In Re: Fusion Connect, Inc.

Background

Birch Communications used deceptive telemarketing and billing practices to persuade consumers to switch telecommunications services. The conduct included misrepresenting callers’ identities and purposes, billing for unwanted services, charging early-termination fees, and changing or charging for services without authorization. The Federal Communications Commission investigated and entered into a 2016 consent decree with Birch.

Under the consent decree, Birch agreed to provide at least $1.9 million in refunds and credits to consumers and pay a $4.2 million civil penalty to the United States in monthly installments over five years. Birch paid $2.1 million of the penalty. In 2018, Fusion merged with Birch’s parent company and became responsible for the remaining $2.1 million.

Fusion filed for chapter 11 reorganization in 2019. The Government filed a claim for the unpaid penalty and later argued that the debt could not be discharged under 11 U.S.C. §§ 523(a)(2)(A) and 1141(d)(6)(A). Section 523(a)(2)(A) generally excludes from discharge debts arising from money obtained through false pretenses, false representations, or actual fraud. Section 1141(d)(6)(A) applies that exception to certain debts owed by corporate chapter 11 debtors to domestic governmental units.

Bankruptcy Court Ruling and Appeal

Fusion moved to dismiss the Government’s complaint. It argued that the fraud exception did not apply because Birch’s misrepresentations were directed at consumers, not the United States, and the United States had not relied on the misrepresentations or suffered a direct loss. Fusion also argued that Congress’s failure to extend a separate exception for government fines and penalties, § 523(a)(7), to corporate chapter 11 cases showed that the penalty should be dischargeable.

The bankruptcy court granted Fusion’s motion to dismiss. It held that the fraud-based exception did not reach the FCC penalty because the Government was not itself defrauded. The Government appealed to the district court.

District Court’s Analysis

The district court reviewed the bankruptcy court’s legal ruling anew because the parties agreed that the appeal presented a pure question of law.

The court relied heavily on Cohen v. de la Cruz, in which the Supreme Court held that § 523(a)(2)(A) covers all liability arising from fraudulent acquisition of money or property, including treble damages, attorney’s fees, and costs. Under Cohen, the debt itself need not be the money obtained through fraud; once specific money or property was obtained by fraud, any debt arising from that fraud can be nondischargeable.

The court first held that the FCC penalty qualified as a “debt” under the Bankruptcy Code because it was an enforceable obligation and the FCC had a right to payment. It then held that the penalty arose from money obtained by fraud. Birch had obtained money from consumers through fraudulent practices, and the consent decree imposed the additional penalty on account of that fraud.

The court rejected Fusion’s argument that the fraud exception applies only when the creditor owed the debt was itself the fraud victim. The court concluded that neither the statutory text nor the Supreme Court’s interpretation in Cohen requires the fraud to have been directed at the creditor holding the debt. The fact that consumers, rather than the United States, were the victims therefore did not prevent the penalty from being excluded from discharge.

The court also rejected Fusion’s argument based on § 523(a)(7). Although that provision separately excludes certain government fines and penalties from discharge for individual debtors, Congress’s decision not to extend § 523(a)(7) to corporate chapter 11 cases did not narrow the separate fraud-based exception that Congress did extend through § 1141(d)(6)(A). The court stated that the two provisions can overlap in some circumstances and still retain different applications.

Holding and Disposition

The court held that the FCC penalty was nondischargeable under § 523(a)(2)(A), as applied to corporate chapter 11 debtors through § 1141(d)(6)(A), even though the United States was not a victim of Birch’s fraud. The court reversed the bankruptcy court’s decision and remanded the matter to the bankruptcy court for proceedings consistent with the decision. It also directed the Clerk of Court to close the motion pending at Docket 6.