The latest decision by the Second Circuit Court of Appeals in the long-running Tribune Company fraudulent conveyance litigation provides Court of Appeals endorsement of safe harbor defenses to clawback actions that had been considered potentially vulnerable following the Supreme Court’s decision in Merit Management Group LP v. FTI Consulting, Inc. The opinion amounts to a reconsideration and reaffirmation of the Second Circuit’s 2016 Tribune decision in light of Merit Management. It approves a broad reading of the statutory definition of “Financial Institution,” extending the protection of the safe harbor to thousands of shareholder defendants who tendered their shares in the 2007 Tribune leveraged buyout. More generally, the result provides a blueprint for structuring transactions when it is important to have comfort that the safe harbor will provide protection against some of the consequences of a future bankruptcy.
As there is no circuit split on this issue, Supreme Court review of the issue seems unlikely. Thus, while other appeals remain pending in Tribune, the odds (from the perspective of Tribune bondholders) of recovering from the shareholders have lengthened appreciably.
The legal issues were discussed at length in our prior alert. The Tribune plaintiffs had taken the position that the Supreme Court’s 2016 decision in Merit Management invalidated the Second Circuit’s Tribune decision that had been rendered earlier in 2016. The Tribune district court rejected the plaintiffs’ position in April 2019, in a decision that did not become ripe for appeal until recently. The most recent opinion was issued in a separate Tribune proceeding while the briefing on that appeal had not yet begun.
While the appellate panel did not cite to or discuss the April 2019 district court decision it reached the same conclusion – that Tribune itself fits within the definition of a Financial Institution, due to the way in which the term is statutorily defined, and that as a result the safe harbor is applicable to protect the Tribune defendants.
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 conveyances based on federal bankruptcy law or any fraudulent conveyance action based on 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.
The Tribune Interpretation of “Financial Institution”
The Tribune decision turns on the scope and definition of “Financial Institution,” which is one of the listed qualified entities. The Bankruptcy Code defines “Financial Institution” to include not only banks and other such entities, but also a customer of such financial institutions, if the financial institution is acting as an agent or custodian for that customer in connection with a securities contract.
Tribune had engaged Computershare Trust Company to act as depositary in connection with the 2007 leveraged buyout. Computershare itself was a Financial Institution, and Computershare acted as agent and custodian for Tribune. The tender offer, which provided for the purchase of securities and the redemption of other securities, was held to fit within the definition of “securities contract.” Thus the panel concluded that Tribune, as Computershare’s customer, was a Financial Institution, and held the safe harbor to be applicable.
The panel also reaffirmed its 2016 conclusion, based on the doctrine of implied preemption (discussed in our prior alert) that the plaintiffs could not work around the safe harbor by framing the action as one brought by creditors of Tribune rather than by a bankruptcy trustee. It rejected the plaintiffs’ arguments that Merit Management, which was based on a strict interpretation of the plain meaning of a statutory provision, should be interpreted to supply a policy rationale for allowing the workaround and making the safe harbor inapplicable.
Potential Effects of the Tribune Decision
The Tribune decision marks the first decision by a circuit court of appeals interpreting this aspect of the Bankruptcy Code’s “Financial Institution” definition. For future cases, the decision should make it considerably more difficult for trustees and others to challenge transactions that proceeded through the public securities markets, where it is common for financial institutions to serve as depositories and financial agents.
More generally, the result provides a blueprint for structuring transactions when it is important to have comfort that the safe harbor will provide protection against some consequences of a future bankruptcy. Those who structure transactions may wish to consider using banks as custodians or agents in transactions involving securities.
In addition, the Tribune decision may create an anomalous situation in future cases. For example, payments to shareholders in a future leveraged buyout akin to that in Tribune might be avoidable in actions brought by creditors under state law, but could be protected by the safe harbor if there is a bankruptcy filing. This anomaly may well affect the calculus of various stakeholders in workout situations.
Kleinberg Kaplan represents certain defendants in the Tribune adversary proceedings.