United States: Lawsuit Against Lyondell Shareholders For Repayment Of LBO Proceeds Survives Motion To Dismiss

Last Updated: September 16 2014
Article by Timothy J. Durken

The Southern District of New York Bankruptcy Court held in Weisfelner v. Fund 1 (In re Lyondell Chemical Co.) that Section 546(e)'s safe harbor for settlement payments of securities transactions does not apply to or preempt a state law constructive fraudulent transfer claim to recover LBO payments to shareholders. See Decision and Order on Motion to Dismiss, No. 09-10023, Adv. No. 10-4609 (Bankr. S.D.N.Y. Jan. 14, 2014) (Gerber, B.J.).

On January 14, 2014, the Court ruled that the post-confirmation Creditor Trust's lawsuit against Lyondell shareholders seeking repayment of LBO proceeds as intentional and constructive fraudulent transfers under state law can continue to go forward.

In 2007, Lyondell was acquired in an LBO led by Leonard Blavatnik for $21 billion of debt secured by the company's own assets. Shareholders were paid $12.5 billion of the LBO proceeds. Less than 13 months later, Lyondell filed for bankruptcy under the weight of the LBO debt. The Creditor Trust argues that the LBO payments allowed shareholders to leap frog unsecured creditors in violation of the absolute priority rule of bankruptcy law that debt is paid before equity. The clawback action sought to recover $6.3 billion from shareholders to pay creditors.

Generally, the Creditor Trust must allege and prove that the payments to shareholders were made with actual intent to hinder, delay, or defraud creditors (an intentional fraudulent transfer) or made for less than reasonably equivalent value and caused Lyondell to become insolvent, have unreasonably small capital, or be unable to pay its debts (a constructive fraudulent transfer). Shareholders filed a motion to dismiss on five grounds, which was granted in part and denied in part by the Court.

First, shareholders sought to rely on Section 546(e) of the Bankruptcy Code that provides a safe harbor prohibiting a bankruptcy trustee from avoiding under Sections 544 and 548 of the Bankruptcy Code (except an intentional fraudulent transfer claim under Section 548(a)(1)(A)) certain settlement payments made in securities transactions. But the Creditor Trust was intentionally structured to avoid the Section 546(e) proscription and did not assert claims under Section 544 or 548. Instead, the state law fraudulent transfer actions, which could have been brought by a bankruptcy trustee under Section 544, were abandoned by the Debtors and contributed by the individual creditors to the Creditor Trust to be brought on their behalf.

Judge Gerber followed the recent decision in In re Tribune Co. Fraudulent Conveyance Litig. and held that Section 546(e) is not applicable to the state law actions and further that the claims are not preempted by federal bankruptcy law. 499 B.R. 310 (S.D.N.Y. 2013) (Sullivan, J.).There was no contention that Congress expressly preempted the state law actions. The Court also could not find field preemption where federal and state fraudulent transfer statutes have coexisted for centuries and Section 544 expressly incorporates state law avoidance actions. Finally, the Court rejected shareholders' conflict preemption argument on both impossibility and obstacle grounds.

With respect to obstacle conflict preemption, the Court followed the well-reasoned Tribune opinion and held that state fraudulent transfer laws do not stand as an obstacle to or actually conflict with the full purposes and objectives of Congress. Judge Gerber recognized that Section 546(e)'s protection of the financial markets from reversal of settled securities transactions was merely one of many competing concerns in federal bankruptcy policy. Those concerns include the availability of avoidance actions to recover a debtor's transfers for the ratable and equitable distribution to similarly situated creditors and the absolute priority rule providing that creditors are paid before shareholders. Further, Congress was well aware of how to expressly preempt state fraudulent transfer laws and did so with respect to charitable contributions. Because Congress was fully aware of state fraudulent transfer laws and chose not to expressly preempt them with respect to Section 546(e), Judge Gerber could not find conflict preemption.

Even if the policies underlying Section 546(e) were the only federal policies to be implemented (which is not the case), Judge Gerber explained that he still would not have found conflict preemption. Section 546(e) is concerned with protecting financial markets from a "ripple effect" caused by the insolvency of one securities firm spreading to other firms like falling dominos and threatening a systematic collapse of the market. Section 546(e) was not added to the Bankruptcy Code with a concern to protect individual investors. Drawing a line between the needs of the markets and creditors, the Court held that there is simply no systematic market risk in the reversal of LBO payments to shareholders (including financial institutions) at the end of the asset transfer chain. Judge Gerber followed Tribune in distinguishing the Whyte v. Barclays Bank PLC case arising out of the SemGroup bankruptcy, which involved a single trust bringing both bankruptcy trustee and individual creditor state law fraudulent transfer claims, and "more fundamentally" disagreed with the analysis in Whyte as flawed. 494 B.R. 196 (S.D.N.Y. 2013) (Rakoff, J.).

Second, Judge Gerber rejected as "puzzling" the shareholders' argument that the LBO payments were never Lyondell's property because the payments merely passed through Lyondell from the banks to shareholders. As routinely done, the Court collapsed the transactions of the LBO—(1) the pledge of a security interest in all of Lyondell's pre-existing property as collateral, and (2) the payment of loan proceeds secured by such collateral to shareholders—to find that the LBO payments constituted property of Lyondell subject to avoidance.

Third, the Court granted the motion to dismiss as to all Defendants that were mere conduits (including nominees or depositories) of LBO proceeds. An "initial transferee" from which avoidable transfers may be recovered does not include those who are not beneficial owners of the LBO payments.

Fourth, the Court held that the Creditor Trust could not avoid fraudulent transfers on behalf of and for the benefit of the LBO lenders who were participants and must be deemed to have ratified the transfers as part of the LBO. This is critically important to shareholders because the Creditor Trust will now only be able to recover up to the amount owed to trade creditors and bondholders harmed by and who did not participate in the LBO.

Fifth, with respect to the intentional fraudulent transfers, the Court found that the Creditor Trust failed to allege that CEO Dan Smith controlled Lyondell with respect to the LBO and shareholder payments, whether by influence on remaining Board members or otherwise, to impute his fraudulent intent to Lyondell. Further, the Creditor Trust failed to identify the particular Debtors that made the fraudulent transfers (although corporate distinctions ultimately could be disregarded under the collapsing doctrine). The Court dismissed the intentional fraudulent transfer claims as deficient, but with leave for the Creditor Trust to replead the claims to correct the deficiencies. The Court found sufficient allegations of fraudulent motive with respect to CEO Smith and other corporate officers and directors seeking to enrich themselves through benefits secured in the LBO, including as shareholders of Lyondell, with reckless disregard of the harmful consequences to creditors. Similarly, the Court rejected shareholders' argument that the allegations are not plausible because of participation in the LBO by the sophisticated LBO lenders. Judge Gerber recognized that the LBO lenders were motivated to participate in the LBO to earn substantial fees and the fact that their secured interest ensured payment ahead of unsecured creditors.

The Lyondell decision is another important step with Tribune of repositioning the rights of creditors in front of shareholders in failed LBOs and recognizing that avoiding LBO payments to shareholders at the end of the transfer chain does not implicate the market protection concerns of Section 546(e). The Tribune and Whyte decisions have been appealed and are being heard in tandem by the Second Circuit early this year. Case Nos. 13-2653 (2d. Cir.), ECF Nos. 192-93, 198; 13-3992 (2d Cir.), ECF Nos. 33-34, 37.The Lyondell Creditor Trust has filed an appearance as amicus counsel in that actionand an appeal of the Lyondell decision is expected. These appeals should be closely watched for their effect on the ability of creditors to recover from shareholders of failed LBOs.

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
 
In association with
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
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). 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 & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd 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 or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.