A 2013 court decision has cast doubts over the future scope of the U.S. Bankruptcy Code’s safe harbor protections against the reversal of settled securities transactions. If the ruling stemming from the Tribune Company bankruptcy is applied to future cases, the Chapter 11 process may no longer be viewed as the method to address prebankruptcy claims conclusively.
Fraudulent Transfers and Bankruptcy Code Section 546(e) Safe Harbor
Fraudulent transfer causes of action allow creditors to unwind transactions that unfairly or improperly deplete a debtor’s assets. Every state has enacted a fraudulent transfer statute that gives creditors a right to assert claims to recover fraudulent transfers. In addition, the Bankruptcy Code permits the bankruptcy trustee to undo fraudulent transfers. After a bankruptcy filing, a bankruptcy trustee (generally, a debtor-in-possession in Chapter 11 cases) has the exclusive right to assert fraudulent transfer claims (including those authorized by the Bankruptcy Code).1 These claims can be based either on actual fraud (where the transferor had intent to hinder, defraud or delay recovery to its creditors) or constructive fraud (where the unfairness stems not from intent but from the debtor not receiving reasonably equivalent value in exchange for what it transferred).
The Bankruptcy Code, however, also places some limits on the debtor-in-possession's ability to bring avoidance actions. For example, Section 546(e) prevents a bankruptcy trustee from avoiding settlement payments made by a debtor in a securities transaction. Section 546(e) does not, however, provide a safe harbor for such settlement payments if they are shown to be an intentionally fraudulent transfer, which can be challenging, as it requires proof of the transferor’s intent to harm its creditors (thus, generally requiring wrongdoing).
Prior to the September 2013 decision in In re Tribune,2 courts generally had expanded the scope of the Section 546(e) safe harbor by interpreting it broadly to cover a wide range of transactions.
The Tribune Company Bankruptcy
The Tribune debtors are a media company that publishes newspapers and operates radio, television stations and Internet businesses. In the mid-2000s, Tribune’s financial conditions were deteriorating, and the company agreed to go private through a leveraged buyout (LBO) that paid more than $8.2 billion to thousands of public shareholders in exchange for their Tribune shares. After the payouts were made and, as the publishing industry began to decline, Tribune was forced to file for bankruptcy in 2008;3 the company emerged from Chapter 11 in late 2012.
Under Tribune’s Chapter 11 plan of reorganization, intentional fraudulent transfer claims, which are not barred by Section 546 (e), were transferred to a litigation trustee for a litigation trust created under the plan.4 Because the estate representative was limited to bringing actual fraudulent transfer claims against shareholders in this context, under Tribune’s Chapter 11 plan, the debtors’ estates disclaimed the right to assert constructive fraudulent conveyance claims against Tribune shareholders who received LBO payments for their shares. As a result, those claims would allegedly revert back to individual creditors, who subsequently filed numerous state law constructive fraudulent conveyance claims against former Tribune shareholders nationwide. In theory, thousands of creditors could sue thousands of shareholders all over the country to seek to recover more than $8 billion in payouts from the LBO. The state law constructive fraudulent conveyance suits that were filed were consolidated into a multidistrict litigation in the U.S. District Court for the Southern District of New York.
The Court’s Decision
In the multidistrict litigation, the shareholder defendants argued that Section 546(e) preempted the creditors’ state law constructive fraudulent conveyance claims. However, the district court held that, by its plain language, the Section 546(e) safe harbor for securities transaction settlement payments applies only to protect such payments against fraudulent transfer avoidance actions brought by a bankruptcy trustee and does not preclude state law constructive fraudulent conveyance claims asserted by individual creditors.
The court held that individual creditors’ state law constructive fraudulent conveyance claims against former Tribune shareholders were automatically stayed by Bankruptcy Code Section 362, which, among other things, provides for a broad stay of litigation upon the filing of a bankruptcy case. According to the court, the state law claims were stayed because an estate representative (in this case, the litigation trustee) already was asserting actual fraudulent conveyance claims targeting the same LBO shareholder payment transactions. The court reasoned that unless and until the estate representative actually and completely abandoned its claims, the individual creditors lacked standing to bring their own fraudulent conveyance claims targeting the same transactions. The litigation trustee has stated that it intends to proceed with its intentional fraudulent conveyance claim, but reserves its right to amend its complaint to abandon those claims.
Prior to Tribune, courts had expanded the Bankruptcy Code Section 546(e) safe harbor giving shareholders who received payouts in an LBO (and others participating in settled secured transactions) more comfort that their recoveries could not be avoided. The Tribune decision leaves open the possibility that that safe harbor provision will now be routinely circumvented.
It follows that in the wake of Tribune, settlement of fraudulent transfer actions by an estate representative will become more complicated. While Chapter 11 bankruptcy plans are meant to address all prebankruptcy claims conclusively, the Tribune ruling may impede that goal if certain claims may now be asserted outside the bankruptcy process.
1 At least some courts have held that this exclusive right to assert fraudulent transfer claims does not last forever, and that state law claims revert back to creditors when the bankruptcy trustee relinquishes the claim or no longer has a viable cause of action. See, e.g., In re Integrated Agri Inc., 313 B.R. 419, 427-28 (Bankr. C.D. Ill. 2004).
2 In re Tribune Company Fraudulent Conveyance Litigation, 11 MD 2296 (RJS) (S.D.N.Y. Sept. 23, 2013).
3 Skadden currently represents, among others, certain of the selling shareholders and the members of the special committee for the board of directors.
4 In this case, the official committee of unsecured creditors obtained derivative standing to stand in the shoes of the debtor-in-possession to file certain claims, including intentional fraudulent conveyance claims against the selling shareholders.
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* This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.