Overview of Section 546(e) Safe Harbor
The Bankruptcy Code allows a bankruptcy trustee or a debtor-in-possession (DIP) to recover certain 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. Section 546(e), however, preempts claims from 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.
Background and Procedural History
Tribune’s LBO was consummated in 2007 and resulted in the cash out of shareholders. After the LBO, the applicable funds were transferred first to financial intermediaries, which subsequently distributed the funds to individual shareholders in exchange for their shares. Tribune then filed for bankruptcy in 2008. Soon after, under federal bankruptcy law of “actual intent,” the creditor committee filed a fraudulent transfer claim against both the shareholders and other associated parties. However, the creditor committee did not bring an action against the shareholders for transfers under the state’s fraudulent conveyance statutes. As such, in 2011, the Bankruptcy Court granted appellants’ motion to lift the automatic stay regarding the state law fraudulent conveyance claims. The Bankruptcy Court found that due to the creditor committee’s decision not to bring a state law constructive intent fraudulent conveyance claim before the two-year limitation period had lapsed, the appellants had recovered the right to bring such a claim under state law under Bankruptcy Code Section 544.
However, the court was careful to note that it had not ruled on whether or not the claims were permitted under the Bankruptcy Code Section 546(e) “safe harbor,” or whether the appellants had standing to bring the suit. The creditor’s committee was terminated by the reorganization plan set forth by the debtor, and as a result, the federal fraudulent transfer claims had been transferred to a litigation trust.
The shareholders were sued in both federal and state court. These actions were then transferred and consolidated (along with the litigation now associated with the litigation trust) into a New York multidistrict proceeding. When the Tribune shareholders made a motion to dismiss, it was granted by the district court, which found that the appellants were deprived of their statutory standing by the automatic stay because the same transfers were being challenged by the litigation trust’s suit (under separate legal theories). However, the district court rejected the argument that Section 564(e) barred the state law constructive intent fraudulent conveyance claim because that statutory provision applied only to the bankruptcy trustee and Congress declined to extend Section 564(e) to claims brought by creditors.
Second Circuit’s Decision
On appeal, the appellants argued that the plain language of section 546(e) bars only claims brought by a trustee, not claims brought by a creditor or its assignee. The appellants argued that because the debtor (or the Official Committee of Unsecured Creditors on its behalf) failed to bring a constructive fraudulent conveyance action within the two-year statute of limitations period set forth under section 546(a)(1)(A) such claims reverted back to the appellants as creditors who could therefore pursue their own constructive fraudulent conveyance actions.
The Second Circuit court definitively overruled the district court’s ruling and rejected the appellants’ contentions by holding that the “safe harbor” of Section 564(e) was applicable to the litigation of the appellants who were creditors of Tribune. In formulating its ruling, the court considered federal preemption in relation to Section 564(e). The court found that any conflict between state laws and federal laws will result in the preemption of said state laws to the extent that they conflict with any federal statute under the doctrine of “implied preemption.” As such, the court rejected appellants’ argument that because fraudulent conveyance claims are included under the police powers they should be considered state claims to be convincing. According to the court, the Bankruptcy Code dictates that state laws regarding the rights of creditors were entirely preempted once a party entered bankruptcy. Furthermore, the court found that this preemption was proper given that securities markets protection, which informed the policies underlying Section 546(e), constituted an important federal concern, rather than a state concern.
In addition, the court was not convinced that creditors automatically regained fraudulent transfer claims when the bankruptcy estate representative had not brought such a claim within the two-year limitation period because of the intent behind Section 546(e). Specifically, the court found that under federal preemption principles the intent of Section 546(e) was to protect against particular types of transactions regardless of the originator of said transactions. By allowing claims like the appellants to stand, the court reasoned, it might threaten the profitability of certain markets.
The Second Circuit’s holding in Tribune has numerous potential implications for creditors. First, an individual creditor’s constructive fraudulent transfer claims under state laws against a shareholder or other beneficiary in an LBO transaction are extinguished by the Bankruptcy Code’s preemption of those claims, at least to the extent that such claims fall within the scope of the safe harbors of sections 546(e), (f) and (g). As a result, the tactics creditors have utilized over the years to circumvent the language of the safe harbors, whether through assigning a creditor’s claim to a litigation trust or having it brought by an individual creditor, are no longer viable options.