Former Lyondell shareholders may be set back by recent developments in the Lyondell bankruptcy case leaving Lyondell shareholders open to creditor fraudulent conveyance claims.

Law360, New York (January 27, 2014, 1:17 PM ET).  Lisa Schweitzer writes, “On Jan. 14, 2014, the U.S. Bankruptcy Court for the Southern District of New York held that the Bankruptcy Code’s § 546(e) safe-harbor provision[1] neither protects against nor preempts state law constructive fraudulent transfer claims brought on behalf of individual creditors against cashed-out former shareholders of a company acquired in a leveraged buyout.
By refusing to dismiss these claims, prosecuted by a creditor trust pursuant to a confirmed plan of reorganization, Bankruptcy Judge Robert E. Gerber’s opinion in Weisfelner v. Fund 1 (In re Lyondell Chemical Co.), Adv. Proc. Case No. 10-4609 (REG) (Bankr. S.D.N.Y. Jan. 14, 2014), opens up the former shareholders who received distributions under a failed LBO to creditor fraudulent conveyance claims where the Bankruptcy Code § 546(e) safe harbors would preclude a debtor from pursuing such claims.”

The Opinion

Facts and Procedural Background

In 2007, Basell AF SCA acquired Lyondell Chemical Company through an LBO financed entirely by debt secured by Lyondell’s assets. The LBO left Lyondell with nearly $21 billion in secured debt, where $12.5 billion of the loan proceeds were used to cash-out Lyondell stockholders (the “LBO consideration”).

Just over a year later, Lyondell sought Chapter 11 relief in the Southern District of New York. At the time of the filing, Lyondell’s unsecured creditors’ right to payment on their claims remained subject to the outstanding $21 billion secured loan. The court specifically noted that in connection with the LBO, the company’s assets had been depleted by the $12.5 billion payment of loan proceeds to stockholders — “who, under the most basic principles of U.S. insolvency law, are junior to creditors in right of payment.” Opinion at *1.

To bolster the recoveries possibly available for the unsecured creditors, Lyondell’s plan of reorganization created multiple litigation trusts, each of which was assigned the right to pursue certain types of claims.[2] The trust at issue in this litigation (the “creditor trust”) received the right to prosecute certain Lyondell creditors’ state law avoidance claims against the cashed-out stockholders. Pursuant to the plan, after the Lyondell estate abandoned its right under § 544[3] of the Bankruptcy Code, the creditors assigned their claims to the creditor trust.

The creditor trust then sued certain shareholders in state court for state law fraudulent conveyance avoidance claims arising out of the LBO. A group of defendants — primarily investment banking houses, brokerage firms and financial institutions — removed the state proceeding to the bankruptcy court and filed a motion to dismiss the state law claims, relying heavily on the protections afforded by § 546(e)’s securities-contract safe-harbor provisions.

The Holding

The court rejected the defendants’ two primary arguments that § 546(e) both (1) protects against and (2) preempts individual claimants’ state law fraudulent transfer claims. Making quick work of the defendants’ first argument that § 546(e) served as a valid defense to state law claims for all purposes, the court held that § 546(e) provided no defense to a state law fraudulent transfer action because “there is no statutory text making section 546(e) applicable to claims brought on behalf of individual creditors, or displacing their state law rights.” Id. at *6.

The defendants’ argument that the existence of § 546(e) (and the debtors’ rights to pursue such claims under § 544 of the Bankruptcy Code) preempted the creditor trust’s claims fared no better, but in reaching its preemption holding, the court offered important insights into the purposes of the Bankruptcy Code, § 546(e), and competing securities-contract safe-harbor precedents.

The defendants argued that § 546(e) preempted individual creditors’ state law avoidance actions because such state actions obstruct the “accomplishment and execution of the full purposes and objectives of Congress.” Id. at *10 (quoting Niagara Mohawk Power Corp. v. Hudson River-Black River Regulation Dist., 673 F.3d 84, 95 (2d Cir. 2012)). Section 546(e) reflected Congress’ intent to protect securities-contract transfers, defendants argued, so state laws that challenge the same transfers must yield to Congress’ purpose.

Relying heavily on In re Tribune Co. Fraudulent Conveyance Litigation, 499 B.R. 310 (S.D.N.Y. 2013), a recent Southern District of New York decision that also refused to use § 546(e) to limit individual creditors’ state law avoidance actions, the court refused to find that individual claimants’ state law avoidance actions obstructed the Bankruptcy Code’s purpose.

In support, the opinion suggested that as “quite obvious to those in the bankruptcy community,” bankruptcy addresses “many competing concerns,” and “[i]t is not at all clear that Section 546(e)’s purpose with respect to securities transactions trumps all of bankruptcy’s other purposes.” Id. at *11 (quoting In re Tribune, 499 B.R. at 317). The opinion also credited Tribune’s finding that Congress could have — if it desired — expressly preempted these state fraudulent transfer laws, as Congress did when it preempted state laws enabling individual claimants to recover certain charitable contributions.[4]

The court also rejected the defendants’ argument that the claims obstructed the purpose of § 564(e). To reach this conclusion, the opinion traced § 546(e)’s legislative history and determined that Congress enacted the section to guard the financial markets against a “ripple effect” caused by the insolvency of a single commodity or security firm. Section 546(e)’s purpose was not to protect “individual investors who are beneficial recipients of insolvents’ assets,” and the court refused to find that § 546(e) preempted an action against “cashed out beneficial holders of stock, at the end of the asset dissipation chain.” Id. at *19.

The opinion noted the contrary result reached by the court in Whyte v. Barclays Bank PLC,[5] a recent decision of the Southern District of New York that held § 546(g) of the Bankruptcy Code[6] impliedly preempted similar state law fraudulent transfer claims.

Relying heavily on In re Tribune, the opinion distinguished Whyte on several grounds. Id. at *19–23. First, in Whyte, the plan of reorganization created just one litigation trust to prosecute both estate and creditor causes of action, effectively allowing the trust to pursue causes of action on the estate’s behalf that § 546(g) barred the trustee from bringing on its own. The creditor trust in Lyondell, by contrast, holds “only creditor claims,” assigned to it by the creditors themselves after the estate abandoned its § 544 rights to the claims. Id. at *20.

Furthermore, the opinion criticized Whyte for declining to apply the courts’ “usual presumption against implied preemption,” and refusing to analyze thoroughly the Whyte defendants’ claim that voiding the challenged payments would create market disruption. Id. at *21–22. As a result, the opinion qualified Whyte and refused to dismiss the Lyondell individual claimants’ state law constructive fraudulent transfer claims.

While the court did not dismiss the creditor trust’s claims outright, the court did narrow the claims that could proceed and noted the possible availability of certain defenses that could limit or preclude the successful prosecution of the claims. First, the court dismissed certain state law intentional fraudulent conveyance claims (while allowing the creditor trust to replead those claims), on the basis that the complaint did not adequately plead an actual intent by the company to defraud its creditors. Id. at *29–34.

The court also dismissed the claims that had been assigned to the creditor trust by the secured lenders to the LBO, on the basis that such lenders had ratified the loans and therefore could not claim to have been defrauded by the transactions. Id. at *27–29. The court left for another day the issue of the effect the dismissal of these claims (which constituted a substantial portion of the total claims being pursued) would have in limiting the amount any one shareholder would have to disgorge if the dividends were ultimately avoided. Id. at *29 n.182.

Additionally, the court dismissed any claims asserted against entities that acted as conduits or nominees by passing on payments to others, because only beneficial owners can be held liable as fraudulent transfer recipients. Id. at *26–27. Finally, while the defendants sought dismissal of the claims on the basis that the entire LBO transaction should be collapsed and that once collapsed the claims fell away because Lyondell was a mere conduit for the payments, the court held that such defenses could not be proven on the face of the complaint and could be raised at a later date. Id. at *23–26.

The Opinion’s Importance

The opinion adds to the developing, and to date inconsistent, case law on the question of the extent to which the § 546 safe harbors preempt or otherwise preclude the prosecution of state law avoidance actions by creditors following the confirmation of a plan of reorganization.

By endorsing the Tribune ruling, the opinion may signal a shift (at least in the Southern District of New York) toward allowing such claims to be filed against shareholders in a failed LBO. It remains to be seen whether other courts will follow these decisions or whether these claims ultimately will be able to be successfully prosecuted to judgment.

—By Lisa M. Schweitzer and Philip A. Cantwell, Cleary Gottlieb Steen & Hamilton LLP

Lisa Schweitzer is a partner and Philip Cantwell is an associate in Cleary Gottlieb’s New York office.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Section 546(e) of the Bankruptcy Code provides that, “[n]otwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a … settlement payment … or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract.”  11 U.S.C. § 546(e).

[2] For example, one trust received the fiduciary-duty claims against Basell’s and Lyondell’s officers and directors, while another obtained all of the federal fraudulent transfer claims under § 548 of the Bankruptcy Code against shareholders that received LBO Consideration.

[3] Section 544 of the Bankruptcy Code provides that “the trustee may avoid … any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim.”  11 U.S.C. § 544(b)(1).

[4] See 11 U.S.C. § 544(b)(2) (“Any claim by any person to recover a transferred contribution [to charity] under Federal or State law in a Federal or State court shall be preempted by the commencement of the case.”).

[5] 494 B.R. 196 (S.D.N.Y. 2013).

[6] Section 546(g) states that “[n]otwithstanding sections 544, 545, 547, 548(a)(1)(B) and 548(b) of this title, the trustee may not avoid a transfer, made by or to (or for the benefit of) a swap participant or financial participant, under or in connection with any swap agreement and that is made before commencement of the case, except under section 548(a)(1)(A) of this title.”  11 U.S.C. § 546(g).

This article is from a Law360 update released on January 27, 2014.

 

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