Lyondell Decision in SDNY Reminds Fraudulent Transfer Plaintiffs of the Heightened Pleading Standard for Actual Fraudulent Transfer Claims

Fraudulent transfer plaintiffs be reminded: the heightened pleading standard in Rule 9(b) continues to create difficulty surviving a motion to dismiss actual fraudulent transfer claims. In In re Lyondell Chem. Co,[1] in the context of fraudulent transfer litigation following a leveraged buyout, the United States Bankruptcy Court for the Southern District of New York reaffirmed that the Rule 9(b) heightened pleading standard applies to actual fraudulent transfer claims, dismissing them in the absence of very specific pleading of the defendants’ actual intent to hinder, delay or defraud. On the other hand, the bankruptcy court confirmed that the more rigorous pleading standard does not apply to constructive fraudulent transfer claims and allowed those claims to survive the pleading stage. This decision serves as a reminder for plaintiffs asserting actual fraudulent transfer claims that actual intent must be pled with specificity in order to survive a motion to dismiss.

Lyondell stems from a leveraged buyout (LBO) and merger shortly before Lyondell’s bankruptcy, which the acquiring company financed entirely with a whopping $21 billion of debt secured by Lyondell’s assets. Of that amount, $12.5 billion was paid out to Lyondell’s shareholders. After the bankruptcy filing, the trustee filed avoidance actions alleging, among other things, that the LBO transaction constituted an avoidable fraudulent transfer under both actual fraud and constructive fraud theories. The shareholder defendants, who benefitted from the transaction, moved to dismiss both the actual fraud and constructive fraud counts of the trustee’s Third Amended Complaint[2] for failure to state a claim. Although the trustee had added facts pertaining to the actual intent of Lyondell’s Board of Directors that approved the LBO transaction, the shareholder defendants claimed that the Third Amended Complaint still failed to meet the heightened pleading standard required by Rule 9(b) for actual fraudulent transfer claims.

For its analysis, the bankruptcy court first recognized that the fraudulent transfer statute[3] is intended to apply to circumstances where some intentional act — not mere negligence or breach of duty — is done with the goal of placing assets out of the reach of creditors.[4] The court then thoroughly discussed four different approaches to determine the existence of actual intent, including: (1) the approach utilized by the Second Restatement of Torts;[5] (2) reference to traditional badges of fraud;[6] (3) the existence of motive and opportunity;[7] and (4) a recklessness standard.[8] The bankruptcy court held that the trustee failed to meet the heightened pleading standard under any of these approaches.

The bankruptcy court specifically held with respect to each approach:

The Restatement standard — The court found no allegations supporting even an inference of any wrongful intent.

The badges of fraud standard — The court did not find the existence of even a single badge of fraud based on the allegations pled by the trustee. “[W]here the showing of badges of fraud is minimal, badges of fraud obviously cannot provide a basis for finding allegations of intentional fraudulent transfer to be plausible.”[9]

The “motive and opportunity” standard — The court found that any motive was too generalized in nature to be sufficiently specific to support a finding of actual intent.

The recklessness standard — The court did not find the consequence to be reasonably likely enough to find actual intent.

While the court again denied the motion to dismiss the constructive fraud claims, the Lyondell decision reminds us that Rule 9(b) set forth a stringent standard that applies to fraudulent transfer claims that is difficult to meet. Plaintiffs beware!