SDNY Holds Trustee Cannot Evade Section 546(g) Safe Harbor by Bringing Avoidance Action Under State Law

by Orrick, Herrington & Sutcliffe LLP

On June 11, 2013, Southern District of New York Judge Jed Rakoff dismissed the complaint of the Trustee for the SemGroup estate seeking to avoid a novation made to Barclays pre-bankruptcy under a swap agreement.  The Court held that the pre-bankruptcy transaction constituted a safe harbored transfer made in connection with a swap agreement and thus could not be avoided by the estate.  The Court held further that the safe harbor applied to actions brought under state law fraudulent transfer theories, not just those brought under federal law.  Judge Rakoff stated that to permit the trustee to proceed under state law would allow estates to evade the safe harbor by delaying litigation until post-bankruptcy.  Whyte v. Barclays Bank PLC, 12 Civ. 5318 (JSR), 2013 U.S. Dist. Lexis 82040 (S.D.N.Y. June 11, 2013).  


As part of the plan confirmed in the SemGroup bankruptcy in Delaware, the Court created the SemGroup Liquidating Trust, and charged the Trust with liquidation of the debtors' assets, including certain avoidance actions under chapter 5 of the Bankruptcy Code.  In this matter, the Trustee sought to avoid a pre-filing novation of SemGroup's NYMEX portfolio to Barclays under a swap agreement.  The Trustee argued the novation constitiuted a constructive fraudulent conveyance under New York state's fraudulent conveyance laws.  

Applicable Law  

Section 544 of the Bankruptcy Code incorporates state fraudulent transfer laws into the Bankruptcy Code.  Section 546(g) of the Bankruptcy Code states that a 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 that is made before the commencement of the case."  


The Trustee asserted that "despite the legal fiction of section 544, avoidance claims remain property of creditors during bankruptcy."  The Trustee argued that because section 546(g) applies only to "an estate representative who is exercising federal avoidance powers under [section 544 of] the Bankruptcy Code" section 546(g) does not apply to "claims asserted by creditors" under state law after conclusion of the bankruptcy.  Therefore, because the Trustee "need not assert these claims as the trustee of" the estate, but rather as a creditor, the Trustee argued that section 546(g) does not apply.

Judge Rakoff stated:  

The trouble with this clever argument is that it would, in effect, render section 546(g) a nullity.  But such an absurd result is here avoided, because under well-established principles of federal preemption, section 546(g) impliedly preempts the Trustee's attempt to resuscitate fraudulent avoidance claims as the assignee of certain creditors, where, as here, she would be expressly prohibited by section 546(g) from asserting those claims as assignee of the [debtor].

The Court stated that permitting avoidance of a swap under state law would stand contrary to the purposes of Congress in adopting the section 546(g) safe harbor.  As noted by Judge Rakoff:  "The obvious purpose of section 546(g), fully confirmed by the legislative history, is to protect securities markets from the disruptive effects that unwinding such transactions would inevitably create."  Congress adopted section 546(g) in 1990 "to ensure that the swap and forward contract markets are not destabilized by uncertainties regarding the treatment of their financial instruments under the Bankruptcy Code and to minimize volatility in swap markets."

In 2005, Congress amended section 546(g) "to make even more complete the protection of participants in swap transactions and swap agreements by introducing an 'extremely broad' definition of swap agreements."  The Court concluded: "The patent purpose and intended effects of section 546(g) would be totally undercut if, at the same time that a trustee in bankruptcy was prohibited from avoiding swap transactions, a Chapter 11 'litigation trustee' could hold swap-related avoidance actions in abeyance for eventual litigation as the mere assignee of creditors' claims."  

The Court feared that "section 546(g) could be thwarted in any bankruptcy by the simple devise of conveying fraudulent conveyance claims into a litigation trust for later use, repackaged as creditors' state law fraudulent conveyance claims."  The Court noted that the 8th Circuit and the District Court of Delaware had reached similar conclusions with respect to the section 546(e) safe harbors.


This case is one of a number in recent years that treats the safe harbors, and particularly the section 546 safe harbors, as broadly protective of non-debtor transferees in financial transactions.  The Court emphasizes Congress' intent that section 546(g) apply to ensure certainty in the financial markets.  This is similar to the multiple recent cases in which courts gave non-debtors wide berth under section 546(e)'s similar safe harbor.  Those cases include the Second Circuit's ruling issued just a day prior to this one, in Quebecor World (USA) Inc., No. 12-4270-bk, 2013 U.S. App. Lexis 11615 (2d Circ. June 10, 2013).  Other courts have reached similar rulings under section 546(e) in recent years as the Courts have, with a handful of exceptions, taken generally non-debtor friendly views of the bankruptcy safe harbors for financial transactions.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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