In a recent decision in the case of Ryniker v. Washington (In re Augustus Intelligence), Case No. 21-10744, Adv. Proc. No. 23-50370, the U.S. Bankruptcy Court for the District of Delaware (the Bankruptcy Court) adjudicated a pending motion to dismiss a complaint filed by a liquidating trustee. In this case, the liquidating trustee asserted several claims on behalf of the estate (the estate claims), which included breach of contract claims, breach of fiduciary duty claims, fraud claims and conversion claims, among others. In addition, the complaint also asserted a set of claims that were assigned to the liquidating trustee by investors (the investor claims) who had invested money into the debtor prior to the petition date. In his motion to dismiss, the defendant moved to dismiss all of the investor claims and one of the breach of contract claims.

The facts of this case were as follows: Prior to the commencement of the bankruptcy case, Wolfgang Haupt (Haupt) was the founder and CEO of the debtor, “a company designed to develop and deliver artificial intelligence solutions across a variety of industries.” Following the debtor’s formation, Haupt developed a relationship with Kevin Washington, the son of a billionaire, who had an indirect “investment in CryptoWatt Mining LLC (CW Mining), a company whose assets included two bitcoin mining data centers.” As a result of this relationship, both Haupt and Washington decided that they should work together so that the debtor could provide artificial intelligence to assist CW Mining’s cryptocurrency mining. Both Haupt and Washington agreed that in order to effectuate these goals, the debtor needed to raise over $80 million.

In an effort to raise this money, Haupt proffered up Washington as being a lead investor in the debtor. As the son of a billionaire, Haupt believed that news of Washington’s investment “would gather great weight with other possible investors.” However, Washington did not want to be the initial investor. Eventually, Haupt and Washington surreptitiously worked out a deal to resolve this impasse by which Haupt would pretend that Washington had, in fact, invested $50 million in the debtor even though Washington, himself, never did with the “tacit” understanding that once additional investors had placed their funds, Washington would invest then $50 million.

As a result of Haupt’s efforts, he raised $30 million from investors plus obtained subscriptions of an additional $60 million. Flush with this cash, the debtor hired dozens of employees and software engineers at a cost of billions of dollars. However, Washington never paid the $50 million, and eventually this house of cards collapsed.

On Aug. 24, 2021, the debtor filed a Subchapter V bankruptcy case, and on May 3, 2022, the debtor filed its plan of reorganization. As part of its plan, the debtor transferred all of its assets, including any and all causes of action, to a liquidation trust to be pursued by a litigation trustee for the benefit of the trust’s beneficiaries. In addition, the plan also contained a provision whereby certain of the debtor’s pre-petition investors could elect to assign their liquidation claims to the litigation trustee, who would pursue them on their behalf. Eventually, the plan was confirmed on July 16, 2022, and on April 23, 2023, the litigation trustee commenced an adversary proceeding against Washington, among others.

Following the filing and service of the complaint, Washington moved to dismiss on the basis of lack of subject matter jurisdiction. In particular, Washington asserted that the Bankruptcy Court lacked subject matter jurisdiction over the assigned investor claims because “they are claims among non-debtors that have no relation to the bankruptcy case.”

In addressing this issue, the Bankruptcy Court noted that it has jurisdiction over four types of matters: “‘cases under Title 11, proceedings related to a case under Title 11, proceedings arising in a case under Title 11, and proceedings related to a case under Title 11,’” (quoting In re Millennium Lab Holdings II, 562 B.R. 614, 621 (Bankr. D. Del. 2016) (quoting 28 U.S.C. Section 157)). Furthermore, cases “falling under the first three categories are typically referred to as core proceedings, whereas proceedings ‘related to’ a case under Title 11 are designated as non-core proceedings.”

The Bankruptcy Court then addressed the issue of pre- and post-confirmation jurisdiction and acknowledged its own limited jurisdiction following confirmation, especially with respect to non-core proceedings. As noted by the Bankruptcy Court, post-confirmation jurisdiction exists “only if there is ‘a close nexus to the bankruptcy plan or proceeding,’” (quoting In re Penson Worldwide, 587 B.R. 6, 12 (Bankr. D. Del. 2018)). In this case, the parties agreed that the claims at issue were not core matters, and therefore the only way the Bankruptcy Court could maintain jurisdiction over these claims would be if there was a “close nexus” to the debtor’s bankruptcy plan or proceeding. While noting that liquidation trusts “by their nature” maintain a connection to the debtor’s bankruptcy case even following confirmation of a plan, the Bankruptcy Court opined that “‘the question is how close a connection warrants post-confirmation bankruptcy jurisdiction,’” (quoting In re Resorts International, 372 F.2d 154, 167 (3d Cir. 2004)).

In this case, the Bankruptcy Court found that the claims at issue did not provide a close nexus to the debtor’s plan or proceeding. In particular, the Bankruptcy Court noted that the claims at issue in this case were claims over which the court did not have pre-confirmation jurisdiction, nor would they be claims that would be liquidated for the benefit of the estate and its creditors. As noted by the Bankruptcy Court, the investor claims were “never subject to the court’s jurisdiction and would be claims liquidated for the benefit of only those equity holders who assigned them.” Simply put, these claims were, in essence, claims “by nondebtors against non-debtors.” Accordingly, the Bankruptcy Court found that it did not have jurisdiction over these claims.

With respect to the breach of contract claim, the Bankruptcy Court analyzed those claims on a Section 12(b)(6) basis and found them to not be plausible. Simply put, the court found that the underlying agreement between Washington and Haupt was an illegal contract and therefore unenforceable as a matter of public policy.

This case highlights the pitfalls associated with an assignment of claims from non-debtor parties. Practitioners should be wary of such assignments, particularly in a post-confirmation context.

Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.