On the date it filed bankruptcy in a Nevada federal court, and just days before Massachusetts regulators and the Securities and Exchange Commission accused the company of being a massive pyramid and Ponzi scheme that had raised at least hundreds of millions of dollars from investors worldwide, TelexFree LLC filed a rather innocuous-sounding motion to “Authorize the Debtors to Reject Certain Executory Contracts Nunc Pro Tunc As Of The Petition Date.” Cloaked in bankruptcy parlance, the title of the motion holds little meaning to the estimated hundreds of thousands of “promoters” that, until recently, were promised lucrative returns for placing daily advertisements and recruiting new investors.
However, a casual read of the Motion makes clear that the company accused by regulators of being an “egregious” pyramid scheme seeks now to use the Bankruptcy Court’s power to eliminate the obligation to pay accrued compensation likely totaling hundreds of millions of dollars to “promoters” – under the theory that elimination of these obligations will allow the company to “ultimately prove successful and profitable.” Ironically, one of the chief concerns cited by TelexFree related to questions “raised as to whether the Original Comp Plan is compliant with law, which jeopardized the Debtors’ business.”
The Motion was filed on April 13, 2014 – the same day that TelexFree and two of its affiliates filed for bankruptcy in the Nevada bankruptcy court. While TelexFree’s main business centered on the sale of its voice over internet protocol (“VoIP”) program, 99TelexFREE, the company also operated a passive investment program. By the terms of the previous compensation plan, an investor making an initial investment of either $289 or $1,375 would be required to so spend several minutes per day in an “effortless” path to astronomical gains – at least 200% per year. These massive returns quickly resulted in a scenario where obligations to promoters drastically outpaced company revenues – indeed, according to the Commission, this compensation program racked up more than $1.1 billion in obligations to promoters.
As the Commission recognized, the $1.1 billion in promoter obligations was 100x larger than the $1.1 million realized in revenue from the sale of 99TelexFREE. In March 2014, TelexFree announced a drastic revamp to its compensation plan. Rather than simply place a daily advertisement and earn $20 per week on a $289 investment, the new compensation plan effectively required the purchase or sale of five $49.90 VOIP packages in order to be eligible for a return. As BehindMLM recognized, the compensation plan suddenly shifted from previously allowing the passive investment program to function independently of the VoIP product to now integrating the two programs and counting on the viability of the VoIP product as a standalone product.
The Motion positions TelexFree as a “telecommunications business that uses multi-level marketing to assist in the distribution of voice over internet protocol telephone services.” Touting 99TelexFree, the Motion claims that customer usage increased each month since its introduction in 2012. For the first time, the Motion disclosed that TelexFree has “over 700,000 promoters” worldwide, and referenced the recent discontinuation of its compensation plan in favor of a revised compensation plan. However, the “discretionary” payments owing to promoters under the original compensation plan soon allegedly “became a substantial drain on the Company’s liquidity,” and the company soon ceased making those payments prior to filing bankruptcy.
Despite experiencing “exponential” growth in revenue (which it claimed was over $1 billion), TelexFree claimed that it filed Chapter 11 bankruptcy due to “substantial asserted liabilities” against the company due to previous compensation arrangements. Citing its belief that the soon-to-be released TelexFree mobile app and other products would propel the company to profitability, the Motion sought court approval to reject “all agreements between the debtors and the promoters under both the Original Comp Plan and the Revised Comp Plan.” According to the Commission, this included at least $174 million in requests for payment by promoters submitted after the change in the compensation plan.
Of note, the Motion takes great pains to characterize the relationships between the promoters and the company as contractual, reciting a number of obligations that each owed one another. While the company’s obligations primarily consisted of paying the promoters, the promoter’s obligations were characterized as adhering to the rules, agreeing to receive messages in their inboxes, and providing true and accurate information – primarily passive obligations.
The likelihood of success for the Motion is unknown. Indeed, a case cited to in the Motion specifically cautions that such a “business decision” should not be granted if the decision was the product of “bad faith, whim, or caprice.” In re Trans World Airlines, Inc., 261 B.R. 103, 121 (Bankr. D. Del. 2001). One bankruptcy authority recently recognized the difficulty the company would face in trying to discharge its obligations to creditors, noting the Bankruptcy Code’s prohibition under 11 U.S.C. 523 against the discharge of debts arising from the debtor’s bad acts:
1) debts arising from fraud by the debtor as a fiduciary, embezzlement, or larceny; (2) debts obtained through false pretenses, false representations, or actual fraud; (3) consumer obligations – credit card debts and luxury goods – owed to a single creditor over a certain threshold; and (4) willful and malicious injury caused by debtor to another’s property.
While in a vacuum the request might not appear as questionable, the recent allegations by Massachusetts regulators and the Commission paint a picture of widespread fraud – indeed, the recently-appointed Chief Financial Officer of TelexFree was caught trying to leave the company’s headquarters with nearly $40 million in cashier’s checks after federal authorities raided the office. Moreover, the Commission alleged that approximately $30 million has been transferred in the last 5 months to company principals and related entities.
There has been no ruling as of yet on the Motion.
Ponzitracker coverage of TelexFree to-date is here.
The Motion is below: