Today, the Second Circuit reissued the latest in a line of cases adopting an expansive reading of the safe harbor under Section 546(e) of the Bankruptcy Code. In re Tribune Co. Fraudulent Conveyance Litig., Case 13-3992, Doc. 356-1 (2d Cir. Mar. 29, 2016). (This opinion was originally issued on March 24 and withdrawn on March 28. The opinion released today contains minor, non-substantive alterations to the text on pages 8, 22, 26, and 40. In all other respects, it is identical to the opinion withdrawn last week).
- Overview of Section 546(e) Safe Harbor
The Bankruptcy Code allows a bankruptcy trustee or debtor-in-possession to avoid (i.e., recover) a variety of pre-bankruptcy transfers for the benefit of the bankruptcy estate. These avoidable transfers include fraudulent conveyances under state law and constructive fraudulent conveyances under the Bankruptcy Code. In general terms, under state law or the Bankruptcy Code, a constructive fraudulent conveyance is a transfer of property for less than reasonably equivalent value at a time in which the transferor was insolvent (or becomes insolvent as a result of the transfer).
Section 546(e) shields from avoidance certain transfers arising in connection with a securities contract that involve specified financial intermediaries, including pre-petition transfers made by or to financial institutions or securities clearing agencies.
- Factual and Procedural Background
The year before it filed for bankruptcy, the Tribune Media Company was bought through a leveraged buyout. The leveraged buyout involved borrowing $11 billion and $315 million in sponsor equity. Ultimately, about $8 billion of the proceeds were used to refinance Tribune’s debt and cash out its former shareholders.
In this litigation, two subsets of unsecured creditors (the “Creditors”) sought to recover the money received by the former shareholders from the LBO. The Creditors (former Tribune employees with retirement-benefit claims, and the successor indenture trustees for Tribune’s pre-LBO senior notes and subordinated debentures) argued that these transfers amounted to constructive fraudulent conveyances under applicable state law.
Procedurally, this case is novel because the state law fraudulent conveyance claims asserted by the Creditors originally belonged to Tribune, as the debtor-in-possession. Under Section 546(a) of the Bankruptcy Code, Tribune had two years from its bankruptcy filing in 2008 to bring these claims. The bankruptcy court entered an order establishing that once this two-year statute of limitations period expired, the Creditors regained the right to prosecute their state law claims. This procedural issue was not on appeal, but it underscores the Creditors’ precarious position: they sought to litigate claims that Tribune, as debtor-in-possession, could not bring due to the Section 546(e) safe harbor.
- The Second Circuit’s Ruling and Rationale
The Second Circuit definitively rejected the creditors’ position and held that Section 546(e) preempted their claims.
As a preliminary matter, this litigation was not about the scope of Section 546(e) for a trustee or debtor-in-possession, as the statute expressly prohibits either from bringing state law fraudulent conveyance claims. Instead, the question in Tribunewas whether Section 546(e) preempts creditors (or their representatives) from asserting those same claims.
The Second Circuit found no legal or policy support for the Creditors’ position: “On its very face, the idea of preventing a trustee [or debtor-in-possession] from unwinding the specified transactions while allowing creditors to do so, but only later, is a policy in a fruitless search of a logical rationale.” 2016 WL 1138723 at *15.
This decision aligns with several of the Second Circuit’s prior decisions on Section 546(e), which read this section with an eye towards “minimizing the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.” In re Quebecor World (USA) Inc., 719 F.3d 94, 100 (2d Cir. 2013) (quoting Enron Creditors Recovery Corp. v. Alfa, S.A.V. de C.V., 651 F.3d 329, 333 (2d Cir. 2011)). Consistent with this position, in Tribune, the Second Circuit explained that Section 546(e) applies equally to Tribune’s former shareholders as it should to the financial intermediaries who brokered the LBO because “Section 546(e) protects transactions rather than firms, reflecting a purpose of enhancing the efficiency of securities markets in order to reduce the cost of capital to the American economy.” 2016 WL 1138723 at *17.
The Tribune decision further confirms that Second Circuit is a friendly forum for intermediate and ultimate transferees in the context of business combinations involving securities contracts. This is an important consideration for restructuring professionals and investors. On the front end, it may impact the transaction structure of a distressed investment opportunity, and on the back end, it may impact claw back exposure.