Canada: LBO Investors Shielded From Creditors' State Law Fraudulent Conveyance Claims

On March 29, the United States Court of Appeals for the Second Circuit issued an opinion holding that the safe harbor provision in Section 546(e) of the Bankruptcy Code, which bars constructive fraudulent conveyance claims against settlement payments brought by a "trustee" in bankruptcy, also bars state law constructive fraudulent conveyance claims asserted by creditors against shareholders to recover settlement payments made in the context of a leveraged buyout (LBO) of a company that subsequently commences a bankruptcy case (Tribune).1 In a related appeal, the Court upheld the safe harbor provision applicable to swap transactions in Section 546(g) (Whyte).2

What You Need To Know

  • Section 546(e) securities safe harbor provision protects shareholder settlement payments in LBO transactions from constructive fraudulent conveyance attack by individual or collective creditors.
  • Second Circuit broadly interprets the safe harbor provisions of the Bankruptcy Code to protect the securities markets.
  • State law constructive fraudulent conveyance claims are preempted by the federal Bankruptcy Code.

Whyte Appeal

The Whyte case involved an appeal from the decision of Judge Rakoff of the United States District Court for the Southern District of New York where he held that the Section 546(g) safe harbor provision for swap transactions impliedly preempted state law causes of action brought by the litigation trustee (Litigation Trustee) of a litigation trust formed pursuant to the chapter 11 reorganization plan of SemGroup. Certain individual creditors in SemGroup assigned their claims to the trust wherein the Litigation Trustee asserted a fraudulent transfer claim under New York state laws against Barclays and other defendants. The Litigation Trustee posited that because Section 546(g) expressly applies to a "trustee" exercising federal avoidance powers under Section 544 of the Bankruptcy Code, the safe harbor provision did not apply to creditor claims brought under state laws after the termination of the bankruptcy case. Judge Rakoff based his decision on a theory of implied preemption that allowing such state law fraudulent conveyance actions to proceed in a litigation trust would frustrate Congress's intent in protecting swap transfers from avoidance.

Tribune Appeal

The Official Committee of Unsecured Creditors of the Tribune Company commenced a lawsuit (the Committee Action) on behalf of the bankruptcy estate of Tribune Company against former shareholders alleging fraudulent conveyance claims based upon federal bankruptcy law. The Committee was replaced by a litigation trustee for the Tribune Litigation Trust. The Committee Action involves claims for intentional fraudulent conveyance but not constructive fraudulent conveyance which would have been barred by Section 546(e).

In a separate action, certain other creditors of Tribune Company including Deutsche Bank, Wilmington Trust, Law Debenture, and William A. Niese, et al. on behalf of the Tribune Company Retirees commenced lawsuits (Individual Creditor Actions) against defendants alleging claims based on state law constructive fraudulent conveyance causes of action. Both the Committee Action and all of the Individual Creditor Actions were transferred to the Southern District of New York for coordination under multidistrict litigation. The Individual Creditor Actions were dismissed on September 23, 2013 by Judge Sullivan of the United States District Court for the Southern District of New York, a decision subsequently appealed to the Second Circuit.

Judge Sullivan had ruled that individual creditors seeking to avoid payments made to former shareholders of the Tribune Company during the Company's 2007 leveraged buyout were precluded from asserting such fraudulent conveyance actions as long as the litigation trustee which represents Tribune's bankruptcy estate continues to assert his avoidance powers. The Court, however, held that Section 546(e) of the Bankruptcy Code, the statute that provides a safe harbor from a trustee's avoidance claims for settlement payments in securities transactions, does not preempt individual creditors' state law constructive fraudulent conveyance claims. 

Judge Sullivan's Tribune opinion conflicted with Judge Rakoff's Whyte opinion that the section 546(g) safe harbor provision shielding swap transactions from federal avoidance actions by bankruptcy trustees also preempts state-law claims commenced by creditors or their representatives. Judge Sullivan distinguished Whyte on the basis that the plaintiff in Whyte served in the capacity of both the bankruptcy trustee and the representative of outside creditors, whereas Tribune, the plaintiffs were individual creditors. These conflicting decisions prompted the Second Circuit to consider the appeals of Whyte and Tribune together. 


The Second Circuit affirmed the dismissal of the state law constructive fraudulent conveyance claims in Tribune based upon Section 546(e) of the Bankruptcy Code and not a theory of standing relied on by Judge Sullivan. The Second Circuit noted that when the Tribune reorganization plan was confirmed, the automatic stay was lifted and individual creditors were not barred from bringing claims outside of bankruptcy which were expressly preserved in the plan. While the state law claims were preempted during the case, at issue was whether the Individual Creditor Actions were restored or reverted to creditors once the official committee of creditors with the powers of a trustee did not pursue them. The Second Circuit found no support for this reversionary theory and found no reason why  the Bankruptcy Code safe harbor provisions would bar such claims during a bankruptcy case but then allow them to proceed in multiple forums against multiple defendants. The Court then looked to the statutory interpretation of Section 546(e) and its legislative history. The Second Circuit emphasized the purpose of the safe harbors to provide certainty, speed, finality and stability to the securities markets to attract capital. Allowing the Individual Creditor Actions to proceed would undermine this Congressional intent. In a summary order in the Whyte Appeal, the Second Circuit affirmed the dismissal of the actions involving the swap transactions under the Section 546(g) safe harbor provision for substantially the same reasons as in Tribune.

The Second Circuit decision provides an expansive view of the safe harbor provisions protecting investors from constructive fraudulent conveyance attacks. Financial institutions, pension funds and other investors can take comfort in the Court's robust defense of the stability and security of the financial markets as a basis for limiting creditor lawsuits. While the insiders involved in a leveraged buyout transaction may still face intentional fraudulent conveyance litigation, those shareholders who merely received settlement payments may breathe a sigh of relief.


1 In re Tribune Co. Fraudulent Conveyance Litig., No. 13-3992, slip op. (2d Cir. Mar. 29, 2016).

2 Whyte v. Barclays Bank PLC, No. 13-2653, summ. ord. (2d Cir. Mar. 24, 2016).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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