The US Court of Appeals recently decided in In re Tribune Co Fraudulent Conveyance Litigation(1) that Section 546(e) of the Bankruptcy Code(2) impliedly pre-empts state fraudulent conveyance laws that creditors might otherwise use to unwind payments made by a corporate debtor to public shareholders in a pre-bankruptcy leveraged buy-out. Overruling the lower court, the appellate court so held even though Section 546(e) in terms applies to claims only by a bankruptcy 'trustee'.(3)
The Tribune Company, a media conglomerate and publisher of the Chicago Tribune and the Los Angeles Times, filed bankruptcy in the wake of a 2007 leveraged buy-out (LBO) and the onset of the 2008 worldwide financial downturn. The bankruptcy court authorised a creditors' committee to wield the powers of a trustee for the prosecution of claims arising out of the LBO that might have led to recoveries from cashed-out stockholders and others.
The committee filed a complaint to unwind billions of dollars in LBO pay-outs pursuant to federal law as transfers made in actual fraud of creditors, but it asserted no state law claim or theory of constructive fraudulent conveyance. The committee undoubtedly refrained from raising such a claim because Section 546(e) expressly bars the 'trustee' from avoiding settlement payments for securities transactions as constructive frauds. However, retirees and holders of pre-LBO notes (hereinafter, the 'creditors') procured a bankruptcy court order that permitted them to file complaints seeking to set aside the LBO as constructively fraudulent under the laws of various states. The order expressly stopped short of determining whether the creditors had standing to assert such claims or whether such claims were pre-empted by Section 546(e).
The bankruptcy court later confirmed a reorganisation plan under which allowed claims were to be paid 33 cents on the dollar. The plan also purportedly authorised the creditors to pursue all LBO-related fraudulent conveyance claims arising under state law, while also assigning the committee's federal claims to a litigation trust for prosecution.
Avoidance claims and limitations
Tribune involved the complicated interplay of the automatic stay, avoidance claims arising in favour of creditors under state law, trustee avoidance powers in bankruptcy and the limitations on such powers embedded in the Bankruptcy Code.
Throughout the United States, non-bankruptcy law recognises causes of action to avoid transfers made by debtors that are:
- actually fraudulent – undertaken with intent to hinder, delay or defraud creditors; or
- constructively fraudulent – the debtor received no reasonably equivalent value in exchange for the assets transferred and the transfers were undertaken when the debtor was insolvent or thereby reduced to a state of insolvency or its functional equivalent.
Case law holds that such claims are automatically stayed in accordance with Section 362 when the debtor files bankruptcy. However, the Bankruptcy Code creates an array of avoidance powers that may be exercised by the trustee. In Chapter 11 reorganisations it is common for the 'debtor in possession' to operate as the 'trustee' or, as occurred in Tribune, for the bankruptcy court to clothe a creditors' committee with the trustee's avoidance powers.
The trustee's powers to avoid or set aside fraudulent conveyances are found mainly in Sections 544(b) and 548(a) of the Bankruptcy Code. Section 544(b) creates the formidable 'strong arm power' under which the trustee may take on the role of unsecured creditors holding allowable claims against the debtor and wield derivatively all of the avoidance rights that the chosen creditors could bring under state law if the debtor had not filed bankruptcy. The Bankruptcy Code also confers direct federal authority on the trustee to avoid fraudulent conveyances – actual or constructive – by virtue of Sections 548(a)(1)(A) and (B). Against the backdrop of the automatic stay of claims by individual creditors, all Bankruptcy Code provisions that create avoidance powers speak in terms of claims that the trustee is authorised to pursue.
However, the trustee's avoidance powers are circumscribed by certain statutory limitations. Section 546(a) limits the period during which the trustee may file an avoidance claim. In the usual case, such claims must be filed within two years from the commencement of the bankruptcy. Section 546(e) prescribes another limitation – one directly at issue in Tribune. This statute bars the trustee from avoiding certain kinds of transfer carried out in securities and commodities markets, which may be described generically as 'settlement payments'. It provides:
"Notwithstanding sections 544... 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... commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract,... commodity contract... or forward contract, that is made before the commencement of the case, except under section 548(a)(1)(A) of this title."(4)
Where it applies, the impact of this limitation on the trustee's prerogatives is profound. Essentially, if the transfers in question were settlement payments made by or to a financial institution in connection with a securities contract, Section 546(e) expressly overrides the trustee's derivative 'strong arm power' under Section 544(b) in its entirety. Section 546(e) also specifically rules out any direct claim for constructive fraudulent conveyance that would otherwise lie in favour of the trustee under Section 548(a)(1)(B). There is just one proviso to the limitation of Section 546(e): its final clause leaves intact the trustee's direct authority under Section 548(a)(1)(A) to avoid transfers undertaken with actual intent to hinder, delay or defraud creditors.
After creditors had filed approximately 20 state law fraudulent conveyance actions in courts throughout the United States to attack the Tribune's LBO, the US Judicial Panel on Multidistrict Litigation consolidated these matters in the US District Court for the Southern District of New York. The defendants then moved to dismiss the complaints for failure to state facially valid claims. These motions contended that:
- as a matter of law, the automatic stay had deprived the creditors of standing to assert fraudulent conveyance claims; and
- by virtue of Section 546(e), federal law pre-empts the state laws under which the creditors had asserted their alleged claims.
The district court rejected the pre-emption argument, holding that Section 546(e) barred only the trustee, not the creditors, from setting aside settlement payments as constructive fraudulent conveyances under state law. However, the court dismissed those claims on the ground that the automatic stay deprived the creditors "of standing to avoid the same transactions that the Committee is simultaneously suing to avoid".(5) Cross-appeals placed both issues – standing and pre-emption – before the Second Circuit, which reversed on both issues.
Decision and analysis
The Second Circuit first determined that the bankruptcy court had relieved the creditors of the automatic stay by, among other things, permitting them to file complaints and confirming a reorganisation plan that expressly called for the creditors to pursue state law claims relating to the LBO. It therefore concluded that the creditors did not lack statutory standing to sue. The appeal court then held that Section 546(e) barred the creditors' claims because the statute pre-empts the fraudulent conveyance laws of the various states by implication. Like the district court, the court of appeals recognised that Congress's intent or purpose "is the ultimate touchstone" of pre-emption.(6) Yet that shared premise led the appeal court to overrule the lower court on the basis that, by Section 546(e), Congress has elevated the stability of securities markets over all countervailing purposes of bankruptcy law, except for preserving the trustee's direct federal authority to challenge actual frauds.
The creditors argued, as the district court had held, that by its plain terms Section 546(e) applies only to the trustee. They rested on a certain idea of how various provisions of the Bankruptcy Code interact. Thus, the creditors contended that:
- their claims arose under state law before the bankruptcy;
- when bankruptcy supervened, Section 362 stayed those claims in the hands of the creditors while Section 544(b) vested in the trustee a right to prosecute those claims derivatively; and
- the claims reverted to the creditors and became available once more for direct prosecution by them when the trustee chose not to raise the claims within the two years afforded to it for that purpose under Section 546(a).
Once the claims were restored to the creditors, they argued that Section 546(e) became irrelevant because it limits only the trustee's powers under the Bankruptcy Code, not the creditors' right to pursue state law claims outside of the bankruptcy court.
The Second Circuit first rebuffed the 'plain meaning' approach – the idea that, in addressing the limitations of Section 546(e) to the 'trustee' and no one else, Congress has spoken so clearly that there can be no basis for looking beyond the words of the statute to find its intent. The court was unpersuaded of this because it found Section 546(e) ambiguous when viewed in the context of the broader statutory scheme. It observed that – when this statute was enacted – "a contemporaneous reader would not... necessarily have believed it plain that Section 546(e)'s reference only to a trustee's... avoidance claim meant that creditors could bring their own claims".(7) To the contrary, the court suggested that the idea of claims reverting from the trustee to creditors might strike such a reader as anomalous or contradictory when juxtaposed against the automatic stay of Section 362, the limitations period of Section 546(a) and the absence of any express Bankruptcy Code provision for reversion.
The appeal court also refused to apply a presumption against implied pre-emption. The district court had emphasised that the "burden of establishing obstacle preemption … is heavy", since a federal law does not pre-empt a state law "unless 'the repugnance or conflict is so direct and positive that the two acts cannot be reconciled or consistently stand together'".(8) However, whereas 'obstacle pre-emption' stems from concerns for federalism and the sovereignty of the states, the Second Circuit emphasised that "the regulation of creditors' rights has 'a history of significant federal presence'".(9) It went so far as to characterise the Bankruptcy Code as "a wholesale preemption of state laws regarding creditors' rights",(10) which leaves courts free to infer "congressional intent from the Code, without significant countervailing pressures of state law concerns".(11)
Dissecting the creditors' reversion theory, the Second Circuit found it unsupported by any language in the Bankruptcy Code and replete with "ambiguities, anomalies, and outright conflicts with the purposes" of Sections 362, 544 and 548, as well as the limitations of Sections 546(a) and 546(e).(12) The court also deemed the creditors' theory inconsistent with the Bankruptcy Code's scheme for concentrating avoidance claims in the trustee so as to simplify proceedings, reduce costs and assure an equitable distribution among creditors. Notably, these same considerations had figured importantly in the district court's ruling that the creditors lacked statutory standing to prosecute their claims.(13)
The appeal court also rejected the view that the legislative history of Section 546(e) cuts against 'obstacle pre-emption'. It was moved neither by the fact that the US Commodity Futures Trading Commission and Comex had unsuccessfully urged Congress to pre-empt state law expressly by Section 546(e), nor by Congress's failure to amend the statute in the face of a 2003 bankruptcy court decision holding it inapplicable to creditors.(14) The court was also unconvinced by the presence of an express pre-emption provision set forth in Section 544(b)(2); it cited precedent to the effect that such a provision does not exclude pre-emption by implication in related statutes.(15)
Most importantly, the decision turned on the appeal court's inability to discern any reason why Congress would limit the trustee to an actual fraudulent conveyance theory for attacking settlement payments without also "extinguishing constructive fraud claims but rather leaving them to be brought later by individual creditors".(16) The creditors argued that Congress moulded Section 546(e) to strike a balance between competing policies – insulating securities markets from the supercharged powers of the trustee, while still leaving creditors with some recourse against constructive frauds. The district court had embraced an interpretation along those lines when it wrote that "Congress has struck some balance between various policy priorities, which means that it has determined that fraudulent conveyance actions are not necessarily and in all cases 'repugnant' to the interest of market stability".(17)
By stark contrast, the Second Circuit dismissed as merely "imagine[d]" any "deliberate balancing of interests" in Section 546(e).(18) Sweeping away nuances, the court held simply that the purpose of Section 546(e) was to ""promot[e] finality... and certainty" for investors, by limiting the circumstances, e.g., to cases of intentional fraud, under which securities transactions could be unwound".(19) As the appeal court saw it, Congress's intention to protect investors does not accommodate any countervailing purpose of "maximizing the assets available to creditors". Instead, those two goals are "in full conflict".(20)
Thus, according to the Second Circuit's decision in Tribune, Section 546(e) pre-empts state laws that would avoid settlement payments, regardless of whether the plaintiff who asserts that right is the trustee acting in the collective interest of creditors or individual creditors acting for themselves.
Tribune speaks to a narrow issue, but one with important implications for how the Bankruptcy Code should be read. Some may regard the narrow issue as more difficult than the Second Circuit's opinion would suggest.
Supreme Court precedent teaches that, as a matter of 'plain meaning' in the application of statutes, courts should not take a Bankruptcy Code provision that authorises action only by a specified bankruptcy participant – such as the trustee – as a basis for imputing such authority to other actors.(21) By parity of reasoning, it is problematic to read a statutory prohibition that expressly mentions only the trustee as extending somehow to creditors in their individual capacities. While bankruptcy implicates important federal interests, the Bankruptcy Code is a legal structure that is superimposed on a foundation of non-bankruptcy law and is usually understood to leave state-created rights intact, except where they are specifically adjusted by the code.(22) Thus, the absence of a Bankruptcy Code provision expressly providing for the reversion of claims from the trustee to creditors may be less significant for pre-emption analysis than the absence of one expressly extinguishing derivative state law claims that the trustee fails or chooses not to assert. In short, the interplay of federal bankruptcy law and state law is both important and subtle. Courts therefore would do well to search for clear manifestations of congressional intent before concluding that a particular Bankruptcy Code provision broadly pre-empts state law by implication.
The priority of creditors' claims over shareholders' interests is usually recognised as a fundamental policy of the Bankruptcy Code.(23) LBOs can do much to undermine this policy if they purchase stockholders' interests while leaving companies insolvent or unable to pay pre-existing debts when due, thus condemning the companies to eventual bankruptcy. Further, given the extent to which corporate finance in the United States generally depends on debt securities as much if not more than on equities, it is something of a leap to conclude that Congress must have meant for Section 546(e) to promote the stability of equity securities markets at the expense of creditors' rights – in the broad way that the Second Circuit posited – rather than striking the more nuanced balance that the creditors discerned in the statute. Any untoward consequences threatened by the simultaneous prosecution of claims by a trustee and creditors could be prevented by a Section 105(a) injunction freezing the creditors' claims to allow the trustee a clear field to recover for the collective benefit of creditors at large.(24)
If similar cases find their way to other appeal courts, it will be interesting to see whether the Second Circuit's Tribune opinion holds sway.
For further information on this topic please contact Trevor Swett at Caplin & Drysdale by telephone (+1 202 862 5000) or email (firstname.lastname@example.org). The Caplin Drysdale website can be accessed at www.capdale.com.
(1) In re Tribune Co Fraudulent Conveyance Litig, F3d, 2016 WL 1226871 (March 29 2016) (hereinafter, 'Tribune II'). All section references in this update are to Title 11 of the US Code (ie, the Bankruptcy Code).
(2) 11 USC § 546(e).
(3) In overturning District Judge Sullivan's decision in In re Tribune Co Fraudulent Conveyance Litig, 499 BR 310, 313 (SDNY 2013) (hereinafter, 'Tribune I'), the Second Circuit also rejected the lengthy and detailed opinion that a prominent bankruptcy judge addressed to the pre-emption issue concerning Section 546(e) in In re Lyondell Chem Co, 503 BR 348, 369 (Bankr SDNY 2014), as corrected (January 16 2014). Moreover, on the basis of its Tribune II analysis, the Second Circuit upheld District Judge Rakoff's ruling on a closely related issue by determining that 11 USC § 546(g) impliedly pre-empts state law fraudulent conveyance laws when levelled against swap transactions. See Whyte v Barclays Bank PLC, Fed Appx, Case No 13-2653-cv, Summary Order (2d Cir March 24 2016) (affirming Whyte v Barclays Bank PLC, 494 BR 196 (SDNY 2013)).
(5) Tribune I, 499 BR at 313.
(6) Tribune II, 2016 WL 1226871 at 6 (quoting parenthetically Cipollone v Liggett Grp, Inc, 505 US 504, 516 (1992)); see Tribune I, 499 BR at 317.
(7) Tribune II, 2016 WL 1226871 at 14.
(8) Tribune I, 499 BR at 317 (quoting In re Methyl Tertiary Butyl Ether (MTBE) Prods Liab Litig, 725 F3d 65, 101 (2d Cir 2013)).
(9) Tribune II, 2016 WL 1226871 at 6 (quoting United States v Locke, 529 US 89, 90 (2000)).
(10) Id at 7 (citations omitted).
(11) Id at 8.
(12) Id at 10.
(13) Compare Tribune II, 2016 WL 1226871 at 11 with Tribune I, 499 BR at 324-25.
(14) PHP Liquidating, LLC v Robbins, 291 BR 603, 607 (D Del 2003), aff'd, 128 Fed Appx 839 (3d Cir 2005).
(15) Tribune II, 2016 WL 1226871, at 19 (citing Arizona v United States, US, 132 S Ct 2492, 2504-05 (2012)).
(16) Tribune II, 2016 WL 1226871 at 11.
(17) Tribune I, 499 BR at 318 (citations omitted).
(18) Tribune II, 2016 WL 1226871 at 12.
(19) Id at 17 (quoting In re Kaiser Steel Corp, 952 F2d 1230, 1240 n10 (10th Cir 1991)).
(20) Tribune II, 2016 WL 1226871 at 19.
(21) Hartford Underwriters Ins Co v Union Planters Bank, NA, 530 US 1, 7(2000); see Tribune I, 499 BR at 316.
(22) For example, Raleigh v Illinois Dep't of Revenue, 530 US 15, 20 (2000).
(23) "Important federal policies... include that of the traditional priority of creditors of insolvent companies over those companies' stockholders, as implemented by the absolute priority rule, which has been an element of US insolvency law for over a hundred years." In re Lyondell Chem Co, 503 BR 348, 369 (Bankr SDNY 2014), as corrected (January 16 2014), abrogated on other grounds by Tribune II, 2016 WL 1226871.
(24) See generally Caesars Entm't Operating Co v BOKF, NA (In re Caesars Entm't Operating Co), 808 F3d 1186 (7th Cir 2015); see also "Seventh Circuit rules on authority to temporarily stay non-debtor litigation".
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