Suspension and prevention: The story behind suspended judgments

It’s a phrase you see every now and then in announcements about FTC settlements: “The order includes a $___  judgment, which has been partially suspended based on the defendants’ inability to pay.” What happens if it turns out the defendants weren’t telling the truth about their financial condition? A ruling by a federal judge in Arizona explains the consequences.

The story starts with a 2014 lawsuit against Clint Ethington and HCG Diet Direct for deceptive weight loss claims for purported human chorionic gonadotropin drops. (HCG, a hormone produced by the placenta, has been bogusly peddled for years as a diet product.) To settle the case, the defendants agreed to tough injunctive provisions requiring them to have at least two clinical studies to back up future weight loss claims. They’ll also need sound science to support other health-related representations. In addition, the order imposed a $3.2 million judgment against Ethington and the company, which was suspended based on their financial condition.

Let’s press the pause button right there to make it clear that the FTC doesn’t just take defendants’ word for it when they say they can’t pay. FTC staff requires that the defendants swear to the accuracy of a stack of documentation – in this case, personal and corporate financial statements.

And that’s not the end of it. If any portion of a judgment is suspended, our practice is to include a provision spelling out that the FTC’s agreement to settle was expressly premised on the truthfulness, accuracy, and completeness of the defendants’ financial information. In addition, we’ll typically ask the Court to include a provision lifting the suspension – and making the total immediately due – if it turns out that a party “failed to disclose any material asset, materially misstated the value of any asset, or made any other material misstatement or omission” in their statements. (For obvious reasons, we call those avalanche clauses.) As part of the order compliance process, we keep a close watch for any signs that the parties may not have been truthful in what they said about their finances.

In September 2015, the FTC asked a federal court in Arizona to lift the suspension in the HCG Diet Direct case based on a series of misrepresentations and omissions in Ethington’s financial statements. Ethington claimed the inaccuracies were unintentional and not material. The Court ruled otherwise:

Given this context, a reasonable person in the FTC’s shoes would have attached importance to inaccuracies relating to Ethington’s finances. A reasonable litigant would have wanted to know, for example, that Ethington’s monthly income was approximately $5,000 higher than he said it was, that the Related Companies had at least $65,000 more in financial assets than he said they did, and that those companies had recently paid hundreds of thousands of dollars to their owners. Such knowledge would have produced a perception of Ethington’s financial condition markedly different from the perception the FTC had when choosing to settle. Thus, the inaccuracies were material.

Ethington argued that he was still unable to pay because his liabilities exceeded his assets. The Court saw things differently:

But a negative net worth does not mean Ethington could not have paid the FTC. It only means Ethington could not have paid the FTC and all his other creditors while maintaining his then-existing lifestyle.

(The italics are the Judge’s, by the way.)

The upshot: a ruling from the Court that “the previously entered judgment in favor of the FTC and against Defendants in the amount of $3,212,310, plus interest, is now due and may be executed on.”

Other companies can take two points from the HCG Diet Direct story. First, the FTC is slow to accept a judgment that is even partially suspended and there’s a lot more that goes on behind the scenes. Second, a suspended judgment isn’t the end of the matter. If the compliance process reveals evidence that a defendant wasn’t truthful about finances, the FTC will ask the Court to activate the built-in avalanche clause.