Recently, in In re Tribune Co. Fraudulent Conveyance Litig., No. 13-3875-CV, 2016 WL 1226871, (2d Cir. Mar. 29, 2016), the U.S. Court of Appeals for the Second Circuit ruled that – on the basis of federal preemption over state laws – a safe harbor provision of the Bankruptcy Code shields defendant public pension funds and other former shareholders of the Tribune Media Company from constructive fraud claims brought by its unsecured creditors under various state laws. If efforts to overturn this decision fail, the appellate opinion should provide shareholders that receive proceeds in other leveraged buyouts with a significant precedent to undercut attempts by creditors to unwind settled transactions.
The action arose from Tribune’s 2007 leveraged buyout, in which the media corporation borrowed billions of dollars secured by its assets to refinance preexisting debt and transfer proceeds to shareholders. Following the buyout, Tribune filed for bankruptcy. An appointed committee of its unsecured creditors later filed a series of fraudulent conveyance actions, including “constructive” fraud claims under various state laws, to recover proceeds paid to shareholders. The creditors alleged, in part, that the transfer operated as a constructive fraud because it occurred at a time when Tribune was insolvent and Tribune (as a transferor) did not receive a fair value. In 2011, these actions were consolidated in a multi-district litigation in the Southern District of New York. And in 2012, the bankruptcy court confirmed a reorganization plan that transferred responsibility for other “intentional” fraud claims to a litigation trustee.
Granting a motion to dismiss later filed by Tribune’s shareholders, the district court presiding over the multi-district action held that an “automatic stay” provision of the Bankruptcy Code deprived creditors of standing as the litigation trustee was still litigating intentional fraud claims arising from the transfer. But the court rejected shareholders’ arguments that Section 546(e) of the Bankruptcy Code barred the creditors’ state law constructive fraud claims. Under that section, a bankruptcy trustee “may not avoid a transfer” to a financial intermediary “in connection with a securities contract.”
A Second Circuit panel affirmed dismissal but on federal preemption grounds – as a matter of Congressional intent – and not standing grounds. Noting federal regulation of creditors’ rights has existed for over two centuries and that once a party enter bankruptcy, the Bankruptcy Code constitutes a wholesale preemption of state laws regarding creditors’ rights, the panel reasoned that the history and purpose of Section 546(e) reflected a Congressional intent to preempt state law claims. Moreover, the panel noted that Congress intended that the section “provide certainty as to [the consummation of financial transactions], speed to allow parties to adjust the transaction to market conditions, finality with regard to investors’ stakes in firms, and thus stability to financial markets.” And the panel added that unwinding settled securities transactions through claims like those filed by the creditors would undermine markets in which “certainty, speed, finality, and stability are necessary to attract capital.”
This month, the Tribune’s creditors asked the entire Second Circuit to reconsider the panel’s decision through a petition for an en banc rehearing. But assuming that the petition is rejected and that the creditors do not successfully seek review by the U.S. Supreme Court, the opinion will avoid disruption in the market place that would be caused by unsettled transactions, provide shareholder transferees in leveraged buyouts with protection from suits based on constructive fraud claims and foster finality with respect to investors’ stakes in firms.
The Second Circuit’s decision does not impact the actual fraud claims being pursued by the litigation trustee. But, the trustee faces a considerable hurdle in proceeding with the actual fraud claims against investors who were not involved with the buyout (and simply received resulting proceeds), as the claims require a showing that such investors actually intended to defraud creditors.
Berman DeValerio serves as defense counsel in Tribune matters, representing: the California Public Employees’ Retirement System, the California State Teachers’ Retirement System, the University of California Board of Regents, and others.
*In August 2017, our firm name changed to Berman Tabacco. Case references and content published before that date may refer to the firm under our prior name, Berman DeValerio.