An opinion issued in connection with the bankruptcy cases of Lyondell Chemical Company and its affiliates may have significant implications for shareholders who receive payments in connection with a leveraged buyout when the underlying company subsequently files for bankruptcy.
Earlier this month, Judge Robert Gerber of the United States Bankruptcy Court for the Southern District of New York narrowly interpreted the safe harbor of section 546(e) of the Bankruptcy Code to neither bar nor preempt state law constructive fraudulent conveyance claims asserted by or on behalf of individual creditors against shareholders receiving payments in connection with an LBO, even though that safe harbor protects those shareholders from analogous causes of action asserted under federal bankruptcy law.
The LBO and bankruptcy cases
In December 2007, Basell AF S.C.A. acquired Lyondell by means of a leveraged buyout with a newly formed company, LyondellBasell Industries AF S.C.A. (LBI), emerging as Lyondell’s parent. To finance the LBO, Lyondell took on US$21 billion in secured indebtedness, while its shareholders received distributions totaling US$12.5 billion in connection with the transaction. Just over a year later, in January 2009, Lyondell and 78 of its affiliates filed for protection under chapter 11 of the Bankruptcy Code. LBI and various other Lyondell affiliates became additional debtors shortly thereafter.
In April 2010, the bankruptcy court confirmed Lyondell’s chapter 11 plan of reorganization which, among other things, created a creditor trust to litigate state law avoidance actions against the former shareholders of Lyondell that received payments in connection with the LBO. This creditor trust was separate from the trust created under Lyondell’s plan that would initiate or continue litigation at one time belonging to the bankruptcy estate.
The mechanics of Lyondell’s plan were such that (i) various causes of action against former Lyondell shareholders were abandoned by the debtors and their estates to the creditor trust and (ii) various creditors contributed to the creditor trust any causes of action they had against former Lyondell shareholders arising under state law, including state law fraudulent conveyance claims.
Thereafter, the creditor trust filed a lawsuit against certain former Lyondell shareholders, seeking to recover about US$6.3 billion of the distributions made to them in connection with the LBO. Thus, as structured, the creditor trust was not asserting any claims that arose in any way under the Bankruptcy Code.
In January 2011, the shareholders filed a motion to dismiss, alleging several defenses, including that state law constructive fraudulent conveyance actions are preempted by section 546(e) of the Bankruptcy Code and barred by that section’s safe harbor.
The underlying bankruptcy principles
Section 546(e) provides a “safe harbor” from the avoidance of certain transfers, where such transfer is made by or to (or for the benefit of) a financial institution and is a “settlement payment” or made in connection with a “securities contract.” That section of the Bankruptcy Code, however, is silent with respect to its applicability as a defense to state law constructive fraudulent transfer claims brought by individual creditors.
The Bankruptcy Court’s findings with respect to Section 546(e)
The motion to dismiss made two main arguments with respect to section 546(e):
(1) that it bars the creditor trust from proceeding with its lawsuit and
(2) that it preempts the state law constructive fraudulent conveyance claims asserted by the creditor trust.
First, the defendants argued that because section 546(e) bars federal avoidance claims brought under other sections of the Bankruptcy Code, it also acts as a bar to claims brought by or on behalf of creditors under state law. The court dismissed this argument summarily, relying on Congressional history and language in the statute preventing only the “trustee” (i.e., the debtor or its estate representative) from avoiding such transfer. The court found that section 546(e) does not act as a safe harbor against state law claims brought by or on behalf individual creditors even though those claims were contributed to the creditor trust by those creditors under the Lyondell plan. Notably, however, the court dismissed the secured lender deficiency claims assigned to the creditor trust, since the LBO lenders had ratified the LBO transaction and therefore could not benefit from litigation arising from it.
Second, the defendants argued that state law constructive fraudulent transfer statutes are preempted by section 546(e). As an initial matter, despite not having been raised by the defendants, the court found “express preemption” to be inapplicable because the plain language of section 546(e) does not prevent the enforcement of state constructive fraudulent conveyance laws. Moreover, the court found “field preemption” to be inapplicable, stating that “Congress has not evidenced any intention to wholly occupy the fields of avoidance or recovery of fraudulent transfers” or to preclude enforcement of state laws on the same subject.
Finally, the court found “conflict preemption” to be inapplicable, holding that state fraudulent transfer laws neither conflict with federal fraudulent transfer laws nor stand as an obstacle to the accomplishment and execution of Congressional intent in enacting section 546(e) and more generally, bankruptcy policy. In that regard, the court stated that “[i]n the LBO context, state fraudulent transfer laws do no more than attach consequences to past conduct, and grant rights of action to those – unpaid creditors – who have been injured thereby.” Indeed, the court stated that although the Congressional purpose of the section 546(e) safe harbor was to avoid potential injury to commodities and securities markets, it was not to “protect individual investors who are beneficial recipients of insolvents’ assets.” Consequently, the court rejected the defendants’ motion to dismiss with respect to their section 546(e) arguments.
Implications: shareholder vulnerability to lawsuits?
The court’s decision does not limit section 546(e)’s applicability to avoidance actions brought by a debtor or a representative of the debtor’s estate, but it leaves shareholders who received distributions in connection with an LBO vulnerable to suits where the claims are based solely on state law and are brought by or on behalf of individual creditors or a trust to which those individual creditors contribute their claims.
A similar issue regarding the applicability of section 546(e) to state law claims is scheduled to be heard in March by the Second Circuit Court of Appeals in an appeal arising out of another bankruptcy case, and it is foreseeable that the decision in Lyondell will be appealed as this area of the law regarding creditor remedies in failed LBOs continues to develop.