A recent decision by the Court of Appeals for the Second Circuit, In re Tribune Company Fraudulent Conveyance Litigation, has emphatically rejected a controversial workaround strategy used by plaintiffs in several pending fraudulent conveyance cases brought against shareholders of public companies, providing clarity regarding the scope of the “Safe Harbor” defenses of Bankruptcy Code section 546(e) and comfort to participants in the public markets. The result gives relief not only for Tribune defendants but likely also for defendants in similar actions brought in the In re Lyondell Chemical Co. bankruptcy case.
The Safe Harbor Workaround
The issue decided by the Second Circuit addresses a litigation strategy used in several recent bankruptcy cases where creditors alleged that a pre-petition leveraged buyout was a fraudulent conveyance. The purpose of the strategy is to find a way to bring actions against former shareholders notwithstanding that the Safe Harbor was designed to bar most bankruptcy estate actions against market participants such as shareholders. The particulars of the strategy spring from the fact that Bankruptcy Code fraudulent conveyance provisions are in substance similar to provisions found in the law of most states. One difference is that under state law fraudulent conveyance actions are brought by individual creditors as plaintiffs, whereas in bankruptcy fraudulent conveyance actions are brought by the trustee on behalf of all creditors.
Once a bankruptcy case is filed, fraudulent conveyance actions that otherwise could have been brought under state law by individual creditors pass to the bankruptcy estate, and creditors are barred from prosecuting such state-law fraudulent conveyance claims. However, the Safe Harbor limits bankruptcy trustees (and others representing the bankruptcy estate) from bringing fraudulent conveyance actions against the former shareholders. The strategy used by creditors to try to work around the Safe Harbor was to structure the litigation so that the named plaintiff was not a bankruptcy trustee but instead a creditor or a representative of creditors. The point was that the language of section 546(e) appears to limit only actions brought by “the trustee,” and thus an action brought by a creditor arguably is outside of the scope of the Safe Harbor. Pursuant to the workaround strategy, the bankruptcy estate disclaimed any right to avoid transactions under the state fraudulent conveyance statutes, and instead the same transactions became the subject of avoidance actions brought by creditors under state fraudulent conveyance laws.
The Tribune litigation arose from the 2008 bankruptcy of the Tribune Company. In 2007, the Tribune employee stock ownership plan had acquired all of Tribune’s outstanding shares through a leveraged buyout, pursuant to which Tribune’s shareholders were paid a total of approximately $8.2 billion. In December 2008, Tribune and its subsidiaries filed for bankruptcy.
In April 2011, the Bankruptcy Court modified the automatic stay to permit creditors of Tribune to file state law constructive fraudulent conveyance complaints against former Tribune shareholders. Beginning in June 2011, various creditors of Tribune initiated 44 actions against thousands of former Tribune shareholders in 21 state and federal courts around the country, asserting state law constructive fraudulent conveyance claims and seeking to avoid billions of dollars in payments that the shareholders received in the LBO.
In December 2012, the Tribune plan of reorganization became effective. The plan provided for a litigation trust to prosecute certain actions on behalf of the bankruptcy estate (including actual intent fraudulent conveyance actions against the former shareholders), but also provided that state law constructive fraudulent conveyance claims were to be disclaimed by the bankruptcy estate and could continue to be prosecuted by the creditors themselves. Those actions were consolidated, and the actions, which comprise 52 actions originally filed in 24 courts, have proceeded before the District Court for the Southern District of New York.
Following the filing of an omnibus motion to dismiss by the defendants, District Judge Richard Sullivan held that the workaround did not violate section 546(e). He reasoned that the language of section 546(e) restricted nothing more than the power of a trustee to bring avoidance actions, and that if Congress wanted to prohibit workaround actions brought by creditors, it could have expressly banned the practice.
Court of Appeals Decision
The Court of Appeals reversed Judge Sullivan’s decision and held that section 546(e) blocks the workaround. It based its decision on the doctrine of implied preemption, holding that the purpose of the protections of the Safe Harbor would be eviscerated if the Safe Harbor applied to only actions brought by a trustee and not to actions brought by creditors.
One interesting aspect of the decision was its treatment of the “plain meaning doctrine” which holds that statutes should be interpreted primarily according to plain meaning of the text, without recourse to such interpretive aids as legislative history and statutory purpose. This doctrine has been applied in several decisions interpreting the Bankruptcy Code. In Tribune, the plain meaning doctrine was relied upon by the plaintiffs and by District Judge Sullivan, who determined that the phrase “by the trustee” in section 546(e) was determinative. But the Court of Appeals considered this approach too simplistic, criticizing “an isolated focus on the word ‘trustee’ in Section 546(e)” and substituting a broader focus on the purposes of the Safe Harbor and the way it works within the legislative scheme. The Court determined that permitting creditor actions to proceed “results in anomalies and inconsistencies with parts of the Code,” rendering the plain language ambiguous. Because the language was ambiguous the Court next examined legislative intent and determined that the only interpretation that was consistent with legislative intent was for the Safe Harbor to apply to creditor actions as well as trustee actions.
The Court of Appeals buttressed its conclusion with a policy analysis. It determined that the purpose of the Safe Harbor was to promote the stability and reliability of the financial markets. It found that “unwinding settled securities transactions by claims such as appellants’ would seriously undermine … markets in which certainty, speed, finality, and stability are necessary to attract capital.” Indeed, it considered that even the threat of actions against former shareholders that seek to unwind old transactions would add significant risks and uncertainties for market participants, contrary to the purpose of the Safe Harbor: “the idea of preventing a trustee from unwinding specified transactions while allowing creditors to do so, but only later, is a policy in a fruitless search of a logical rationale.”
It is too soon to tell whether the Tribune plaintiffs will seek an en banc rehearing by the Second Circuit or the grant of a writ of certiorari from the Supreme Court. Supreme Court review appears to be unlikely, because grants of certiorari are unusual in cases like this one where there is not a split among the Circuits. But the Tribune defendants still must litigate the actual intent action brought by the trustee.
Effect on Lyondell Litigation
The Tribune decision is likely to result in a dismissal of the constructive fraud actions brought by a purported creditor representative in fraudulent conveyance actions arising from the In re Lyondell Chemical Co. bankruptcy case, brought against former shareholders of Lyondell that tendered their shares in a 2007 leveraged buyout. As noted in our prior Alert, the Bankruptcy Court in those cases already has dismissed the actual intent actions, in a decision that is under appeal. Barring a reversal of that decision, the Lyondell defendants could see a complete dismissal of both the actual and the constructive fraudulent conveyance actions against them.
More broadly, the Tribune decision continues a trend in which the circuit courts of appeal have broadly construed the Safe Harbor, including decisions in the Enron, Quebecor, Madoff, Grede, Plassein, QSI Holdings and Contemporary Industries cases, and may presage favorable treatment for defendants raising Safe Harbor defenses in other pending cases, such as Lehman.
Kleinberg Kaplan represents certain defendants in the Tribune, Lyondell, Madoff and Lehman adversary proceedings.
 The Safe Harbor generally precludes trustees (and others representing the bankruptcy estate) from bringing fraudulent conveyance actions based on state law, which often provides a reach-back period that is significantly longer than the two year reach-back period established under the Bankruptcy Code. It also generally precludes trustees (and others representing the bankruptcy estate) from bringing actions alleging constructive intent to defraud. From a plaintiff’s perspective, constructive intent actions, which generally require the plaintiff to prove only that the transfer was made for less than reasonably equivalent value while the transferor was insolvent, are easier to establish than are actual intent actions. A discussion of the types of transfers and entities protected by the Safe Harbor is beyond the scope of this Alert, but those issues were discussed in our prior Alert. In Tribune, the transfers were conceded to have been “settlement payments” and “payments made in connection with securities contracts,” which fall within the list of transactions covered by the Safe Harbor, so the only Safe Harbor issue presented was the permissibility of the workaround.
 The order provided that the actions begun by those complaints would be stayed pending further order of the Court.
 In the same decision Judge Sullivan granted the defendants’ motion to dismiss on an alternative theory of lack of standing, but a discussion of that issue goes beyond the scope of this Alert.
 The decision also reversed Judge Sullivan’s decision regarding standing. Even though all elements of the District Court’s reasoning were rejected, because the net result of the Court of Appeals decision (dismissal of the case) was the same as the District Court’s decision, the District Court order technically was affirmed.
 While the Safe Harbor contains an express exception permitting actual intent actions, the public policy concerns discussed in the Tribune opinion generally support dismissal of (or a restrictive interpretation for) the actual intent actions as well.