Circuit precedent, because
When construing a statute, the court must interpret the statute in such a manner as to give effect to all of its parts. Boise Cascade Corp. v. United States Envtl. Prot. Agency, 942 F.2d 1427 (9th Cir. 1991). A portion of the statute is not to be rendered superfluous by the court in reaching a conclusion as to the statute’s meaning. United States v. Fiorillo, 186 F.3d 1136 (9th Cir. 1999). Should the bankruptcy court be the appropriate forum to conclude that the requirements of subpart (A) have been met, subpart (B) is superfluous. The existence of subsection (B) to § 523(a)(19) leads to the conclusion that the bankruptcy court, once some regulatory or other judicial tribunal has determine a violation of securities laws exists, may determine whether the debt at issue resulted from the violation and is thus not subject to discharge.
In re Bundy, 468 B.R. at 921.
Andreiu v. Ashcroft, 253 F.3d 477 (9th Cir. 2001) (en banc) is instructive on the Ninth Circuit’s statutory interpretation. There, the Ninth Circuit sitting en banc held that, while 8 U.S.C. § 1252(f)(2) refers to “enjoin[ing] or restrain[ing]” certain actions, 8 U.S.C. § 1252(f)(2) refers only to “enjoin[ing] the removal of any alien” and not to “restraining” removal. Andreiu held the difference was “significant,” reasoning:
It is clear from this language that Congress did not view the terms “enjoin” and “restrain” as synonymous. If Congress had intended the term “enjoin” to cover the entire universe of judicial power over immigration proceedings, there would have been no need to include the phrase “or restrain.” If “restrain” has any operative meaning, as we must presume it does, Congress’s omission of this term from § 1252(f)(2) must be significant. The only construction that saves § 1252(f)(1) from surplusage is that “enjoin” refers only to the class of actions properly defined as injunctions, not to the full range of judicial action.
Andreiu, 253 F.3d at 480.
Likewise, in drafting section 523(a)(19), Congress’ intentional omission of the phrase “results, before, on, or after the date on which the petition was filed” from other subsections in § 523(a)-specifically subparts (1)-(18)-“must be significant.” Andreiu, 253 F.3d at 480. Thus, “[t]he only construction that saves § [523(a)(19)(B)] from surplusage is that” the debt is memorialized in a judicial or administrative order or settlement agreement. Id.
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