false advertising & bankruptcy law: $18 million for deceptive campaign in violation of automatic stay

In re Windstream Holdings, Inc., 627 B.R. 32 (S.D.N.Y. 2021)

Plaintiffs/Debtors argued, and the court held in relevant part, that defendants (Charter) breached the automatic stay by a literally false and intentionally misleading advertising campaign to induce the Debtors’ customers to terminate their agreements with the Debtors by telling them that bankruptcy risked impairment of their service. (Charter, notably, had previously been the victim of a similar campaign by DirecTV when Charter filed for bankruptcy ten years prior, and obtained a TRO against DirecTV, which the court doesn’t mention here but might bear on the concept of willfulness.)  

As alleged in the initial complaint, Charter mailed solicitations whose envelopes “used Windstream’s trademark and copied the same distinct color pattern from Windstream’s current advertising campaign.”

"Important Information Enclosed for Windstream Customers."

Text: Windstream Customers,

Don’t Risk Losing Your Internet and TV Services.

Windstream has filed for Chapter 11 bankruptcy, which means uncertainty. Will they be able to provide the Internet and TV services you rely on in the future? To ensure you are not left without vital Internet and TV services, switch to Spectrum.

With a network built for the future, Spectrum is here for the long haul . . . .

Windstream’s future is unknown, but Spectrum is here to stay—delivering internet and TV services you can count on. . . .

Example consumer call alleged in the complaint: “…. I got a letter in the mail saying that ya’ll were going bankrupt and for me to go with Spectrum so I have gone to Spectrum and I have just called to have the services of Windstream disconnected.”

On social media:

"Were U planning on telling UR customers" [to switch before they lose service]?

This opinion considered whether Charter was liable in civil contempt and the amount of harm caused by its conduct to the relevant creditors. The court found that yes, Charter was in contempt of the automatic stay, and should be sanctioned $19,179,329.45 for the losses caused by intentionally and wrongfully interfering with the Debtors’ customer contracts and good will.

Along with knowledge of an order and failure to comply with it, civil contempt generally requires “that (1) the order the contemnor failed to comply with is clear and unambiguous, (2) the proof of noncompliance is clear and convincing, and (3) the contemnor has not diligently attempted to comply in a reasonable manner.” If there’s “a fair ground of doubt as to the wrongfulness of the defendant’s conduct,” civil contempt isn’t appropriate. But an additional bad faith/willfulness finding isn’t required. The touchstone is not an intent to violate, but an intentional act in violation of the order; an objectively unreasonable belief that one is complying with the order does not avoid a contempt finding.

Courts have sometimes been more aggressive when treating violations of the automatic stay, which “aims to prevent damaging disruptions to the administration of a bankruptcy case in the short run.” Given the importance of the automatic stay to multiparty bankruptcy cases and the continuing judicial supervision of a bankruptcy case, “it is logical to require those in doubt whether the stay applies to seek clarification from the court or be sanctioned for shooting first and aiming later.” Certainly no more than an objective standard for a clear violation is required.

This made the nonadvertising part of the case easy: Charter breached the automatic stay when it terminated services to some of debtors’ customers based on debtors’ default on prepetition obligations.

Of possible interest to cyberlaw folks, Charter argued that it was unable to comply, because its termination of service was wholly mechanical, arising from “automatic nonpayment protocols” programmed into its computerized billing system. The court disagreed: “[I]t is not really a defense for a large and sophisticated entity like Charter that provides services to many customers, some of whom inevitably will file for relief under the Bankruptcy Code, to argue that its systems do not have an effective fail-safe to prevent it from violating the automatic stay.” Charter didn’t argue that it couldn’t create systems to override automated collection activity. “Turning a blind eye to the automatic stay by choosing systems that are incapable of complying with it is not tantamount to an inability to comply nor with making diligent efforts to comply in a reasonable manner.”

For advertising folks: Charter was also held in contempt for interfering with debtors’ customer contracts and goodwill “through Charter’s literally false and intentionally misleading advertising campaign intended to create the impression, using mailings designed to seem as if they were coming from the Debtors, that the Debtors were going out of business.” There was clear knowledge of the automatic stay, given that “Charter premised the campaign on false assertions regarding the Debtors’ bankruptcy cases.”

The Bankruptcy Code automatically stays “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” It’s not confined to acts to collect or enforce a claim or judgment against the debtor, but was designed to ensure that a trustee or debtor in possession maintains control of the estate’s property and to protect against its “dismemberment” in furtherance of an eventual equitable distribution to creditors. It covers executory contracts, which are property of the debtor’s estate, and protects them both against termination and “other interference that would have the effect of removing or hindering the debtor’s rights” in violation of the statute. Goodwill is also well recognized property of the estate.

Comment: This is an interesting question given that TM/advertising people tend to define goodwill differently than general business valuation people, especially in the TM/false advertising context. Is a counterfeiter of products of a bankrupt entity in violation of the automatic stay if it knows about the bankruptcy? Or say an unrelated competitor to a bankrupt pharmaco starts falsely advertising comparatively about its painkillers without reference to the bankruptcy. Does its awareness of the stay mean that its false advertising violates the automatic stay? A few of the cited cases seem to say yes, but even the closest analogous case seems to have been premised on prior contractual dealings: Alert Hldgs., Inc. v. Interstate Protective Services, Inc. (In re Alert Hldgs., Inc.), 148 B.R. 194 (Bankr. S.D.N.Y. 1992) (court summary: “intentionally deceptive advertising that interfered with debtor’s customer contracts and harmed goodwill automatically stayed”; contempt defendants had previously sold the relevant accounts to the debtor); see also Phillips v. Diecast Marketing Innovations, LLC (In re Collecting Concepts), 2000 Bankr. LEXIS 615 (court summary: “preliminary injunction granted against interference with debtor’s goodwill and executory contracts by competitor in violation of section 362(a)(3)”; competitor was in negotiations to buy the business line before bankruptcy and had dealings with relevant party with prepetition debtor’s knowledge).

The court noted that many such decisions didn’t require “acts for which the violator would be liable under applicable non-bankruptcy law” as long as there was simply interference with the debtor’s contract rights. Where the acts were clearly lawful under applicable non-bankruptcy law, courts use a balancing test, but that didn’t matter here because the literally false and intentionally misleading advertising campaign was not “ordinary course commercial conduct,” but rather unlawful under nonbankruptcy law.

Defendants unhelpfully argued that they subjectively didn’t believe they were violating the stay, which didn’t matter. Nor could they cast off blame onto their ad agency or their consultant. Defendants authorized the campaign “to be modeled on a prior campaign relating to a competitor that was ‘shutting down service’ to create doubt whether the Debtors would remain in business,” and anyway acts of their agents in violation of the stay would be imputed to them.

Defendants also argued that applying the automatic stay to their advertising would violate the First Amendment, and (implicitly) that the First Amendment provided them with a fair ground for doubt that the automatic stay applied. But First Amendment rights can be restricted when they are an integral part of conduct that violates a valid statute, such as that providing for the automatic stay. (This seems to treat the false advertising as speech rather than conduct; that creates problems when it comes to, say, truthful comparative advertising that also implicates the estate, but apparently that is not unique to this case. Cited: Collier v. Hill (In re Collier), 410 B.R. 464 (Bankr. E.D. Tex. 2009), “in which the posting of a sign that said, ‘Brad Collier owes me $943.23. Will you please come and pay me!’ was not protected by the First Amendment because it was debt collection activity prohibited by 11 U.S.C. § 362(a)(6), and In re Andrus, 189 B.R. 413 (N.D. Ill 1995), “which held that conduct including the posting of signs stating that the debtor ‘Went Bankrupt! He Didn’t Pay His Bills! He Is A Deadbeat! This Is a Public Service Announcement’ and ‘Gene Andrus, Where’s My Money?’ was not protected speech, but, rather, properly prohibited.” Also—and perhaps even more sound—false/misleading commercial speech isn’t protected by the First Amendment. The automatic stay “protects a strong governmental interest threatened by the Defendants’ conduct.” By contrast, defendants’ primary case, In re National Service Corp., 742 F.2d 859 (5th Cir. 1984), involved a defendant who “accurately reported a debtor’s bankruptcy status on a billboard commissioned from it by the debtor which otherwise would have inaccurately implied that the debtor was affiliated with a financially healthy company and therefore could pay its bills.” There, the addition “was found to be primarily informational; there was no act to harm and thus no violation of section 362(a) of the Bankruptcy Code.” Seems like a lot of work is being done by “harm” there, which is pretty manipulable when it comes to intangibles. Another case cited by the court, In re Golden Distribs., Ltd., 122 B.R. 15 (Bankr. S.D.N.Y. 1990), found that “the debtor’s former salespeople did not harm the debtor’s goodwill or contracts because they had not appropriated any customer lists or similarly protected information and the former customers who changed their allegiance did not have contracts with the debtor.” But of course that doesn’t mean they didn’t harm the debtor’s goodwill—it means that outside of bankruptcy, they didn’t commit a tort.

But did these defendants nonetheless have a fair ground for doubt about whether their advertising campaign violated the stay” The provision has sometimes been found to be ambiguous with respect to the meaning of “any act ... to exercise control over property of the estate,” but only in irrelevant contexts (e.g., when the alleged violator of the stay has a strong countervailing interest that would be affected, such as when federal law precluded a nonbankruptcy injunction against a union’s actions in contacting prospective customers). This last one, coming out of a Trump bankruptcy, strikes me as a solid precedent to protect truthful comparative advertising that damages the estate—but that’s not relevant here. The court considered the Trump case relevant when it’s tricky to determine “the nature and extent of the estate’s interest in the property.” But there was no ambiguity here—the debtor had uncontroverted evidence that debtors’ customer contracts’ average duration at the time of the stay violation was 50 months—and anyway the caselaw clearly points to the rule that if a party isn’t sure, it should seek relief from the automatic stay.

Future guidance: “Although every corporation expects legitimate advertising by competitors, and thus such advertising does not ‘exercise control’ over its property, improper advertising such as the Defendants’ clearly and objectively interfered with the Debtors’ customer contracts and goodwill and thus clearly was precluded by section 362(a)(3)’s plain terms and the caselaw applying them.” Again, this is a manipulation of what counts as “control” to insert “wrongful” in front. And the automatic stay isn’t overbroad simply because it “could conceivably be applied more broadly to advertising in general”; “the foregoing caselaw sufficiently cabins that application for there to be no fair ground of doubt that Charter fell on the wrong side of the statute when it undertook to mislead the Debtors’ customers to end their contracts and impaired the Debtors’ goodwill.”

For the advertising violations, the court basically accepted debtors’ evidence of (1) lost profits from customers who switched to Charter as a result; (2) corrective advertising costs; (3) “the cost of a promotional campaign to recover market share, or new customer momentum lost because of the breach,” and (4) related attorneys’ and expert witness fees and expenses. While Lanham Act courts are sometimes hesitant about damages from categories (2) and (3), the court here was satisfied that “corrective advertising is a well-recognized component of damages for harm caused by wrongful advertising,” and defendants didn’t fight very hard on whether the corrective advertising costs were reasonable and causally related to their ad campaign. Though they did object to (3), the court was satisfied that the $4 million campaign was “incurred because of and in response to Defendants’ ad campaign,” based on testimony that it was “the most aggressive campaign that [Plaintiffs] have run,” “was absolutely uncommon for [Plaintiffs],” and was aimed to address the Charter campaign’s “profound impact on [Plaintiffs’] business, and we didn’t see it in the non-Charter [Exchanges],” where the false advertising campaign didn’t occur.

Nor did (3) unfairly duplicate lost profits because it was trying to win back lost customers. It surely stood to reason that some of the promotional campaign reached former customers, but still, “damages for wrongful advertising can include both lost profits and the cost of damage control programs, including corrective advertising, at the same time.” Plaintiffs’ witness testified credibly that before the false ad campaign, they were on a growth trajectory, but after, they were “behind plan” by about 5000 customers. The promo program was primarily designed to recover suppressed demand. That met plaintiffs’ burden of showing that (3) was a category of damages separate from lost profits—or, in the alternative, that established that (3) approximated the value of plaintiffs’ lost goodwill. And here’s an interesting statement relevant to my point about goodwill above: “Defendants’ contention that this should be precluded because the Debtors’ monthly operating reports filed during their bankruptcy cases showed no erosion in goodwill clearly misses the mark; GAAP goodwill for purposes of the Debtors’ monthly operating reports is not business goodwill for purposes of calculating damages.”

Plaintiffs also received a chunk of their attorneys’ fees; if willfulness was required for that, they showed it. “While the ratio of Plaintiffs’ fees and expenses to Plaintiffs’ damages is high ($9,183179.45 /$9,996,200), a large portion of the legal fees and expenses were incurred in response to several questionable litigation choices by Defendants” as well as the costs of obtaining the cessation of the false advertising.