In “Settle or Fight the FTC: A ‘Hobbesian’ Choice” (DRMA Voice, July 2012), I wrote that the former president of now defunct Commerce Planet, Charles Gugliuzza, was found liable for deceptive marketing of a “free trial” of an eBay moneymaking product with a negative option feature and ordered to pay $18.2 million in a Federal Trade Commission (FTC) action filed in U.S. District Court in the Central District of California. The court said the negative option was not “clearly and conspicuously” disclosed, leaving the deceptive “net impression” that the consumer could get the product for free.
Gugliuzza was held jointly and severally liable for payment of the $18 million judgment on evidence that he had the authority to control the deceptive conduct, participated in it, and did so knowingly by showing a “reckless indifference” to the deception. The company and other individual defendants had chosen to settle, but Gugliuzza – who had insurance for a defense – opted to fight.
He is still fighting. After the verdict, he filed for bankruptcy and simultaneously appealed to the U.S. Ninth Circuit Court of Appeals, represented in the latter by Erwin Chemerinsky, dean of the University of California, Irvine School of Law and one of the top constitutional lawyers in the country.
The FTC, as it normally does with a judgment debtor, followed Gugliuzza into bankruptcy court, filing an adversarial complaint and alleging that the judgment was not dischargeable. A debt is dischargeable unless it arises from “false pretenses, a false representation, or actual fraud.” The issue for the court was whether the FTC had proven falsity or fraud in the underlying case. If it had, then Gugliuzza would not be permitted to litigate the issue of “non-dischargeability” under the doctrine of “collateral estoppel,” and the judgment would stay in effect.
The FTC generally wins non-dischargeability fights, and at the outset it looked like it would be no different here. The bankruptcy court granted it summary judgment, finding it had proven falsity or fraud by showing that Gugliuzza had knowingly and intentionally made materially false claims for the Commerce Planet product because he had been “recklessly indifferent” to the fact they were misleading.
Undaunted, Gugliuzza appealed to the federal district court, which is the first level of review of bankruptcy decisions. The appeal was heard by the same judge, Cormac Carney, who had presided at the underlying trial and is no stranger to FTC cases, having heard several.
In what may be one of the few (if not the first) defeats for the FTC in bankruptcy court, Carney reversed, holding that non-dischargeability was not “collaterally estopped” from being litigated because the FTC had not proven one key element of falsity or fraud. The elements are: (1) a fraudulent or deceptive representation or omission; (2) the debtor’s knowledge of the falsity or deception; (3) the debtor’s intent to deceive; (4) justifiable reliance on the debtor’s conduct; and (5) the creditor’s loss was the result of the debtor’s conduct.
Carney held that the FTC had established every element except “intent to deceive,” which he said is “crucial” in the context of non-dischargeability because non-discharged debts usually involve “intentional wrongdoing or fraud.” By contrast, he wrote:
… proof that the individual intended to deceive consumers or acted
in bad faith is unnecessary to establish a violation of Section 5(a)
[of the FTC Act]. In the Underlying Action, this Court did not make
a finding of Gugliuzza’s intent to deceive, as it was not critical or
necessary to establish a Section 5(a) violation.
The FTC argued that Gugliuzza’s proven “reckless indifference” to the deception was sufficient to establish intent to deceive and preclude litigation of non-dischargeability under collateral estoppel. Carney disagreed, saying, “Collateral estoppel applies only when the issues are identical, not merely similar,” and that “reckless indifference and intent to deceive are separate issues and require separate inquiries.” In addition to permitting him to litigate “intent to deceive,” Carney said Gugliuzza also could assert “good faith” and “advice of counsel” defenses to non-dischargeability, even though they are not defenses in an FTC case. He sent the case back to the bankruptcy judge for adjudication of these issues.
For myriad reasons, bankruptcy should be a last resort and until now has not provided much protection from an FTC judgment because the FTC usually has won the non-dischargeability battle. Carney’s decision suggests the “bankruptcy card” may now warrant greater consideration in a besieged FTC defendant’s survival strategy because proving actual intent to deceive could be decidedly more difficult than simply showing reckless difference. While its legal effect is limited to the Central District of California, the opinion is well reasoned – and with Carney’s strong reputation, it could have persuasive appeal to other courts.
Meanwhile, as Carney was rocking the FTC’s boat on the bankruptcy front, Chemerinsky was attempting to do the same in the pending Ninth Circuit appeal. Among other grounds for reversal, he is contending there can be no “joint and several liability” for restitution or disgorgement in FTC federal court actions because joint and several liability is a “legal” concept, while federal courts’ authority in such actions is “equitable” and restitution and disgorgement are purely “equitable” remedies. (I will save for another day, or never, an explanation of the esoteric difference between the two.)
Should this novel argument prevail, it would register an 8.0 on the FTC’s Richter scale, since it would be an existential threat to the Damocles sword of liability for 100 percent of consumer losses or “ill-gotten gains” that the FTC is now able to wield over defendants in litigation and settlement negotiations. Why? Because without joint and several liability, an individual defendant would be liable for no more than the share of consumer loss he caused and would have to disgorge only the funds he personally received.
When presented with a no-compromise demand for all of his assets in pre-litigation settlement talks, a top FTC official warned Gugliuzza that unless he took it, “You’ll be working for me all your life.” Will Gugliuzza have the last laugh? Stay tuned.