United States: Taking Sides—Lyondell Limits The Use Of The Section 546(e) Safe Harbor In Fraudulent Transfer Litigation

Last Updated: June 4 2014
Article by Amanda Suzuki

In Weisfelner v. Fund 1 (In re Lyondell Chem. Co.), 503 B.R. 348 (Bankr. S.D.N.Y. 2014), the U.S. Bankruptcy Court for the Southern District of New York held that the "safe harbor" under section 546(e) of the Bankruptcy Code for settlement payments made in connection with securities contracts does not preclude claims brought by a chapter 11 plan litigation trustee on behalf of creditors under state law to avoid as fraudulent transfers pre-bankruptcy payments to shareholders in a leveraged buyout ("LBO") of the debtor. By its ruling, the Lyondell court contributed to a split among the courts in the Southern District of New York, aligning itself with the district court in In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. 310 (S.D.N.Y. 2013), and against the district court in Whyte v. Barclays Bank PLC, 494 B.R. 196 (S.D.N.Y. 2013). Lyondell and Tribune appear to signal that even in the Second Circuit, where courts have liberally interpreted the scope of the Bankruptcy Code's financial safe harbors, the reach of section 546(e) is not without bounds.

Bankruptcy Avoidance Powers and Limitations

The Bankruptcy Code gives a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") the power to avoid, for the benefit of the estate, certain transfers made or obligations incurred by a debtor, including fraudulent transfers, within a specified time prior to a bankruptcy filing. Fraudulent transfers include transfers that were made with "actual" fraudulent intent—the intent to hinder, delay, or defraud creditors—as well as transfers that were "constructively" fraudulent, because the debtor received less than "reasonably equivalent value" in exchange and, at the time of the transfer, was insolvent, undercapitalized, or unable to pay its debts as such debts matured.

Fraudulent transfers can be avoided by a bankruptcy trustee or DIP for the benefit of the estate under either: (i) section 548 of the Bankruptcy Code, which creates a federal cause of action for avoidance of transfers made or obligations incurred up to two years before a bankruptcy filing; or (ii) section 544, which gives the trustee or DIP the power to avoid transfers or obligations that may be avoided by creditors under applicable nonbankruptcy law. Some state fraudulent transfer laws that may be utilized under section 544 have a reach-back period longer than two years.

Section 546 of the Bankruptcy Code imposes a number of limitations on these avoidance powers. Specifically, section 546(e) prohibits, with certain exceptions, avoidance of transfers that are margin or settlement payments made in connection with securities, commodity, or forward contracts. The purpose of section 546(e) and other financially focused "safe harbors" in the Bankruptcy Code is to minimize "systemic risk" to the securities and commodities markets that could be caused by a financial contract counterparty's bankruptcy filing. Like sections 544 and 548, section 546(e) is expressly directed at a bankruptcy trustee or, pursuant to section 1107(a), a DIP: "Notwithstanding sections 544, 545, 547, 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 . . . ." (emphasis added).

Preemption

The Bankruptcy Clause of the U.S. Constitution grants authority to Congress to establish a uniform federal law of bankruptcy. U.S. CONST., art. I, cl. 8. The Supremacy Clause of the Constitution mandates that federal laws, such as those concerning bankruptcy, "shall be the supreme Law of the Land; . . . [the] Laws of any State to the Contrary notwithstanding." U.S. CONST., art. VI, cl. 2. Thus, under the doctrine of preemption, "state laws that interfere with or are contrary to federal law are preempted and are without effect pursuant to the Supremacy Clause." In re Loranger Mfg. Corp., 324 B.R. 575, 582 (Bankr. W.D. Pa. 2005); accord Hillsborough County v. Automated Medical Labs, Inc., 471 U.S. 707, 712 (1985). Through the years, three types of federal- law preemption over state law have been developed by the courts: (i) express preemption; (ii) field preemption; and (iii) conflict preemption. In re Nickels Midway Pier, LLC, 332 B.R. 262, 273 (Bankr. D.N.J. 2005). Express preemption applies "when there is an explicit statutory command that state law be displaced." Id. Field preemption applies when federal law "is sufficiently comprehensive to warrant an inference that Congress 'left no room' for state regulation." In re Miles, 294 B.R. 756, 759 (B.A.P. 9th Cir. 2003); Hillsborough County, 471 U.S. at 713. Conflict preemption applies if state law conflicts with federal law such that: "(1) it is impossible to comply with both state law and federal law; or (2) the state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress." Nickels Midway Pier, 332 B.R. at 273.

Lyondell contributes to a split of authority in the Southern District of New York on the application of section 546(e). Whereas Barclays continued the trend of liberally applying the safe harbor consistent with its purpose to protect financial markets against systemic risk, Tribune and Lyondell have departed from this approach, limiting the reach of section 546(e) by tempering the need to protect markets with other important bankruptcy principles, such as the protection of creditors' rights.

In Lyondell, the court considered, among other things, whether section 546(e), either by its own terms or under preemption principles, bars state-law fraudulent transfer claims with respect to a prepetition LBO, which claims were assigned as part of a chapter 11 plan to a post-bankruptcy litigation trust established for the benefit of creditors.

Lyondell

In December 2007, Basell AF S.C.A. acquired Lyondell Chemical Company ("Lyondell") through an LBO. The transaction was financed entirely by debt and was secured by the assets of the target company rather than the acquirer. As a result of the LBO, Lyondell took on approximately $21 billion of secured indebtedness. About $12.5 billion of the amount borrowed was paid to Lyondell stockholders, many of which were investment banking houses, brokerage firms, or other financial institutions.

In early January 2009, just 13 months after the LBO, Lyondell and numerous affiliates filed for chapter 11 protection in the Southern District of New York. Ultimately, the bankruptcy court confirmed a chapter 11 plan for Lyondell that provided for, among other things: (i) the creation of a litigation trust (the "Creditor Trust") to which certain estate causes of action were abandoned; and (ii) the assignment by creditors of their state-law claims, including statelaw fraudulent transfer actions, to the Creditor Trust. After the effective date of the plan, the trustee of the Creditor Trust sued all Lyondell shareholders who had received more than $100,000 in connection with the LBO, alleging that the payments were actually or constructively fraudulent and therefore avoidable under state law. The defendants moved to dismiss, asserting, among other things, that the claims were: (i) barred by the terms of the section 546(e) safe harbor; and (ii) preempted by section 546(e).

The Decision: Creditor Trust Claims Are Not Barred by 546(e) or Preemption Principles

The bankruptcy court denied the defendants' motion to dismiss on the basis of section 546(e). The court concluded that, by its terms, section 546(e) does not apply to claims asserted by or on behalf of creditors; rather, it applies only to claims brought by a bankruptcy trustee or DIP. Furthermore, the court ruled that the state-law claims were not preempted by either section 546(e) or other federal law.

The defendants argued that, even though section 546(e) expressly bars only actions brought by a "trustee" to avoid certain financial transactions as constructively fraudulent transfers, the provision also bars similar state-law claims asserted on behalf of creditors. The court flatly rejected this argument, admonishing that "[w]hile the Movants spend 10 pages in their brief arguing the matter as if sections 544 and 548—and hence section 546(e)—apply to this case, this is not a case about sections 544 and 548." The claims at issue, the court explained, were being asserted not on behalf of the estate, but on behalf of individual creditors. Thus, the court wrote, "there is no statutory text making section 546(e) applicable to claims brought on behalf of individual creditors, or displacing their state law rights, by plain meaning analysis or otherwise." Quoting Tribune, the court emphasized that "if Congress intended section 546(e) to be more broadly applicable, 'it could simply have said so.' "

Also following the reasoning of Tribune, the court rejected the defendants' position that, under all three types of preemption doctrine, the absence of a safe harbor similar to section 546(e) in state fraudulent transfer laws should mean that the states' "similar but not congruent" constructive fraudulent transfer avoidance statutes are preempted by section 546(e) and therefore invalid. In this regard, the court initially determined that Congress had not expressly preempted any state-law causes of action for fraudulent transfers.

The bankruptcy court also concluded that there was no "field preemption" because "Congress has not evidenced any intention to wholly occupy the fields of avoidance or recovery of fraudulent transfers." Rather, the court explained, the history of state and federal fraudulent transfer law has long demonstrated a shared interest with the states in protecting creditors from constructively fraudulent transfers. Indeed, the court noted, state fraudulent transfer laws predate the federal equivalents, with no subsequent attempt by Congress to preclude enforcement of existing state laws.

Finally, the court found no "conflict preemption." The defendants argued that the congressional policy underlying the enactment of section 546(e) would be undermined by allowing the statelaw fraudulent transfer action to proceed. In response, the court concluded that it is not impossible for a party to comply with both federal and state fraudulent transfer laws. The court similarly determined that, considering lawmakers' intent with respect to section 546(e) in the context of general bankruptcy policy:

[A]t least in the context of an action against cashed out beneficial holders of stock, at the end of the asset dissipation chain, state law fraudulent transfer laws do not "stand as an obstacle" to the "purposes and objectives of Congress"—even if one were to ignore the remainder of bankruptcy policy and focus solely on the protection against the "ripple effects" that caused section 546(e) to come into being.

Accordingly, following much of the reasoning in Tribune, the Lyondell court ruled that the state-law fraudulent transfer laws were not preempted by section 546(e) or any other federal law.

The Lyondell court determined that the defendants' reliance on Barclays, in which the court granted a motion to dismiss state constructive fraudulent transfer claims brought by a litigation trust, was misplaced. According to the Lyondell court, Barclays is factually distinguishable—in Barclays, the same trust prosecuted both estate and individual creditor claims, whereas in Lyondell, the Creditor Trust held only claims assigned by creditors, and the estate specifically abandoned its section 544 rights. The Lyondell court also faulted both the Barclays court's ultimate judgment and its reasoning, particularly with respect to preemption.

The Lyondell court appeared to be particularly troubled by the Barclays court's focus on the congressional objective of protecting the financial markets and the court's failure to consider other congressional bankruptcy objectives, such as the "longstanding and fundamental principles that insolvent debtors cannot give away their assets to the prejudice of their creditors." According to the Lyondell court, this narrow focus prevented the Barclays court from drawing the proper conclusion that "[p]rotecting market participants is not the same thing as protecting markets." Characterizing the analysis in Barclays as "flawed" and "less thorough than that of Tribune," the Lyondell court ruled that nothing in section 546(e) demands that state-law fraudulent transfer claims be either expressly or impliedly preempted.

Outlook

Lyondell contributes to a split of authority in the Southern District of New York on the application of section 546(e). Whereas Barclays continued the trend of liberally applying the safe harbor consistent with its purpose to protect financial markets against systemic risk, Tribune and Lyondell have departed from this approach, limiting the reach of section 546(e) by tempering the need to protect markets with other important bankruptcy principles, such as the protection of creditors' rights. Although Tribune and Lyondell both involved specific, somewhat narrow circumstances in which the claims at issue were clearly state-law claims that were not being asserted by the bankruptcy trustee or DIP, the two opinions signal that, even in the Second Circuit (where courts are known for liberally construing the safe harbor), the scope of section 546(e) is not without limits. Furthermore, in the preemption context, Tribune and Lyondell suggest that protection of the financial markets will not always trump other bankruptcy policies.

Both Barclays and Tribune have been appealed to the Second Circuit, which will hear the appeals in tandem and is expected to weigh in on these important issues later this year.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Shearman & Sterling LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions