The United States Second Circuit Court of Appeals in
In re Tribune Co. Fraudulent Conveyance Litig., Case 13-3992, Doc. 356-1 (2d Cir. Mar. 29, 2016) unanimously held that
constructive fraudulent transfer claims brought by creditors under state
law were preempted and extinguished by the Bankruptcy Code. The case involved
efforts by creditors to claw back payments to Tribune Media’s former
shareholders. The investors, who were paid out through a leveraged buyout
(LBO), were protected from fraudulent conveyance claims via Section 546(e)
of the Bankruptcy Code. The Second Circuit Court held that Section 546(e)
“safe harbor” protections should be extended under federal
preemption principles to cover claims brought by the creditors.
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
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.
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