In December 2014, attorneys and financial advisors serving both unsecured creditors’ committees and trustees watched as the Second Circuit expanded the “safe-harbor” provision available to defendants in certain clawback litigations. The safe-harbor provision was designed by Congress to protect certain securities and other transactions including “settlement payments” from avoidance actions. In 11 U.S.C. 546(e),[1] the Bankruptcy Code sets forth that a trustee may not avoid a transfer that was a settlement payment to (or for the benefit of) a broker or financial institution, or for a payment made in connection with a securities contract. In 11 U.S.C. § 741,[2] the Bankruptcy Code widely defines securities contracts to include “a contract for the purchase, sale, or loan of a security” and includes almost any financial instrument.
The court’s December 2014 ruling stated that under § 546(e), Irving Picard, the trustee for the liquidation of Bernard L. Madoff Investment Securities (BLMIS), could not recover funds paid in connection with a securities contract or settlement payment.[3] In doing so, the court rejected Picard’s argument that since BLMIS did not actually engage in securities transactions on behalf of its clients, § 546(e) did not apply. The court found that despite any actual securities trades, the transactions were made in connection with a “securities contract” and therefore should be afforded the protections of § 546(e). The court reasoned that “[p]ermitting the clawback of millions, if not billions, of dollars from BLMIS clients — many of whom are institutional investors and feeder funds — would likely ease the very ‘displacement’ that Congress hoped to minimize in enacting § 546(e).”[4] This ruling continued a trend (Enron, Lehman Brothers, Quebecor, etc.) that has steadily expanded the safe-harbor provisions and caused some industry professionals to question what is not protected by this provision.
Despite the repeated broadening of the safe-harbor provisions found in § 546(e), the Second Circuit did provide a way for unsecured creditors’ committees and trustees to challenge that safe-harbor in March 2015. In a ruling issued in connection with a chapter 15 proceeding, the court has, at least for now, laid out a blueprint for overcoming the safe-harbor defense created by § 546(e) — though it is an easy one to pursue.
Background
In February 2012, the Joint Compulsory Liquidators of Hellas Telecommunications (Luxembourg) II SCA (the “company”), Andrew Lawrence Hosking and Simon James Bonney (the “liquidators”), filed a chapter 15 petition in the Southern District of New York.[5] The primary proceeding was brought in the U.K.’s Royal Courts of Justice in 2011.[6]
The liquidators filed an adversary proceeding in March 2014[7] alleging that in 2005, private-equity firms TPG Capital Management L.P. and Apax Partners LLP,[8] along with various related entities, used the company to acquire TIM Hellas, a Greek telecommunications company, in a scheme that was solely designed to enrich themselves. By late December 2006, TPG Capital and Apax Partners were looking to sell the company, and in April 2007, they did so to an Italian corporation. In the adversary proceeding, the liquidators alleged that TPG Capital and Apax Partners extracted almost €1.85 billion from the company between December 2006 and April 2007. By then, the company was “an insolvent Company staggering toward bankruptcy,”[9] they argued.
As outlined in the adversary proceeding, the liquidators alleged that TPG Capital and Apax Partners exercised almost complete control over the company. TPG Capital and Apax Partners installed their own employees in key positions and controlled not only the company, but also its subsidiaries. The liquidators alleged that they acted with actual intent to defraud the holders of “sub notes” which were comprised of two components, each totaling approximately €960 million and $275 million in December 2006.
In response, TPG Capital and Apax Partners filed a Reargument of their Motion to Dismiss, asserting that, among other things, the Second Circuit’s December 2014 BLMIS decision represented “an intervening change in controlling law.”[10]
While the court rejected that motion to dismiss on several grounds, the most salient one to committees and trustees is that § 546(e) does not preempt an unjust enrichment claim. In ruling, the bankruptcy court wrote:
[T]he Complaint sufficiently alleges that the transfers underlying the Plaintiffs’ unjust enrichment claim were made with actual fraudulent intent, and therefore, this claim is not barred or preempted by section 546(e).
The reference to “actual fraudulent intent” is key here. As set forth in § 548(a)(1)(A):[11]
The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily —
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted;…
As the court explained in echoing its similar January 2015 opinion in this case, “the Plaintiffs … sufficiently alleged their standing to bring their unjust enrichment claim, as the allegations in the Complaint plausibly suggest that the [movants,] through their affiliates, controlled Hellas II, thereby rendering them insiders.”[12]
In its ruling, the court did not force the plaintiffs to fully articulate the “badges of fraud” at this point. Instead, it found that their argument detailing TPG Capital’s and Apax Partners’s domination of the company was sufficient to deny the motion to dismiss.
Conclusion
Professionals serving unsecured creditors’ committees and trustees had reason to worry following the December 2014 Madoff ruling, but the recent decision in Hellas should offer a measure of hope. It underscores that defendants cannot simply rely on a connection to a securities transaction as an absolute shield from clawback litigation. Nonetheless, parties seeking to bring actions against a potential safe-harbor defense have to be diligent in their investigations so that they can adequately demonstrate the existence of actual intent — which, as defined in § 548(a)(1)(A), is the only exception to the safe-harbor provision for payments made pursuant to a securities contract. Effectively articulating the elements of actual intent is no easy task, but it is not impossible. While the bar has certainly been raised in overcoming the safe-harbor provisions of § 546(e), the door has not been shut.
[3] 12-2557-bk(L) (2d Cir. Dec. 8, 2014).
[4] Id. at page 18.
[5] 12-10631 (MG).
[6] 2011 Number 10471.
[7] U.S. Bankruptcy Court Southern District of New York – Adv. Proc. No. 14-01848 (MG).
[8] As defined in the adversary proceeding, various other TPG Capital and Apax Partners related entities were named as defendants.
[9] Adv. Proc. No. 14-01848 (MG) at ¶ 1.
[10] Rearg. Mot. at ¶ 28.
[12] In re Hellas Telecommunications (Luxembourg) II SCA (Bankr. S.D.N.Y. 2015), at 17.