A recent decision by the Bankruptcy Court for the Southern District of New York may enhance the ability of bankruptcy trustees and creditors committees to challenge allegedly fraudulent transfers that could qualify for protection under the “safe harbor” of section 546(e) of the Bankruptcy Code. 

On March 9, Judge Martin Glenn entered an order in In re Hellas Telecomms. (Luxembourg) II SCA denying a motion to dismiss an unjust enrichment claim against two private equity funds accused of using their control over a debtor to siphon money to themselves. The court found that the claim could proceed even though the transaction at issue was among the categories of transfers protected by section 546(e) of the Bankruptcy Code.

As discussed in previous editions of Absolute Priority, section 546(e) provides a safe harbor for certain transfers involving the purchase and sale of securities and protects those transfers from avoidance in bankruptcy proceedings. In recent years, Courts have interpreted this safe harbor ever more expansively, shielding nearly all transactions involving a purported transfer of securities. Section 546(e) provides safe harbor against avoidance actions brought under the Bankruptcy Code for, among other things, constructively fraudulent conveyance actions. However, section 546(e) does not protect against allegations of actual fraudulent conveyance.

To avoid a transfer on the basis of actual fraud, a plaintiff must demonstrate that the transfer was incurred with “with actual intent to hinder, delay, or defraud” a creditor, which often proves difficult. Constructive fraud is easier to prove, as a plaintiff must only demonstrate that a debtor received less than reasonably equivalent value in exchange for a transfer and that the transfer was made while the debtor was or would be left insolvent, with unreasonably small capital, or unable to pay its debts as they mature. Several courts have held that section 546(e) preempts state law claims analogous to claims for constructive fraud brought under the Bankruptcy Code. See AP Services LLP v. Silva, 483 B.R. 63 (S.D.N.Y. 2012); In re Hechinger Investment Co. of Delaware, 274 BR 71 (D. Del 2002). Section 546(e) does not, however, prevent state law claims analogous to actual fraud. See In re Lehman Bros. Holdings Inc., 469 BR 415 (Bankr. S.D.N.Y. 2012).

In Hellas II, the foreign representatives of the Debtor’s administrative proceedings in the United Kingdom brought an adversary proceeding against two private equity firms, TPG Capital and Apax Partners, who purchased Hellas in a 2005 leveraged buyout. The foreign representatives sought to undo a series of transactions consummated in December 2006 whereby Hellas II issued €1.57 billion in subordinated notes then transferred €978.7 million in proceeds to its parent company, Hellas I. Hellas I then transferred the funds to TPG and Apax, purportedly as a redemption of convertible private equity certificates.

Judge Glenn had dismissed all claims for actual and constructive fraud for unrelated reasons, allowing only a state law claim for unjust enrichment to proceed.  The defendants subsequently moved to have the unjust enrichment claim dismissed under section 546(e).  The court denied the motion to dismiss, ruling that the unjust enrichment claim was analogous to an action for actual fraudulent transfer, because the plaintiff alleged that TPG and Apex had acted with the intent to commit fraud.

In allowing the unjust enrichment claim to go forward, Judge Glenn articulated a relaxed pleading standard for allegations of actual fraud. The judge was swayed by the fact that the defendants had allegedly used their control over the Debtor to transfer property to themselves. Given that circumstance, Judge Glenn determined that the plaintiff had adequately pled actual fraud by alleging that defendants knew that the transfer would render Hellas II insolvent and that the resultant damage to creditors was foreseeable.  The standard articulated by the Court is less stringent than the traditional standard, under which plaintiff must allege the transferor’s actual intent to defraud creditors, generally by stating that that certain “badges of fraud” (e.g., a secret or hasty transaction outside the course of business or the retention of control of property by the transferor) surrounded the transaction.

Though courts have expanded 546(e) safe harbor to an ever-widening variety of transactions, the decision in Hellas II provides some hope to bankruptcy trustees and creditors’ committees who seek to avoid suspect prepetition transfers. For transactions in which the transferee controlled the transferor, plaintiffs may find it easier to allege actual fraud and successfully challenge transactions that would otherwise be protected by 546(e).