Digilytic International FZE v. Alchemy Finance, Inc.

Background

Digilytic International FZE and Rishan Bhagowat sued Alchemy Finance, Inc., other Alchemy entities, Sheng-Wen Cheng, Jahril Tafari Bell, and unnamed defendants. The plaintiffs alleged securities fraud, violations of the Racketeer Influenced and Corrupt Organizations Act, and common-law claims based on the defendants’ sale of cryptocurrency tokens. They also alleged breaches of a Token Purchase Agreement, a Master Services Agreement, and an Advisory Agreement.

The plaintiffs alleged that they paid $250,000 for Alchemy cryptocurrency tokens and provided marketing and advisory services. They alleged that the defendants made false statements about Alchemy’s business, investments, software, and token sales. The plaintiffs’ invoices totaled $85,000 under the Master Services Agreement and $230,000 under the Advisory Agreement, and they alleged that those invoices were not paid.

Cheng was served with the lawsuit, but he did not answer by the deadline. The clerk entered a default against him on September 4, 2020. Cheng later moved to set aside that default, explaining that he had been arrested and incarcerated and was subject to strict COVID-19 lockdown conditions. The court was considering only Cheng’s motion to set aside the entry of default, not the ultimate truth of the plaintiffs’ claims.

Legal standard

Under Rule 55(c) of the Federal Rules of Civil Procedure, a court may set aside an entry of default for “good cause.” Courts in the Second Circuit consider three factors: whether the default was deliberate, whether the defendant has a potentially valid defense, and whether removing the default would unfairly harm the other side. Courts also favor resolving disputes on their merits rather than by default, and they give additional procedural leeway to people appearing without lawyers.

Willfulness

Cheng said he believed his former attorney had filed an answer and that the attorney did not give him the case documents after withdrawing. Cheng also said that prison lockdowns left him confined to his cell for much of the day, without access to legal research resources, and limited his ability to communicate with counsel.

The plaintiffs argued that Cheng knew about the case and the requested default judgment. They said he could have used his criminal lawyer, obtained new counsel, or represented himself. The court nevertheless found that Cheng’s failure to answer was not deliberate. The court credited the unchallenged assertion that COVID-19 restrictions prevented him from conducting necessary legal research and responding effectively.

Potentially valid defense

The court found that Cheng had no potentially valid defense to claims arising from the Token Purchase Agreement or the unpaid marketing services under the Master Services Agreement. Cheng had pleaded guilty to securities fraud involving the sale of cryptocurrency to the plaintiffs and the unpaid marketing services. The court held that issue preclusion—a rule preventing a party from disputing an issue already decided in an earlier proceeding—barred Cheng from relitigating those matters.

As to the Advisory Agreement, the court found that Cheng had a potentially valid defense to the breach-of-contract, unjust-enrichment, account-stated, and Racketeer Influenced and Corrupt Organizations Act claims concerning the alleged $230,000 owed for advisory services. Cheng argued that the plaintiffs’ services were unsatisfactory or fraudulent and that he had defenses based on those alleged problems and on statements by his business partners. The court emphasized that Cheng did not have to prove the defense at this stage; it only had to be legally sufficient to give the fact finder an issue to decide.

The court rejected indemnification as a defense to the Advisory Agreement fraud claims because New York law does not allow indemnification when the party seeking it is alleged to have participated in intentional wrongdoing.

Prejudice

The court found that setting aside the default would not unfairly harm the plaintiffs. The plaintiffs did not show that the delay caused loss of evidence, made discovery more difficult, created a greater opportunity for fraud or collusion, or threatened their recovery. The court also noted that discovery was already proceeding against Bell concerning the same or similar conduct. In addition, Cheng would remain barred from disputing the matters covered by his guilty plea.

Ruling

Judge Ramos granted Cheng’s motion to set aside the default. The order did not decide the remaining claims on their merits. Cheng was directed to answer the complaint by July 21, 2023, and the clerk was directed to terminate the motion and mail Cheng a copy of the order.