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Securities & Exchange Commission v. First Choice Management Services, Inc.

United States District Court, N.D. Indiana, South Bend Division

January 24, 2018



          Robert L. Miller, Jr. Judge United States District Court

         We are nearing the end of this action, now in its eighteenth year, in which Joseph Bradley was appointed receiver to try to recover moneys people lost in this fraudulent investment scheme. The receiver's performance has been extraordinary. He has recovered far more of the investors' lost funds than could reasonably have been expected at the action's outset. His pursuit of those funds led him into a thicket of oil leases in Texas. The receiver is now before the court asking that the Railroad Commission of Texas turn over $250, 000 that was posted with it in relation to the oil leases. Through its verified application for summary proceedings and civil contempt, disgorgement and other relief [Doc. No. 1097], the receiver asks the court to find the Railroad Commission in contempt for failing to turn over $250, 000 in alleged defrauded investor funds that were deposited with Bank of America. Alco Oil & Gas Co. deposited the funds as a letter of credit to secure an operating license from the Railroad Commission.

         The receivership has remained open for the past few years as the receiver addressed the refusal of the parties in possession of the remaining assets - particularly those of Branson Energy Texas, Inc. and Branson Energy, Inc.- to turn over those assets per the procedures set forth in this court's orders. Intense litigation ensued in this court, the court of appeals, and state court, and all of the parties who withheld, encumbered, or interfered with the turnover of the Branson Energy assets were sanctioned and ultimately forced to turn over the assets.

         On August 31, 2016, the receiver submitted his “Verified Final Budget and Revised Plan for Closure of the Receivership” [Doc. No. 1093]. The court approved that budget [Doc. No. 1094] and authorized the receiver to make immediate demand of the Railroad Commission for the turnover of the Branson Energy Texas operating bond ($250, 000 plus the interest on it over the past decade-plus), and, if compliance wasn't immediate, to pursue such turnover through summary proceedings. The liquidation of the Branson Energy Texas operating bond would enable the receiver to satisfy the estate's monetary obligations, particularly the outstanding attorney fee invoices.

         The court gave the Railroad Commission 21 days to respond to the receiver's ensuing motion. The Railroad Commission moved to dismiss under Fed.R.Civ.P. 12(b)(1) and 12(b)(6) for lack of personal jurisdiction and failure to state a claim for which a relief can be granted. The motion raised several arguments, many of which the court needn't address.

         The Railroad Commission says it has no obligation to release the cash financial assistance; doing so would violate Texas state law. The September 19, 2008 order lifted the freeze order as to Alco, giving Alco permission to operate the leases [Doc. No. 487]. Alco opted to post cash financial assurance with the Railroad Commission for the purpose of operating the leases. The freeze and turnover order provides in relevant part: “Nothing in this order shall impede ALCO's ability to proceed in all matters and/or before all government agencies, boards and/or commissions as the designated, authorized and lawful operator.” [Doc. No. 487].

         Because the receiver chose to operate the estate property by appointing Alco, see S.E.C. v. First Choice Mgmt. Servcs., Inc., 2010 WL 148313, at *2 (N.D. Ind. Jan. 12, 2010), the receiver must operate that property according to state law under 28 U.S.C. § 959(b). The Railroad Commission used this court's position that "[c]ourts have read § 959(b) in context with § 959(a) to mean that receivers can be held liable in tort and must follow state environmental and other regulatory laws." S.E.C. v. First Choice Mgmt. Servcs., Inc., 2010 WL 148313, at *7 (N.D. Ind. Jan. 12, 2010); accord In re Cajun Elec. Power Co-op., Inc., 185 F.3d 446, 453-54 (5th Cir. 1999) ("[W]e agree with our sister circuits that the import of this section is that the general bankruptcy policy of fostering the rehabilitation of debtors will not serve to preempt otherwise applicable state laws dealing with public safety and welfare.") (internal citations omitted). The statute provides in relevant part:

Except as provided in section 1166 of title 11, a trustee, receiver or manager appointed in any cause pending in any court of the United States, including a debtor in possession, shall manage and operate the property in his possession as such trustee, receiver or manager according to the requirements of the valid laws of the State in which such property is situated, in the same manner that the owner or possessor thereof would be bound to do if in possession thereof.

28 U.S.C. § 959(b)(2) (emphasis added).

         The Railroad Commission says it will, pursuant to Texas law, refund the cash deposit if: (1) the conditions that caused the proceeds to be collected are corrected; (2) all administrative, civil, and criminal penalties relating to those conditions are paid; and (3) the Commission has been reimbursed for all costs and expenses by Commission incurred in relation to those conditions. Tex. Nat. Res. Code Ann. § 91.1091 (West 2017).

         As of August 2017, Alco still had regulatory responsibility for eighteen wells, and the Railroad Commission says it has spent $542, 407.16 directly on plugging and site remediation for the receivership's wells. Once state law is followed regarding Alco's remaining wells and liabilities and the Railroad Commission is reimbursed for its expenses related wells for which Alco has or had regulatory responsibility, the Railroad Commission says it will refund the cash financial assurance to the proper entities.

         The Railroad Commission also says the receiver's demand would require payment from public funds. The $250, 000 financial assurance is on deposit in Texas' “oil and gas regulation and cleanup fund, ” which is for the state's use for well plugging and surface remediation, which in turn protect human health, safety, and the environment.

         The Railroad Commission further argues that the receiver hasn't set forth a case of contempt, and the matter should be dismissed with prejudice pursuant to 12(b)(6). When the freeze and turnover order [Doc. No. 178] was issued, the $250, 000 was in the hands of Bank of America and the Railroad Commission had an independent promise of Bank of America to pay if a demand against the letter of credit should be made. Letters of credit payable to third parties are not receivership estate property, even if they are supported by estate property. See In re Green, 210 B.R. 556, 558-59 (Bankr. N.D.Ill. 1997).

         Even if the receiver could demand turnover of funds that his agent (Alco) deployed for the estate's benefit, he can't do so in this case, says the Railroad Commission because the estate operated estate assets in Texas and the receiver must, as mentioned previously, operate those assets in accordance with state law. See 28 U.S.C. ยง 959(b). The Railroad ...

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