The most recent decision in the long-running Tribune Company Fraudulent Conveyance Litigation multi-district case shores up safe harbor defenses to clawback actions that had been challenged following the Supreme Court’s Merit Management decision. The decision approves a broad reading of the statutory definition of “financial institution,” and thus extends the protection of the safe harbor to thousands of shareholder defendants who tendered their shares in the 2007 Tribune leveraged buyout.
The Safe Harbor Qualified Entity Requirement
The safe harbor has become increasingly important to clawback action defendants, providing defenses where none might otherwise exist and facilitating the dismissal of many cases before trial. It generally precludes trustees (and others representing the bankruptcy estate) from bringing actions alleging preferences or constructive fraudulent transfers based on federal bankruptcy law or state law. For the safe harbor to be applicable the challenged transfer must have been made by, to, or for the benefit of a qualified entity; Tribune interpreted the scope and definition of “Financial Institution,” one of the types of listed qualified entities.
In 2016 the Second Circuit had affirmed the dismissal of constructive fraud claims brought by Tribune creditors in a decision (discussed in our prior alert) that followed Second Circuit precedent that financial institutions that were “mere conduits,” — that is, entities without a substantial stake in the transaction through which the funds passed — satisfied the qualified entity requirement. The Supreme Court’s subsequent 2018 decision in Merit Management Group LP v. FTI Consulting, Inc. (discussed in our prior alert) held that intermediate conduits should be ignored when determining whether the transfer was made “by, to, or for the benefit of” a qualified entity. The Tribune litigation trustee took the position that Merit Management invalidated the Second Circuit’s prior Tribune ruling.
The Tribune Decision
Based on this position, the trustee filed a motion seeking to amend his complaint to add a count alleging that the payments to shareholder defendants could be avoided as constructively fraudulent conveyances. The trustee’s position was that since conduits could not satisfy the qualified entity requirement, the only way that the safe harbor could apply would be if a defendant is a qualified entity. This position raised the specter that separate determinations might be required for each defendant regarding whether it is an qualified entity; Defendants that are banks or large funds could still come within the safe harbor protections, but other defendants might have to defend the case on the merits.
However the district court denied the trustee’s motion to amend, reasoning that the amendment would be “futile” because all of the shareholder defendants would be able to successfully assert a safe harbor defense in a motion to dismiss. (The court also relied on a separate determination that permitting the amendment would result in undue prejudice to shareholder defendants, “whose only involvement in this transaction was receiving payment for their shares,”) The safe harbor conclusion is based on a ruling that Tribune itself fits within the definition of a Financial Institution, due to the terms by which the term statutorily defined. As the court explained, “The Bankruptcy Code [in section 101(22)(A)] defines a ‘financial institution’ to include not only traditional financial institutions, but also, in defined circumstances, the customers of traditional financial institutions.”
Tribune had engaged Computershare Trust Company to act as depositary in connection with the 2007 leveraged buyout. Computershare itself was a Financial Institution, which made Tribune, as Computershare’s customer, also a Financial Institution. Accordingly, the safe harbor applies.
The court further determined that this application of the safe harbor is consistent with Merit Management. Under Merit Management it is irrelevant, for safe harbor purposes, that Computerserve, as a Financial Institution, served as a conduit for the flow of funds from Tribune to shareholders. Merit Management requires that the qualified institution be the payor or the payee. Here, the payor, Tribune, was determined to be a qualified institution itself. And the Merit Management decision expressly disclaimed any ruling on the “customer as Financial Institution” portion of the Financial Institution definition that was critical in Tribune.
Potential Effects of the Tribune Decision
The Tribune decision states that it is consistent with “Section 546(e)’s goal of promoting stability and finality in securities markets and protecting investors from [clawback] claims,” but those goals have been met only partially in this case. It is true that the decision preserves the status quo in the litigation, in which all claims against the shareholder defendants have been dismissed on legal grounds without subjecting those defendants to discovery or trial. At the same time, those defendants have been enmeshed in this litigation for nearly ten years. So while the decision takes the shareholder defendants one large step closer to ultimate final dismissal of the litigation, an appeal to the Second Circuit is likely, so the ordeal of the shareholder defendants is not over yet.
From the perspective of Tribune bondholders, the odds of recovering from the shareholders have lengthened appreciably.
For future cases, the Tribune decision should make it considerably more difficult for trustees to challenge transactions that proceeded through the public securities markets, where it is common for financial institutions to serve as depositories and intermediaries. One would expect that future transactions will be structured to ensure that the qualified entity requirement is satisfied, and that the agreements for such transactions to contain recitals and representations to support the application of the safe harbor to any subsequent clawback attack.
Kleinberg Kaplan represents certain defendants in the Tribune adversary proceedings.