[Note: The opinion, originally issued on March 24, was “filed in error and stricken from the record” by a docket entry on March 28. The next day, the appeals court reissued the opinion with changes immaterial to the holdings.]
Broadly interpreting the safe harbor for “settlement payments” provided by Section 546(e) of the Bankruptcy Code, the Second Circuit triple-locked the door against individual creditors trying to sue shareholders for the recovery of payments received in a leveraged buyout before the company filed bankruptcy.
In a March 24 opinion by Circuit Judge Ralph K. Winter Jr., the appeals court foreclosed virtually any argument that creditors individually or collectively can sue shareholders on a constructive fraudulent transfer theory seeking recovery of payments received in a leveraged buyout for stock in a company that later files bankruptcy.
The case arose in the chapter 11 reorganization of newspaper publisher Tribune Co. and centered around Section 546(e), which provides that “the trustee may not” sue for recovery of a “settlement payment,” unless the suit is brought under Section 548(a)(1)(A) for recovery of a fraudulent transfer within two years of bankruptcy made with actual intent to hinder, delay or defraud creditors.
The Second Circuit in substance was called on to decide whether there are any loopholes allowing creditors to sue for recovery of constructive fraudulent transfers when an LBO goes sour. The district court in the opinion on appeal had opened the door a crack, and a bankruptcy judge in the reorganization of Lyondell Chemical Co. had also found loopholes.
In Tribune’s reorganization, the official creditors’ committee was authorized to sue selling shareholders for allegedly receiving fraudulent transfers with “actual intent.” Prosecuted after plan confirmation by a creditors’ trust, that suit remains pending in bankruptcy court in Manhattan.
When the two-year statute of limitations was about to expire, Tribune’s bankruptcy judge modified the automatic stay by allowing company retirees, along with pre-LBO unsecured bondholders, to sue selling shareholders using constructive fraudulent transfer theories. In modifying the stay, the bankruptcy judge did not rule on whether individual creditors had standing or whether a suit would be barred by Section 546(e)’s safe harbor. The individual creditors’ suit ended up in district court in Manhattan, where the selling shareholders moved to dismiss.
Granting the motion to dismiss, the district court held that individual creditors lacked standing because the creditors’ trust was simultaneously suing on fraudulent transfer grounds, albeit on a different theory. The judge also held that the safe harbor only bars suits by a trustee and does not preclude creditors from suing under state law.
Judge Winter reversed the district court on both scores, with dismissal still the result. He made short shrift of the district court’s holding that the automatic stay deprived individual creditors of standing when the creditors’ trust was suing to recover the same transfers as fraudulent transfers with “actual intent.” The judge pointed out how the bankruptcy court on at least three occasions had modified the stay so individual creditors could sue.
Although he gave them back the right to sue, Judge Winter nonetheless knocked them out of the box under Section 546(e) on a theory of implied preemption. He said that implied preemption results when “state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.”
He rejected the argument that only trustees are barred from suing by the safe harbor. Although the meaning of Section 546(e) is not “plain,” Judge Winter said the creditors’ arguments rely on “adhering to statutory language only when opportune and resolving various ambiguities in a way convenient to that theory.” Ultimately, he said that the creditors’ theory was in “outright conflict” with the section.
The creditors contended that fraudulent transfer claims revert to creditors if the trustee does not file suit within the two-year statute of limitations or if the automatic stay is lifted to allow suing. Judge Winter said that a reversion of fraudulent transfer claims “is not based on the language of the Code.”
Although he conceded that Section 546(e) is ambiguous, Judge Winter said in his 53-page opinion that “unwinding settled securities transactions” would “seriously undermine” the markets. For reasons developed at length about the congressional policy shown in the safe harbor, the appeals court held that state law constructive fraudulent transfer claims are preempted.
The Tribune opinion cuts the ground from underneath a decision by the Lyondell bankruptcy judge in January 2014 holding that the safe harbor does not preclude fraudulent transfer suits based on state law, nor does it protect selling shareholders who ultimately received proceeds from allegedly fraudulent transfers.
Judge Winter’s opinion contains a useful discussion of how to determine whether a statute’s meaning is plain.