Reversing the bankruptcy court, a district judge in New York laid down a relatively easy pleading standard for a fraudulent transfer with “actual intent” when the plaintiff must impute an executive’s knowledge of fraud to the company itself.
The opinion on July 27 by District Judge Denise Cote involved the Lyondell Chemical Co. bankruptcy that began in 2009 and led to confirmation of a chapter 11 plan the next year. The plan created several trusts. One filed suit alleging that Lyondell’s pre-bankruptcy leveraged buyout was a fraudulent transfer with “actual intent” under Section 548(a)(1)(A).
The complaint alleged that Lyondell’s chief executive knowingly gave inflated financial projections both to the board and to the prospective buyer. Based on those projections, the complaint alleges that the buyer eventually purchased Lyondell in an LBO where the company took on $21 billion in secured debt, which soon led to bankruptcy.
The plaintiff alleged that the CEO concocted false projections because he got $100 million from the LBO, much of that from Lyondell stock and options that he owned.
Former Bankruptcy Judge Robert E. Gerber, who retired in January, dismissed the suit last year, holding that the chief executive’s alleged knowledge of fraud could not be imputed to the company because Lyondell had a “functioning board” and the plaintiffs did not allege that the CEO controlled the board.
Judge Cote reversed and reinstated the suit, holding that Judge Gerber’s formulation of imputation did not square with Delaware law. She said that Delaware courts follow a “general rule of imputation” by holding “a corporation liable for the acts and knowledge of its agents ‘even when the agent acts fraudulently.’”
Therefore, she said, the CEO’s knowledge and intent could be imputed to the company, because requiring control of the board does “not appear to have any basis in Delaware agency law.”
Having imputed the CEO’s knowledge and intent to the company itself, it was also necessary for Judge Cote to decide whether the alleged facts made out a claim for a fraudulent transfer with “actual intent.” Judge Gerber had not reached that issue because he held that the CEO’s knowledge could not be imputed in the first place.
Since the complaint alleged several “badges of fraud,” Judge Cote reinstated the complaint, ruling that the plaintiff stated a claim under Section 548(a)(1)(A).
In Judge Cote’s decision, Judge Gerber was reversed for being too strict on the plaintiff. In his Lyondell decision in January 2014 holding that the Section 546(e) safe harbor does not bar suits based on state law, he was effectively reversed by the Second Circuit’s Tribune decision in March for being too lenient. Not bound by Second Circuit authority, Bankruptcy Judge Kevin Gross in Delaware ruled in June that Judge Gerber got it right on the safe harbor issue. To read ABI’s discussion of the Tribune decision, click here. To read about Judge Gross’ decision, click here.