By Charles C. Platt
The Second Circuit’s recent decision in In re Tribune Company Fraudulent Conveyance Litigation confirms that Section 546(e) of the Bankruptcy Code preempts state law fraudulent conveyance actions aimed at securities settlement payments made by a debtor in bankruptcy even if they are brought by creditors, rather than by the bankruptcy trustee or other representative of the bankruptcy estate.
The case arose from Tribune Company’s 2007 leveraged buyout – a securities transaction in which Tribune took on substantial debt to pay out more than $8 million to its then-shareholders. When Tribune declared bankruptcy in 2008, Section 544 of the Bankruptcy Code gave its bankruptcy estate the right to bring any state-law fraudulent transfer claim – whether for actual or constructive fraudulent transfer – that a Tribune creditor could have brought before the company went into bankruptcy. Similarly, Section 548 of the Code gave the bankruptcy estate the right to sue under federal law to set aside actual or constructive fraudulent transfers made to the shareholders.
But there was one major problem: Another section of the Code, Section 546(e), provides that a bankruptcy trustee may not avoid a “settlement payment” – in essence, a payment made to settle a securities transaction – under Section 544 or as a constructive fraudulent transfer under Section 548. The payments to the Tribune shareholders for their stock were unquestionably settlement payments. As such, the bankruptcy trustee or other representative of the bankruptcy estate could only sue to avoid them as intentional fraudulent transfers under Section 548. Proving an intentional fraudulent transfer is often more difficult than proving a constructive fraudulent transfer. The former requires proof that the debtor (here, Tribune) made the payments with actual intent to hinder, delay or defraud its creditors, while the latter requires proof simply that the debtor was insolvent at the time (or rendered insolvent by the payments) and did not receive “reasonably equivalent value” for the payments.
To avoid Section 546(e)’s “safe harbor” for securities settlement payments, Tribune’s bankruptcy estate brought only an intentional fraudulent transfer claim under Section 548 against the former Tribune shareholders. It disclaimed the right to bring state-law constructive fraudulent transfer claims, and consented to an order entered by the bankruptcy court lifting the “automatic stay” in bankruptcy to allow creditors to bring such claims as if Tribune had not filed for bankruptcy. Many such creditors (the “Creditors”) then filed suit against the former shareholders, asserting state law claims for constructive fraudulent conveyance.
The shareholders moved to dismiss, arguing both that the creditors lacked standing to seek to avoid the same payments under state constructive-fraudulent transfer law that the bankruptcy estate was seeking to avoid under federal intentional-fraudulent transfer law and that, in any event, Section 546(e) preempted or otherwise barred the state law claims.
The district court agreed that the creditors lacked standing, but rejected the defense that Section 546(e) of the Code preempted the Creditors’ state law avoidance actions.
The Circuit’s Decision
The Second Circuit affirmed, but reached the opposite conclusions. It found that the Creditors had statutory standing. But it determined that the Creditors’ state-law constructive fraudulent conveyance actions were impliedly preempted because they conflicted with the purposes of Section 546(e) of the Code: to ensure certainty, speed, finality, and stability in securities transactions, all of which were necessary for the securities markets to attract, retain, and reduce the cost of capital.
The Creditors argued that, as matter of plain language, section 546(e) referred only to avoidance actions brought by a bankruptcy “trustee,” and thus did not bar state-law constructive fraudulent conveyance actions brought by Tribune creditors, rather than by a bankruptcy trustee or other representative of Tribune’s bankruptcy estate. The Second Circuit acknowledged that the language of the statute was ambiguous on the meaning of who was barred from pursuing avoidance actions under 546(e). Nevertheless, the Court concluded that the Creditors’ actions were impliedly preempted because the congressional purpose underlying this statute was in conflict with those claims. In particular, the Creditors’ actions, if successful, would unwind the securities transactions in the Tribune LBO, and seriously undermine the certainty, stability and finality of securities transactions that Section 546(e) was designed to achieve.
In short, even though Section 546(e) arguably did not on its face bar state-law constructive fraudulent conveyance avoidance actions by the Creditors, its significant statutory purpose of protecting the security markets was broad enough to impose such a bar, regardless of the injuries that the Creditors had standing to redress.