In Weisfelner v. Hofmann (In re Lyondell Chem. Co.), 2016 BL 241310 (S.D.N.Y. July 27, 2016), the U.S. District Court for the Southern District of New York reversed a 2015 ruling by the bankruptcy court presiding over the chapter 11 case of Lyondell Chemical Company (“Lyondell”) that dismissed claims asserted by a chapter 11 plan litigation trustee seeking to avoid as actual fraudulent transfers $6.3 billion in payments made to the former stockholders of Lyondell in connection with its 2007 leveraged buyout (“LBO”) by Basell AF S.C.A. See Weisfelner v. Fund 1 (In re Lyondell Chem. Co.), 541 B.R. 172 (Bankr. S.D.N.Y. 2015).
The bankruptcy court ruling dismissed claims seeking to avoid the payments under section 548(a)(1)(A) of the Bankruptcy Code, which empowers a bankruptcy trustee to avoid pre-bankruptcy transfers made with the intent to hinder, delay, or defraud creditors. It ruled that: (i) the trustee did not adequately allege that Lyondell incurred debt and transferred the payments to shareholders with “actual intent” to hinder, delay, or defraud its creditors; and (ii) the knowledge, conduct, and intent of Lyondell’s CEO in connection with the shareholder transfers could not be imputed to Lyondell.
The district court reversed on appeal. It ruled that the bankruptcy court “relied on inapposite law” in concluding that the CEO’s intent could be imputed to Lyondell only if the litigation trustee adequately pleaded that the CEO was in a position to control the decision of Lyondell’s board to proceed with the LBO. According to the district court, the imputation of intent to defraud under the circumstances was “entirely consistent with Delaware agency law.” It also held that the trustee adequately pleaded that Lyondell made the transfers to its shareholders with the intent to hinder, delay, or defraud creditors. The district court accordingly reversed the bankruptcy court’s ruling and reinstated the actual fraudulent transfer claims.
On August 10, 2016, the shareholder defendants asked the district court to reconsider its July 27 decision reversing the bankruptcy court’s 2015 decision. In the alternative, the shareholders requested that the district court certify an interlocutory appeal to the Second Circuit. According to the shareholders, the district court overlooked controlling agency law regarding the imputation of an agent’s intent. Under Delaware agency law, they argued, Lyondell’s CEO did not have authority to make that “extraordinary, merger-related transfer” and “only the Lyondell Board did.” Accordingly, the shareholders contended that “[the CEO’s] intent cannot be imputed with respect to a transfer that he had no authority to approve (and did not approve), and without imputation.”
The district court’s ruling in Lyondell came on the heels of a more favorable decision for Lyondell’s former shareholders by the bankruptcy court on July 20. In that decision, the court retracted 2014 and 2015 rulings that the fraudulent transfer “safe harbor” under section 546(e) of the Bankruptcy Code does not preclude claims brought by a litigation trustee on behalf of creditors to avoid transfers which are constructively fraudulent under state law. See Weisfelner v. Fund 1 (In re Lyondell Chem. Co.), 2016 BL 244458 (Bankr. S.D.N.Y. July 20, 2016). Section 546(e) expressly precludes the avoidance by “the [bankruptcy] trustee” of constructively fraudulent transfers—i.e., transfers made in exchange for less than reasonably equivalent value when the debtor is insolvent or becomes insolvent due to the transfer—made in connection with the settlement of securities contracts.
The bankruptcy court was constrained to retract its previous rulings after the U.S. Court of Appeals for the Second Circuit held to the contrary in Deutsche Bank Trust Co. Ams. v. Large Private Beneficial Owners (In re Tribune Co. Fraudulent Conveyance Litig.), 818 F.3d 98 (2d Cir. 2016), Tribune, the Second Circuit unequivocally ruled that “creditors’ state law, constructive fraudulent conveyance claims are preempted by Bankruptcy Code Section 546(e).” Even so, the court foreclosed an expansive reading of its ruling. It expressly stated that the decision does not address the rights of creditors to bring state law fraudulent transfer claims which are “not limited in the hands of a trustee et al.” by section 546(e) or similar provisions. A more detailed discussion of the Second Circuit’s ruling in Tribune can be found elsewhere in this issue of the Business Restructuring Review.
In Whyte v. Barclays Bank PLC, 2016 BL 90805 (2d Cir. Mar. 24, 2016), which was heard in tandem with Tribune, the Second Circuit (in a summary order) affirmed the district court’s ruling that the separate safe harbor of section 546(g) also “impliedly preempts” a chapter 11 plan litigation trustee from bringing state law fraudulent transfer actions seeking to avoid swap transactions.
On August 19, 2016, the litigation trustee in Whyte filed a petition asking the U.S. Supreme Court to review the Second Circuit’s ruling. See Whyte v. Barclays Bank PLC, No. 16-00239 (U.S. Aug. 19, 2016). According to the litigation trustee’s petition, courts must start with the presumption that federal law does not preempt state law—a principle she says the Second Circuit disregarded. She also argued that the Second Circuit’s ruling is contrary to the Supreme Court’s decision in BFP v. Resolution Trust Corp., 511 U.S. 531 (U.S. 1994), where the Court held that congressional intent to preempt state law by the Bankruptcy Code must be “clear and manifest.” The creditors in Tribune filed a petition on September 9, 2016, asking the U.S. Supreme Court to review the Second Circuit’s ruling.
The Second Circuit’s approach in Tribune has already been rejected by a bankruptcy court in another circuit. In PAH Litigation Trust v. Water Street Healthcare Partners, L.P. (In re Physiotherapy Holdings, Inc.), 2016 BL 251441 (Bankr. D. Del. June 20, 2016), the court granted in part and denied in part a motion to dismiss a chapter 11 plan litigation trustee’s complaint seeking to recover $248.6 million in payments made to selling shareholders in connection with a 2012 LBO.
In an unpublished ruling, the court denied a motion to dismiss actual fraudulent transfer claims as well as claims brought directly under state law, but it granted a motion to dismiss federal constructive fraudulent transfer claims and state law constructive fraudulent transfer claims brought under section 544 of the Bankruptcy Code. In so ruling, the court rejected the approach applied in Tribune:
[T]he [section 546(e)] safe harbor does not bar the litigation trust from asserting its state law fraudulent transfer claims on behalf of the Senior Noteholders. Specifically, the Court holds that a litigation trustee may assert state law fraudulent transfer claims in the capacity of a creditor-assignee when: (1) the transaction sought to be avoided poses no threat of “ripple effects” in the relevant securities markets; (2) the transferees received payment for non-public securities[;] and (3) the transferees were corporate insiders that allegedly acted in bad faith. When these three factors are present, a finding of implied preemption is inappropriate.
The bankruptcy court’s ruling in Physiotherapy has also been appealed, but it is unclear at this juncture whether the appeal will be heard by a Delaware district court or the U.S. Court of Appeals for the Third Circuit. A more detailed discussion of Physiotherapy Holdings can be found elsewhere in this issue of the Business Restructuring Review.