Where Was the Board? Reflections On Potential Legal Issues In PledgeMusic “Administration” Bankruptcy

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3In the wake of PledgeMusic's recent implosion and almost total silence in response to the issue, attorney and artist advocate Chris Castle takes a moment to share some thoughts on the failed crowdfunding platform's bankruptcy, and where they're headed from here.

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Guest post by Chris Castle of Artists Rights Watch

We’ve had a lot of questions about what is going on with the Pledge Music crowdfunding platform which appears to be either on its way or already in a bankruptcy filing according to reports.  This post will be a few thoughts about the current situation which is evolving.  This is not intended as legal advice and if you’re involved in the Pledge situation you need your own lawyers and you need them right now.  Consult your local state bar association (in Texas, that would be www.texasbar.com)  Don’t ask me questions in the comments as I won’t be able to answer them, so I’m afraid this is a one-way communication.

If this is all news to you, that’s understandable because if you go to the company’s website, there’s no indication that anything is amiss, which I find to be just downright bizarre in and of itself.  Normally what one would expect is that there would be some conclusive message blazoned across the landing page, but there’s nothing.

There certainly would not be testimonial endorsements from artists who are blasting the company which arguably qualifies as false advertising even if the site as a whole does not.

This lack of communication is, unfortunately, fast becoming what I find to be the hallmark of Pledge Music’s waning days, days which have been waning for a long time now.  I’m not a bankruptcy expert but one thing I can say from experience is that companies typically do not get into bankruptcy overnight and the seeds of their destruction often go back many months if not years.  In fact, those seeds are often found in the basic business plan.  So don’t let nostalgia allow you to let anyone out of their responsibilities and don’t let anger cloud your judgement.  Easy for me to say, I know.

Which Kind of Bankruptcy

Bankruptcy in a common language sense comes in two flavors:  liquidation and reorganization.  In liquidation bankruptcy the company ceases operations, the company’s assets are sold off, the proceeds used to pay creditors (including employees in some cases), and that’s the end of it.

In reorganization, it’s literally what it sounds like.  The company intends to keep operating (often with the same management as incredible as that may sound) and it reorganizes its finances, pays off creditors as best it can, and then re-emerges on the other side with a new balance sheet and having dealt with (some might say shirked) its obligations.  iHeart is a prime example of how artists and songwriters get screwed in reorganization bankruptcy.

It would be nice if Pledge had at least made a clear statement about what its future intentions are–like you know, on its website–but I don’t think we know definitively today.  It sounds like they’re liquidating.  I saw a lot of that in the Dot Bomb era when “entrepreneurs” burned through the investors money, ran the company into the wall at 100 mph and then flipped the keys to the first bum on the street.  A bit harsh, but that’s essentially what was happening all the time in the Silicon Valley testing range.

The difference is that they did it with the investment from sophisticated investors.  It’s looking more and more like Pledge did it with the artists and fans’ money at least in part.

Creditors

Creditors also come in two flavors and this is important:  secured and unsecured.  An example of a secured creditor is a bank that lends money to the company.  It appears that Pledge had a loan from one Sword, Rowe & Co. that may be secured. There may be others.  We don’t know, but based on open source materials, it appears to be at least one entity that could be a larger secured creditor.  If it’s this Sword Rowe & Co., they are based in New York and Nashville and specialize in music industry lending.  The Bloomberg profile on a Sword Rowe & Company appears to be the same company, and it is a successor to Sword & Company, a New Jersey based investment bank of long standing.

Secured creditors typically will be ahead of practically everyone in the bankruptcy pecking order, and sometimes can essentially wipe out any available assets.

Another attribute of a secured lender is that they typically have the benefit of loan applications and due diligence to have a good look at the financial condition of who they are lending to.  So in the “what did they know and when did they know it” race of the rats running for the door, we have to think that a sophisticated lender would know or should have known of the company’s financial condition whenever they made the loan.  Of course, investment banks sometimes have private equity arms, so it may not be the case that Sword is a secured lender.  It seems inconceivable, however, that they did not know what was going on with the company at some point.

When is a Creditor Not Creditor

The big difference–at least to me–between the kind of creditor relevant to bankruptcy and the artists whose fans pledged money is that the fan did not intend to give money to Pledge for its own use.  I think it’s fair to say that the fan paid money to Pledge to hold the money in trust, deducting solely the agreed 15% commission to Pledge, conditioned on Pledge fulfilling all of its obligations.  Given the reaction online so far, I think that the reality bears this out.  Like I said, I’m not a bankruptcy expert, but I don’t know of any rule that allows a company or its officers and directors to take money “pledged” to a third party and paid to the company in trust, spend it on themselves without authorization from anyone, and then declare bankruptcy to get out of paying it back.

There is, of course, the practical question of where the money comes from to pay the artists as originally intended, refund pledges to the fans who paid the money in the first place, and also refund all or part of any commissions taken by Pledge.  Not an easy answer, but this is why “what did they know and when did they know it” becomes an important question in my view.  If it turns out–and I can’t see how it couldn’t–that someone in a position of authority at the company like an officer or director, or perhaps even a secured creditor, knew that the money was improperly handled and spent–much less even co-mingled with the company’s own money–that person may have the responsibility to pay it back 100 cents on the dollar to either the artist or the fans.

This is one reason why you have directors and officers liability insurance.  That insurance arguably provides another pool of money (assuming Pledge had the insurance coverage).  Crimes are excluded, of course.  It’s worth asking if the coverage was in place (sometimes required by investors or lenders) and explore if one could make a claim against it in good faith.

On the other hand, bankruptcy can be a complex and confusing process that has its own set of rules, so artists and fans may wish to determine how they can perhaps argue in the alternative that they can claim creditor status if they initially take a position that they are not creditors.  That status issue likely would have to be ruled on by a court, so getting the issue in front of a judge quickly will likely be of critical importance.

This is a complex area, so if you’re involved you need to get to a lawyer quickly.

Credit Card Refunds

Fans may be able to pursue a refund through their bank or credit card company.  There are often limitations on how long a card holder can wait to make a claim for an improper charge, sometimes 90 days.  This may explain why one of the few public statements that Pledge made was to ask for 90 days to put its house in order.  By delaying any refund requests for 90 days, the company may have hoped to preclude anyone seeking a refund.

However, consumers might be able to successfully argue to their bank or credit card company that they did not know conclusively that their funds were being misused until the day that Pledge announced it was going into bankruptcy in the UK, which was last week.  One could argue that the clock to disallow the charge did not start running until that time as the company’s public statements indicated that they might ultimately fulfill their obligations to the fan (or “pledger”).

If it turns out that there was fraud involved, the credit card company may actually become your ally as they will have been duped as well.

Law Enforcement Agencies

The scope of this meltdown suggests that law enforcement agencies may at least investigate what happened.  It may turn out that there’s no criminal dimension to the situation, but I don’t think it can be ruled out at this point.

If Pledge violated state consumer protection laws, federal bank or wire transfer rules, mail fraud rules or other criminal statutes, this could be a 51 jurisdiction issue in the U.S. regardless of the choice of law provisions in a click through agreement.  I suspect that law enforcement agencies may be reviewing the situation now.

Artist Rights Groups

So far the only artist rights groups to jump in on the Pledge situation are UK Music and the UK Musicians Union.  I know the Musicians Union has been monitoring the Pledge situation for quite a while to their everlasting credit.

The silence is deafening.

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