A recent decision issued by the U.S. District Court for the Southern District of New York multi-district litigation In re Tribune Company may have altered the landscape for litigating avoidance actions and narrowed the Bankruptcy Code’s “safe harbor” protections against the avoidance of settlement or swap payments.
Section 546(e) of the Bankruptcy Code prevents a debtor from unwinding, or “avoiding,” certain securities and/or commodities transactions. This protection is referred to as a “safe harbor.” Most courts have interpreted this safe harbor broadly, protecting an ever-expanding scope of transactions. However, Tribune cuts against that trend, holding that individual creditors can sidestep section 546(e)’s protections to attack securities transactions.
The decision issued on September 23, 2013 includes three noteworthy rulings. First, section 546(e) only bars claims brought by a “bankruptcy trustee” (i.e., a bankruptcy estate representative). Second, if the bankruptcy trustee does not bring such claims before the two-year statute of limitations period, the causes of action automatically revert to creditors. Third, individual creditors lack standing to pursue avoidance actions on constructive fraud theories after the automatic reversion if the trustee is pursuing avoidance claims regarding the same underlying transaction on actual fraud grounds.
Tribune filed for chapter 11 protection in 2008, one year after completing an LBO that paid out more than $8.2 billion to its public shareholders. During the bankruptcy proceeding, the creditors’ committee was authorized to stand in the shoes of the debtor and to file adversary proceedings on behalf of Tribune’s estate. With this authority, the creditors’ committee sought to avoid certain transfers made to Tribune’s shareholders and other parties in connection with the LBO, claiming that such transfers constituted intentional fraudulent conveyances.
The creditors’ committee did not, however, assert constructive fraudulent conveyance claims against the former shareholders. As a result, in 2011, hundreds of Tribune’s individual creditors requested permission to file state law constructive fraudulent conveyance actions outside of the bankruptcy case. The bankruptcy court conditionally lifted the automatic stay to allow such lawsuits because the creditors’ committee had not brought a constructive fraudulent conveyance claim within the two-year statute of limitations period. Thereafter, many of the individual creditors initiated state law avoidance actions across the country, which were then consolidated by the Judicial Panel on Multidistrict Litigation in the Southern District of New York. Subsequently, the defendants to the consolidated litigation filed a motion to dismiss.
District Court’s Analysis
The district court first ruled that the plain language of section 546(e) limits the availability of section 546(e) as a defense to actions brought by the “bankruptcy trustee,” and not individual creditors “who have no relation to the bankruptcy trustee.” The court also noted that section 546(e)’s legislative history did not impliedly preempt state law constructive fraudulent transfer claims. The district court explained that section 546(e) was intentionally restricted to trustees because, in sum, Congress either declined or neglected to add an express preemption provision that explicitly extended the statute’s applicability to non-trustees in each of the eight times section 546(e) was amended, despite Congress having done so elsewhere in the Bankruptcy Code, and despite court decisions addressing these specific issues. Accordingly, defendants in state law avoidance actions could not avail themselves of section 546(e)’s protections.
The district court’s second noteworthy ruling was that state law avoidance actions are not permanently stayed in bankruptcy and automatically revert to individual creditors once the bankruptcy trustee’s statute of limitations to pursue such claims expires. The district court explained that a fraudulent conveyance claim is not property of the bankruptcy estate and, therefore, the bankruptcy court does not need to discharge the debtor in order for avoidance claims to revert to individual creditors.
In its final key ruling, the district court held that the individual creditors’ constructive fraudulent transfer claims and the creditors’ committee’s intentional fraudulent transfer claims could not be pursued at the same time against the shareholders. In doing so, the court reasoned that the automatic stay under section 362(a)(1) does not apply differently based on the theory or Bankruptcy Code provision under which a bankruptcy trustee brings a fraudulent conveyance action. The district court further explained that the bankruptcy process is intended to promote a fair and comprehensive resolution of the debtor’s financial affairs by consolidating multiple claims into one entity. Accordingly, the district court concluded that “unless and until the [creditors’ committee] actually and completely abandons [their] claims, the [individual creditors] lack standing to bring their own claims targeting the very same transactions.”
Although the district court ultimately dismissed the individual creditors’ claims, its separate rulings on the limitations of section 546(e) and the automatic reversion of avoidance claims deviate from the recent pattern of increasingly expansive safe harbor holdings. A good test as to whether this decision represents a turning point in the section 546(e) saga will be the outcome of In re Lyondell Chemical Company. Lyondell, which is pending before the Bankruptcy Court for the Southern District of New York, involves a similar motion to dismiss state law constructive fraudulent transfer claims brought by a litigation trustee.
Regardless of Lyondell’s outcome or the outcome of any possible Tribune appeal, potential defendants to avoidance actions should not hang their hats on section 546(e)’s expansive scope. Rather, given Tribune’s possibly significant implications, all interested parties should be aware of their potential exposure to individual creditor state law avoidance actions when negotiating plans of reorganization and the releases included therein.
For additional articles discussing Bankruptcy Code section 546(e), see: