The cases of In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. 310 (S.D.N.Y 2013) and In re Lyondell Chem. Co., 503 B.R. 348 (Bankr. S.D.N.Y 2014) have narrowed the bankruptcy code’s scope of “safe harbor” regarding fraudulent transfer claims and bolstered the general security of creditors looking to claw back proceeds from pre-bankruptcy LBO’s.
The federal bankruptcy code provides for the transfer of corporate funds to be voided or “clawed back” in certain instances where the transfer would damage the status of creditors in a bankruptcy proceeding. ((See J. Henk Taylor & Justin Henderson, Preferences: When can a Trustee Claw Back Payments to Creditors?, Bus. Law Today, Mar.—Apr. 2010, http://apps.americanbar.org/buslaw/blt/2010-03-04/taylor-henderson.shtml.)) 11 U.S.C. § 548 establishes the ability of bankruptcy trustees to bring clawback actions under federal law in instances of fraudulent transfers. ((Trey Monsour, Understanding Fraudulent Transfers and Ensuing Litigation, Law 360, July 2, 2014, 11:32 AM ET, http://www.law360.com/articles/553894/understanding-fraudulent-transfers-and-ensuing-litigation.)) Actions under Section 548 can be brought both where transfers amount to intentional fraud against creditors and in instances of constructive fraud, which involves transfers made with inadequate consideration. ((Id.)) 11 U.S.C. § 544 permits clawback claims “under applicable law,” effectively allowing for “any legal theory of recovery that a creditor could assert under state law.” ((In re Tribune Co. Fraudulent Conveyance Litig., 499 at 315.))
In spite of the above provisions, 11 U.S.C. § 546(e) serves as a “safe harbor” prohibiting clawback actions for “transfer[s] . . . that [are] . . . settlement payments . . . made by or to (or for the benefit of) a . . . financial institution” or “. . . in connection with a securities contract.” ((Quinn Emanuel Urquhart & Sullivan, LLP, Article: Shedding Light on a Bankruptcy Safe Harbor: Defining the Reach of Section 546(e), Bus. Litig. Rep., http://www.quinnemanuel.com/the-firm/news-events/article-june-2013-shedding-light-on-a-bankruptcy-safe-harbor-defining-the-reach-of-section-546-e/ (last visited Oct. 11, 2015).)) Prior to In Re Tribune, this “safe harbor” had been held to include “payments for shares during an LBO.” ((See In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. at 315 (quoting In re Resorts Int’l. Inc., 181 F.3d 505 at 516 (3d Cir. 1999)).)) From a policy perspective, the “safe harbor” of Section 546(e) was established “to promote stability in financial markets and to prevent financial contagions by protecting securities transactions from being unsettled by later bankruptcy.” ((Quinn Emanuel Urquhart & Sullivan, LLP, supra note 3.)) Although this “safe harbor” covers constructive fraudulent transfer claims made by trustees under Section 548, it allows for an exception in instances of actual fraud under 11 U.S.C. § 548(a)(1)(A). ((See In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. at 315.))
The Tribune Company (“Tribune”), in In re Tribune, was a large media company operating publications such as the Chicago Tribune and the Los Angeles Times. ((Id. at 313.)) Tribune began experiencing financial deterioration in the early and mid 2000s. ((Id.)) In April 2007, Tribune’s board of directors approved a leveraged buyout under which Tribune shareholders would be paid out more than $8.2 billion for their shares. ((Id.))
Although Tribune continued operations for a year after being taken private, the company entered chapter 11 bankruptcy in 2008. ((Id.)) A committee appointed by the Bankruptcy Court for the District of Delaware to “stand in the shoes of the bankruptcy trustee” filed a suit against all beneficiaries of the 2007 LBO, asserting in part that the consideration paid to Tribune shareholders constituted an intentional fraudulent conveyance. ((Id. at 313-14.)) Additionally, in March 2011, individual creditors of Tribune moved to file state-law constructive fraudulent conveyance (“SLCFC”) claims outside of bankruptcy. ((Id. at 314.)) In response, the court conditionally lifted automatic stay as to these claims, though refraining from ruling as to whether the creditors had standing to assert the SLCFC claims or whether these claims were preempted by the “safe harbor” of 546(e). ((Id.)) As a result of the stay being conditionally lifted, individual creditors across the country initiated SLCFC actions against Tribune (more than 40 actions in total). ((Id.)) These actions were subsequently consolidated, along with the bankruptcy committee actions, into a single case in the Southern District of New York. ((Id.))
The S.D.N.Y. court refuted defendants’ motion to dismiss these claims on the theory that 546(e) preempts state fraudulent conveyance laws. ((Id. at 325.)) The court began by addressing the argument that Section 546(e)’s application to trustee claims of constructively fraudulent transfers under Section 548 should apply in the same way to individual creditor SLCFC claims under Section 544. ((Id. at 315-16.)) Looking to the text of 546(e) and applying rules of statutory interpretation, the court found that “because congress has spoken so clearly as to the [the application of “safe harbor” of 546(e) to the actions of bankruptcy trustees only], the Court discerns no basis in the text for barring SLCFC claims brought by Individual Creditors who have no relation to the bankruptcy trustee.” ((Id. at 316.))
The Court then addressed defendants’ argument that Congress intended the enactment of 546(e) to imply a preemption of SLCFC claims. ((Id. at 316-20.)) Defendants asserted here that to deny such a preemption would frustrate the policy intent of Section 546(e) to provide certainty to securities transactions for the purpose of maintaining market stability. ((Id. at 316-17.)) However, the court pointed out that this was only one among several policy considerations that congress had in mind when drafting the bankruptcy code, “not least making whole the creditors of a bankruptcy estate.” ((Id. at 318.)) In weighing these alternative policy considerations, the court looked to legislative history of 546(e), such as the fact that Congress ignored an FTC petition for 546(e) to preempt SLCFCs, and similarly that the eight amendments 546(e) underwent had also not produced an explicit preemption. ((Id.))
The court ultimately concluded that defendants’ preemption argument was not supported by legislative intent analysis, holding that “[o]bviously, Congress has struck some balance between various policy priorities, which means that it has determined that fraudulent conveyance actions are not necessarily and in all cases ‘repugnant’ to the interest of market stability.” ((Id.)) The court further bolstered this interpretation of congressional intent by pointing to other places in the bankruptcy code that do explicitly provide for preemption of state law claims by individual creditors. ((Id. at 318-19.))
In spite of the court’s holding that the “safe harbor” of 546(e) did not preempt SLCFC claims by individual creditors, the court also held that the automatic stay provided by 11 U.S.C. § 362 prevented individual creditors from “avoid[ing] the same transactions that the Committee is simultaneously suing to avoid.” ((Id. at 325.)) Accordingly, the court granted defendants’ motion to dismiss. ((Id.))
Based on a similar fact pattern, In re Lyondell followed the reasoning of In Re Tribune. In December 2007, Basell AF, A.S.C acquired Lyondell Chemical Company through an LBO financed by $21 billion in debt secured in Lyondell’s assets and paying out approximately $12.5 million to shareholders. ((Paul Hastings, Storm Warnings for “Safe Harbor” of Bankruptcy Code Section 546(e), Stay Current, Jan. 2014, at 1, https://www.paulhastings.com/docs/default-source/PDFs/safe-harbor-alert.pdf.)) About a year later, Lyondell filed for chapter 11 bankruptcy. ((Id.)) Lyondell’s reorganization included the establishment of a creditor trust, which encompassed all individual creditors’ SLCFC claims. ((Id.)) In response to a $6.3 billion SLCFC claim, defendants’ mounted similar arguments as posed by those in In re Tribune. ((Id. at 2.)) The S.D.N.Y. Bankruptcy court followed the ruling of In re Tribune, holding that creditor SLCFC claims were not barred by the “safe harbor” of Section 546(e). ((Id.))
The narrowing of Section 546(e)’s “safe harbor” protection can certainly be seen as a bolstering of creditors’ interests in the balance of bankruptcy policy considerations. The ability for creditors to contest LBO payouts will likely deter companies from engaging in transactions that could potentially obstruct creditor recovery in violation of SLCFC claims.
This will also likely result in increased costs for companies to ensure that potential transactions fall outside the scope of SLCFC claims. Although these policy shifts will benefit the security of creditors generally, the increased risk of liability and the associated costs could potentially cause companies to abstain from what could be fruitful transactions creating positive externalities in the market.
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