Making the Safe Harbors Safe Again - United States Court of Appeals for the Second Circuit Holds That State Law Constructive Fraudulent Conveyance Claims Brought by Creditors are Preempted by the Safe Harbor of Section 546(e) of the Bankruptcy Code

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The Bankruptcy Code contains “safe harbors” that, among other things, exempt transfers made in connection with certain financial contracts, including securities contracts, from avoidance by the bankruptcy trustee as preferential or constructively fraudulent. In an attempt to avoid the effect of the safe harbors and allow them to challenge transfers made pursuant to securities contracts in connection with leveraged buyout (“LBO”) transactions, creditors have resorted to plan structures that authorize them (or a creditor trust) – to pursue their state fraudulent transfer claims directly (as opposed to via the bankruptcy trustee). Lower courts have reached different conclusions as to the propriety of these structures, creating a considerable loop hole in the safe harbor protections.

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