Until the Second Circuit steps in to clear up confusion, lower courts in New York are in disarray about the standards to apply when deciding whether a corporation had the requisite intent to set aside a leveraged buyout as a fraudulent transfer with actual intent to hinder, delay or defraud.
The latest installment in the dispute is a Jan. 6 opinion involving Tribune Co. where District Judge Richard J. Sullivan pointedly disagreed with a Lyondell Chemical Co. opinion handed down in July by District Judge Denise Cote.
In the middle is former New York Bankruptcy Judge Robert E. Gerber, whose Lyondell opinion was reversed by Judge Cote. Noting that Judge Cote’s decision was not binding on him but finding Judge Gerber’s “thoughtful” opinion to be “highly compelling,” Judge Sullivan decided to “apply Judge Gerber’s analysis as persuasive.”
The Tribune LBO and Bankruptcy
Tribune – the owner of the Chicago Tribune, Los Angeles Times, six other newspapers and 23 television stations – plunged into chapter 11 in 2008 not long after an LBO where the company took on billions in new debt, in large part to pay off selling shareholders. Tribune implemented a reorganization plan in late 2012, creating litigation trusts to pursue claims on behalf of unsecured creditors.
Broadly interpreting the safe harbor for “settlement payments” provided by Section 546(e) of the Bankruptcy Code, the Second Circuit held in March that the Bankruptcy Code superseded state fraudulent transfer law and barred pre-LBO unsecured creditors from asserting their own constructive fraudulent transfer claims against selling shareholders in the LBO.
The March decision precluded virtually any argument allowing creditors individually or collectively to sue shareholders on constructive fraudulent transfer theories seeking recovery of money received for stock in an LBO that rendered the company insolvent.
In Tribune, the creditors filed a petition for certiorari in September from the Second Circuit’s dismissal, but the Supreme Court has yet to schedule a conference for the justices to consider allowing a final appeal. To read ABI’s discussion of the March Tribune decision, click here.
The Second Circuit decision left the open the possibility of suits for actual fraud against selling Tribune shareholders under Section 548(a)(1)(A). Actual fraud lawsuits were pending in Judge Sullivan’s court, but his Jan. 6 decision slammed the door on those too, for reasons we shall discuss after a quick look at Lyondell.
Lyondell
Filing chapter 11 in 2009, Lyondell Chemical Co. confirmed a chapter 11 plan the next year creating several litigation trusts. One suit alleged that Lyondell’s pre-bankruptcy leveraged buyout was a fraudulent transfer with “actual intent” under Section 548(a)(1)(A). Bankruptcy Judge Gerber dismissed the suit for failing to satisfy the requisite pleading standards. He held that the chief executive’s alleged knowledge of fraud could not be imputed to the company since Lyondell had a “functioning board” and the plaintiffs did not allege that the CEO controlled the board. He was reversed by District Judge Cote on July 27.
Judge Cote reinstated the suit, holding that 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.” She then went on to hold that the complaint alleged several “badges of fraud” justifying reinstatement of the suit. To read ABI’s discussion of Lyondell, click here.
Judge Sullivan Takes on Judge Cote
In dismissing the Tribune actual fraud suit for failure to state a claim, Judge Sullivan momentarily sided with creditors by saying there was no need to show fraudulent intent on the part of selling shareholders. Rather, he said, the corporation’s fraudulent intent mattered.
Next, he analyzed whether the creditors had to show fraudulent intent by the board, or just fraudulent intent on the part of company executives. That’s where Judge Sullivan parted company with Judge Cote and sided with Judge Gerber.
The decision to consummate the LBO was delegated to an independent committee of the Tribune board. At the board level, Judge Sullivan said that the creditors therefore needed to show that the independent directors harbored actual intent to hinder, delay or defraud. If they did, then their intent could be imputed to the company.
It was another matter, Judge Sullivan said, to impute fraudulent intent to the company based on the intent of company executives. Disagreeing with Judge Cote and following Judge Gerber, Judge Sullivan said that the intent of executives mattered only if they were in a position to “control” decision making by the board. In other words, executives must have “formidable voting and managerial power” that rises to the level of “majority voting control.”
Having established the pleading standard based on the executives’ knowledge and intent, Judge Sullivan analyzed the complaint and said that the creditors failed to allege the requisite level of control by management over the board.
The creditors also alleged that management controlled the board by “manipulating the information” provided to the special LBO committee. The complaint failed, Judge Sullivan said, because it did not allege facts showing that the independent committee was “‘supine’” or “‘under the sway of an overweening CEO.’”
Therefore, the sufficiency of the creditors’ complaint turned on the knowledge and intent of the special committee, because Judge Sullivan had held that the role of the executives was irrelevant given their lack of control.
Judge Sullivan then analyzed the badges of fraud alleged in the creditors’ complaint and concluded that they “were insufficient to raise a strong inference” of intent to hinder, delay or defraud Tribune’s creditors. He said the complaint was also deficient if the lower standard in securities law was applicable in deciding whether there was fraudulent intent.
A major chunk of the opinion is a close analysis of factual allegations in the complaint where the creditors were attempting to raise inferences of fraudulent intent. To some readers, the opinion might seem more like a ruling after a bench trial, where the judge draws inferences one way or the other from ambiguous facts. On appeal, Tribune’s creditors might contend that Judge Sullivan was engaged in fact finding rather than making inferences in favor of the non-moving party.
Surely, there will be an appeal. Because Judge Cote denied a motion for an interlocutory appeal of her Lyondell decision, Judge Sullivan’s Tribune decision will reach the Second Circuit first.