When a law enforcement agency like the Federal Trade Commission or Consumer Financial Protection Bureau seeks disgorgement of “ill-gotten gains” from alleged wrongdoers, and has reason to believe some of the funds were passed to a third party who had no hand in the wrongdoing, it can name that party as a “relief defendant” and seek disgorgement from it as well. A claim against a relief defendant does not allege liability but only that it is in receipt of ill-gotten gains from a defendant as to which it has no legitimate claim, and thus must relinquish those funds upon a final monetary judgment against the defendant. To allow otherwise, according to the law, would result in the unjust enrichment of a third-party recipient of illegally acquired monies.
The legal test of a claim against a relief defendant is whether it has an ownership interest in and legitimate claim to the funds it received from an alleged wrongdoer. The FTC, CFPB and other enforcement agencies typically plead relief claims quite generally, alleging few if any predicate facts to support an allegation of lack of an ownership interest in and legitimate claim to the funds in question. This pleading practice was put to the test recently in a case brought by the CFPB against a mortgage lender and student loan debt relief affiliates that were accused of using consumer credit reports in an unlawful way and misleading consumers seeking loan modifications. In addition to the defendants, the complaint named a number of relief defendants, including two – an investment entity and its owner – who the author represented. These relief defendants were named because they were investors in the student loan debt relief entities and had received profit distributions in return for their investment. The CFPB complaint sought disgorgement of those profits.
A claim against a relief defendant that has no ownership interest in the funds, but is a mere custodian, such as a trustee, agent or depository, is straightforward. As there is no dispute over ownership, the relief defendant merely holds the funds pending the outcome of the case and turns them over to the government at the end if the defendant is found monetarily liable. It becomes more complicated, however, when a relief defendant credibly asserts an ownership interest in and legitimate claim to funds received from a defendant in return for fair consideration paid for those funds. In that case, a real dispute exists and the court’s jurisdiction over the relief defendant – who has not been charged with wrongdoing and is before the court only as an alleged possessor of funds with no valid claim to them – is called into question.
In the CFPB case, the relief defendants moved to dismiss the complaint on the dual grounds that it did not adequately allege that they lacked a legitimate claim, and that the court lacked jurisdiction over them upon a factual showing that they had paid valuable consideration for the distributions and thus there would be no unjust enrichment in allowing them to keep the money – even though it was paid from proceeds of alleged unlawful conduct. The motion further asserted that the pleading deficiency was incurable because the complaint alleged that the relief defendants had limited partnership interests in the student loan debt relief defendants, thus affirmatively admitting their ownership interest in the distributions. The CFPB opposed, arguing the complaint was adequately pled and the court had jurisdiction over the relief defendants even though they were investors who had paid consideration in the form of capital contributions to the entities, because investors as a class (in contrast to, say, creditors) have no legitimate claim to profits derived from ill-gotten gains – a position for which there is scant support in the law.
Last month, a federal court, in the Central District of California, granted the motion to dismiss on the ground that the complaint was not pled adequately. It wrote that:
…the Complaint insufficiently alleges that the Relief Defendants lacked a legitimate claim to the profits they received…. The Complaint conclusorily alleges that the Relief Defendants “have received…distributions of profits from the Student Loan Debt Relief Companies that are traceable to funds obtained from consumers through the violations…” and that “[t]hey have no legitimate claim to such funds and would be unjustly enriched if not required to disgorge the funds….” The allegation that the Relief Defendants “have no legitimate claim to such funds” is a bare assertion that lacks adequate factual enhancement.
(Emphasis in original.)
Picking up on relief defendants’ point that the CFPB had made a damning admission, the court reinforced its conclusion by noting that the complaint “affirmatively alleges facts showing that the Relief Defendants have a legitimate claim to the funds, because [they] “owned limited partnership interests in each of the Student Loan Debt Relief Companies….That [relief defendants] were investors in the entities – rather than trustees, agents, or depositories – counsels in favor of granting the motion.” (Emphasis in original.)
Since the court was able to decide the motion on the pleading alone, it did not reach the jurisdictional question, including the evidentiary showing that relief defendants had made in support of their claim to an ownership interest in and legitimate claim to the distributions.
The CFPB was given a chance to replead, which may not be easy given that the court has already found that it has “affirmatively” alleged the relief defendants have a legitimate claim to the funds by virtue of its acknowledgement, in the dismissed complaint, of their limited partnership interests in the student loan debt relief defendants. In any event, the takeaway for current and future relief defendants and their counsel from the court’s ruling is: do not be afraid to challenge the FTC, CFPB, or other enforcement agencies at the pleading stage if you feel the relief claim is pled too generally, or you were an investor in a defendant or held some other capacity in which you gave consideration for the funds the government is trying to take away from you. You might just win.