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), the U.S. Court of Appeals for the Second Circuit held that the “safe harbor” under section 546(e) of the Bankruptcy Code for settlement payments and for payments made in connection with securities contracts preempted claims under state law by creditors to avoid as fraudulent transfers pre-bankruptcy payments made to shareholders in connection with a leveraged buyout (“LBO”) of the debtor.

While Tribune resolved a split on this issue within the Second Circuit, shortly after the ruling was handed down, a Delaware bankruptcy court 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), elected not to follow the Second Circuit, holding instead that the state law claims assigned to a litigation trust in that case were not preempted by section 546(e). These two decisions represent differing views by sophisticated courts on the breadth of section 546(e) and its preemptive scope. While Tribune controls within the Second Circuit, other circuit courts of appeal have not weighed in on this issue, and litigation concerning the application of section 546(e) to state law avoidance claims in the hands of a litigation trustee will likely persist.

Bankruptcy Avoidance Powers and Limitations

The Bankruptcy Code gives a bankruptcy trustee or chapter 11 debtor-in-possession (“DIP”) the power to avoid, for the benefit of the estate, certain transfers made or obligations incurred by a debtor, including fraudulent transfers, within a specified time prior to a bankruptcy filing. Fraudulent transfers include transfers that were made with “actual” fraudulent intent—the intent to hinder, delay, or defraud creditors—as well as transfers that were “constructively” fraudulent, because the debtor received less than “reasonably equivalent value” in exchange and, at the time of the transfer, was insolvent, undercapitalized, or unable to pay its debts as such debts matured.

Fraudulent transfers can be avoided by a bankruptcy trustee or DIP for the benefit of the estate under either: (i) section 548 of the Bankruptcy Code, which creates a federal cause of action for avoidance of transfers made or obligations incurred up to two years before a bankruptcy filing, or (ii) section 544, which gives the trustee or DIP the power to avoid transfers or obligations that may be avoided by creditors under applicable nonbankruptcy law. Some state fraudulent transfer laws that may be utilized under section 544 have reach-back periods longer than two years.

Section 546 of the Bankruptcy Code imposes limitations on these avoidance powers. Among those limitations, section 546(e) prohibits, with certain exceptions, avoidance of transfers made by or to certain protected parties that are margin or settlement payments or transfers made in connection with securities, commodities, or forward contracts. The purpose of section 546(e) and other financially focused “safe harbors” in the Bankruptcy Code is to minimize “systemic risk” to the securities and commodities markets that could be caused by a financial contract counterparty’s bankruptcy filing.

Like sections 544 and 548, section 546(e) is expressly directed at a bankruptcy trustee or, pursuant to section 1107(a), a DIP: “Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment . . . or settlement payment . . . made by or to (or for the benefit of) a [protected participant] . . . or that is a transfer made by or to (or for the benefit of) a [protected participant] . . . in connection with a securities contract . . . .” (emphasis added).


The Bankruptcy Clause of the U.S. Constitution grants authority to Congress to establish a uniform federal law of bankruptcy. U.S. Const. art. I, § 8, cl. 4. The Supremacy Clause of the Constitution mandates that federal laws, such as those concerning bankruptcy, “shall be the supreme Law of the Land; . . . [the] Laws of any State to the Contrary notwithstanding.” U.S. Const., art. VI, cl. 2. Thus, under the doctrine of preemption, “state laws that interfere with or are contrary to federal law are preempted and are without effect pursuant to the Supremacy Clause.” In re Loranger Mfg. Corp., 324 B.R. 575, 582 (Bankr. W.D. Pa. 2005); accord Hillsborough County v. Automated Medical Labs, Inc., 471 U.S. 707, 712 (1985).

Through the years, three types of federal law preemption over state law have been developed by the courts: (i) express preemption; (ii) field preemption; and (iii) conflict preemption. In re Nickels Midway Pier, LLC, 332 B.R. 262, 273 (Bankr. D.N.J. 2005). Express preemption applies “when there is an explicit statutory command that state law be displaced.” Id. Field preemption applies when federal law “is sufficiently comprehensive to warrant an inference that Congress ‘left no room’ for state regulation.” In re Miles, 294 B.R. 756, 759 (B.A.P. 9th Cir. 2003); Hillsborough County, 471 U.S. at 713. Conflict preemption applies if state law conflicts with federal law such that: “(1) it is impossible to comply with both state law and federal law; or (2) the state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.” Nickels Midway Pier, 332 B.R. at 273.

In Tribune and Physiotherapy, the courts considered, among other things, whether section 546(e) preempts state law fraudulent transfer claims with respect to prepetition LBO transactions.


In 2007, Tribune Media Company (“Tribune”) was acquired in an LBO transaction. As part of the transaction, Tribune borrowed more than $11 billion of secured debt, of which more than $8 billion was used to cash out existing shareholders. A year or so later, Tribune filed for chapter 11 relief in the District of Delaware. The fraudulent transfer suits followed.

After the bankruptcy court confirmed Tribune’s chapter 11 plan in July 2012, the official committee of unsecured creditors was granted standing to pursue the bankruptcy estate’s claims against Tribune’s cashed-out shareholders. The committee asserted actual fraudulent transfer claims against the defendants, but not constructive fraudulent transfer claims. Instead, the bankruptcy court conditionally lifted the bankruptcy stay to allow creditors to assert state law constructive fraudulent transfer claims outside of the bankruptcy. Individual creditors filed suit across the country, and the actions were consolidated in a multidistrict litigation proceeding in the U.S. District Court for the Southern District of New York. The defendants moved to dismiss the suits on the basis that section 546(e) of the Bankruptcy Code barred such constructive fraudulent transfer claims.

The district court rejected the argument that section 546(e) of the Bankruptcy Code preempts the claims, but it nonetheless granted dismissal because the automatic stay deprived the individual creditors of standing to sue while the official committee’s suit was ongoing. The Second Circuit affirmed the dismissal but disagreed with the district court’s reasoning. According to the Second Circuit, the Delaware bankruptcy court had lifted the automatic stay, and it was, therefore, not an impediment to filing suit. However, the Second Circuit ruled, the claims nonetheless had to be dismissed because section 546(e) of the Bankruptcy Code preempts creditor state law fraudulent transfer suits under the circumstances.

Prior to Tribune, lower courts within the Second Circuit had come to various conclusions with respect to the preemptive scope of section 546(e) of the Bankruptcy Code. In Tribune, the Second Circuit concluded that the purposes and history of section 546(e) preempted the claims before the court.

At the outset, the court rejected the argument for a strong presumption against preemption in this context. Claims under section 544 of the Bankruptcy Code, the Second Circuit explained, are federal law claims, not state law claims, and any state law claims in this context could proceed only by the grace of federal authority. Thus, the court concluded, it was wrongheaded to apply a robust presumption against preemption, as there was no measurable concern about federal intrusion into traditional state law domains.

The Second Circuit also viewed the purpose and history of section 546(e) of the Bankruptcy Code as justifying preemption. The narrowest purpose of section 546(e) of the Bankruptcy Code, according to the court, is to safeguard intermediaries from avoidance claims between the intermediaries’ customers. Yet even that narrow purpose would be frustrated if creditors could assert constructive fraudulent transfer claims against intermediaries.

Moreover, the Second Circuit viewed section 546(e)’s purpose as extending to much more than intermediaries. Instead, the court reasoned, the history and language of the section reflect a concern regarding the use of avoidance powers against not only a bankrupt intermediary, but any bankrupt customer or participant in the securities markets. The court also observed that Congress had a larger purpose in mind—namely, to promote finality and certainty for investors by limiting the circumstances under which securities transactions could be unwound to situations involving intentional fraud. These purposes not only comport with section 546(e)’s history, the court explained, but make good policy. According to the Second Circuit, a contrary interpretation would result in a lack of protection against unwinding securities transactions that could, in turn, create substantial deterrents to investing in the securities markets. This would unjustifiably create new and substantial risks to market participants and increase monitoring costs.

Accordingly, the Second Circuit concluded that section 546(e)’s language, its history, its purposes, and the policies embedded in the securities laws and elsewhere lead to the conclusion that the safe harbor was intended to preempt the claims before it.


Just a few months after Tribune was decided, a Delaware bankruptcy court refused to interpret section 546(e) of the Bankruptcy Code to preclude a litigation trustee from pursuing state law constructive fraudulent transfer claims arising from the LBO of a debtor.

In 2012, a private equity firm acquired Physiotherapy Holdings, Inc. (“Physiotherapy”) through a reverse-triangular merger. The transaction was financed by, among other things, the issuance of senior notes that were assumed by the new Physiotherapy. As part of the transaction, Physiotherapy’s prior owners received hundreds of millions of dollars for their interests in the company.

On November 12, 2013, Physiotherapy filed a prepackaged chapter 11 case in the District of Delaware. The bankruptcy court confirmed the prepackaged chapter 11 plan, which provided for, among other things, the creation of a litigation trust and the assignment of claims to the trust by consenting senior noteholders. On September 1, 2015, the litigation trustee commenced suit against, among other parties, Physiotherapy’s prior owners.

In substance, the complaint alleged that Physiotherapy’s prior owners had been engaged in accounting fraud for years prior to the LBO. According to the litigation trustee, through the LBO transaction, Physiotherapy incurred a massive amount of new debt that was predicated on false financial statements and used to cash out Physiotherapy’s former owners for inadequate consideration. On the basis of those allegations, the complaint sought to avoid and recover certain transfers (including the payments to the prior owners) as actual and constructive fraudulent transfers under federal and state law.

As in Tribune, the defendants in Physiotherapy argued that the payments made to the defendants were immune from avoidance as constructive fraudulent transfers under section 546(e) of the Bankruptcy Code. However, unlike in Tribune, the court allowed such claims to proceed.

According to the bankruptcy court, Tribune was not binding upon it. Moreover, for several reasons, the bankruptcy court found the lower court decisions in the Second Circuit more persuasive than the reasoning in Tribune.

First, the bankruptcy court found persuasive the argument that states traditionally occupied the field of fraudulent transfer law and that applying the presumption against preemption was therefore appropriate.

Second, while the section 546(e) safe harbor was designed to protect against systemic risk, there was little support, in the bankruptcy court’s view, for the Second Circuit’s focus on promoting finality for individual investors.

Third, the bankruptcy court found it meaningful that, unlike in Tribune, Physiotherapy had no public shareholders. Indeed, the two former shareholders of Physiotherapy controlled 90 percent of the company’s stock, and therefore, the bankruptcy court could see no potential systemic ripple effect.

Fourth, the bankruptcy court accepted as persuasive certain statutory arguments that the Second Circuit rejected. Specifically, the bankruptcy court credited arguments that other provisions of the Bankruptcy Code demonstrate how Congress goes about expressing preemptive intent. For instance, section 544(b)(2) states that “[a]ny claim by any person to recover a transferred contribution described in the preceding sentence under Federal or State law in a Federal or State court shall be preempted by the commencement of the case.” Section 546(e) of the Bankruptcy Code, by contrast, does not contain such express preemption language.

Fifth, unlike in Tribune, the defendants in Physiotherapy had allegedly acted in bad faith. The bankruptcy court found this meaningful because reading section 546(e) to apply to that situation would run counter to other important congressional policies of protecting creditors from being defrauded by corporate insiders.

On the basis of these and other factors, the bankruptcy court refused to hold that the section 546(e) safe harbor preempted the state law fraudulent transfer claims before it.


Tribune and Physiotherapy represent a split of authority between the Second Circuit and the Delaware bankruptcy court on the preemptive application of section 546(e) of the Bankruptcy Code. Whereas Tribune interpreted the preemptive effect of section 546(e) more broadly, Physiotherapy limited the reach of section 546(e) by focusing on the need to protect financial markets as a whole rather than individual investors and transactions that were unlikely to implicate systemic risk. Although Tribune and Physiotherapy involved somewhat different circumstances in which the state claims were not being asserted by the bankruptcy trustee or the DIP, the two opinions signal that the preemptive scope of section 546(e) remains uncertain, at least outside the Second Circuit.

The creditors in Tribune filed a petition on September 9, 2016, asking the U.S. Supreme Court to review the Second Circuit’s ruling. A petition for a writ of certiorari to review a decision in a companion case, Whyte v. Barclays Bank PLC, 2016 BL 90805 (2d Cir. Mar. 24, 2016), in which the Second Circuit concluded that the separate section 546(g) safe harbor “impliedly preempts” a chapter 11 plan litigation trustee from bringing state law fraudulent transfer actions seeking to avoid swap transactions, was filed on August 19, 2016.

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.