United States Securities and Exchange Commission v. Collector's Coffee Inc.

Background

The Securities and Exchange Commission sued Collector’s Coffee Inc., doing business as Collectors Café, and Mykalai Kontilai, alleging violations of federal securities laws through investor fraud. At the beginning of the case, the court entered a temporary restraining order freezing up to $46,121,649.68 in assets held by or under the direct or indirect control of the defendants. The parties later stipulated to the relief while the SEC’s request for a preliminary injunction remained pending.

The motions concerned two lawsuits filed after the asset freeze. In the first, Collector’s Coffee and Kontilai sued former attorneys and their law firm for malpractice. In the second, Kontilai pursued wrongful-death claims as a co-special administrator of his mother’s estate. The wrongful-death litigation produced settlement proceeds, some of which were held in trust. Kontilai sought clarification that the freeze did not prevent pursuing either lawsuit or applying to assets acquired after the freeze. The SEC sought enforcement measures, including restrictions on litigation and settlements and court supervision of settlement proceeds.

Interpretation of the Asset Freeze

The court assumed, without deciding, that the freeze might not apply generally to assets acquired after the order was entered. It nevertheless concluded that the rights represented by these lawsuits existed before the freeze: the malpractice claims arose from 2018 legal representation, and the wrongful-death claims arose from the 2006 death. The court treated the right to bring a lawsuit as a property interest covered by the freeze.

The court reasoned that retaining counsel, pursuing claims, and settling them could change a frozen legal claim into cash and therefore could undermine the order’s purpose of preserving assets for a possible future judgment. It rejected the argument that the claims were outside the freeze because they were untainted or belonged to an estate. The court found that Kontilai had at least indirect control over the wrongful-death litigation and an indirect beneficial interest in it.

The court also recognized some ambiguity in the order’s separate language concerning lawsuits that interfere with the freeze. But it concluded that the order’s main freezing provision controlled. The court held that the temporary restraining order did not authorize Kontilai or Collector’s Coffee to enter retainer agreements, litigate, or settle the malpractice or wrongful-death claims without obtaining relief from the freeze. Kontilai’s motion to clarify was therefore granted to that extent.

SEC’s Motion to Enforce

The court concluded that Kontilai and Collector’s Coffee violated the temporary restraining order by instituting, pursuing, and partially settling the lawsuits. It stated that the violation was not serious because the order was not explicit about this conduct, but it was still a violation.

For the wrongful-death litigation, the court recommended denying a broad restriction requiring every litigation decision by counsel to receive court permission. It found that approach impractical. The court instead recommended conditions requiring counsel to receive the order, requiring notice to the court of any change in counsel, requiring an accounting of settlement funds on request and whenever additional funds were received, and requiring Kontilai’s share of settlement proceeds to remain in escrow unless the court authorized release. The court did not recommend requiring this court to approve every settlement or imposing the same escrow restriction on shares belonging to other persons entitled to compensation.

For the malpractice litigation, the court declined to decide whether the case was a prudent use of resources. It found that evaluating that question would effectively require a separate trial about the lawsuit’s merits. The court was concerned, however, that the attorney’s agreement appeared to limit responsibility for costs to $200,000 and that Collector’s Coffee had not provided a retainer agreement. The court stated that it would be prepared to recommend allowing the malpractice case to proceed only if the attorney agreed to bear litigation costs without a monetary limit, with the agreement making clear that the defendants would not owe those costs out of pocket. Collector’s Coffee was not to proceed until such an agreement was provided.

Disposition and Procedure

The conclusion states that Kontilai’s motion to clarify was granted to the extent described. It recommends that the SEC’s motion to enforce the asset freeze be granted in part and denied in part. The parties were directed to submit an agreed order, or separate proposed orders if they could not agree, within seven days after the district judge ruled on the enforcement motion. The report and recommendation also stated that objections had to be filed within fourteen days after service. Magistrate Judge Gabriel W. Gorenstein issued the report and recommendation combined with opinion and order; the filing identifies Judge Victor Marrero as the judge to whom objections and any extension request were directed.