On June 11, 2013, the US District Court for the Southern District of New York, in Whyte v. Barclays Bank PLC, held that the safe harbor found in section 546(g) of the Bankruptcy Code protecting swap transactions from federal avoidance actions by bankruptcy trustees also preempts state law avoidance claims that creditors or their representatives may pursue after bankruptcy.

On June 15, 2008, SemGroup (Debtor), an energy transport and storage company, sold its portfolio of commodity derivatives (Portfolio) to Barclays Bank PLC (Barclays) for $143 million. On July 22, 2008, the Debtor filed a Chapter 11 bankruptcy petition. On October 28, 2009, the US Bankruptcy Court for the District of Delaware confirmed the Debtor's plan of reorganization. The plan created a litigation trust (Litigation Trust), to which certain creditors and the debtor assigned "any and all claims," including both avoidance actions arising under Chapter 5 of the Bankruptcy Code and state law causes of action.

After confirmation of the plan, the trustee of the Litigation Trust filed a complaint in the US District Court for the Southern District of New York seeking to avoid the sale of the Portfolio to Barclays as a fraudulent transfer under New York state law. The trustee did not seek to avoid the sale under the Bankruptcy Code's fraudulent transfer provisions both because:

The Court began by examining the Bankruptcy Code. Section 544 of the Bankruptcy Code incorporates state fraudulent transfer laws by allowing a trustee to avoid any transfer avoidable under applicable state law, which typically has longer look-back periods. The Court noted that, despite the expiration of the two year SoL to avoid a fraudulent transfer under the Bankruptcy Code, the trustee may have been able to extend the SoL under section 544 to the applicable state law SoL (in this case, six years). However, any recovery under section 544 of the Bankruptcy Code is precluded by section 546(g), which prohibits a bankruptcy trustee from avoiding "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 and that is made before the commencement of the case." The parties agreed that the sale of the Portfolio qualified as a swap transaction protected by this safe harbor.

The trustee argued that section 546(g) applies only to a bankruptcy trustee who is exercising federal avoidance powers under the Bankruptcy Code, and should not apply to claims asserted by creditors after a bankruptcy concludes absent a release of those claims. Therefore, because the trustee was acting on behalf of creditors as trustee of the Litigation Trust, and not as trustee of a bankruptcy estate, section 546(g) was inapplicable and could not bar the state law action.

The Court was not persuaded. Recognizing that allowing a party to pursue state law swap-related avoidance actions after a bankruptcy had concluded would effectively nullify section 546(g), the Court held that these state law avoidance claims were impliedly preempted by the section 546(g) safe harbor. The Court outlined the two types of implicit federal preemption:

The Court found that the second test for conflict preemption was satisfied because allowing a litigation trustee to avoid a swap transaction under state fraudulent transfer law would be an obstacle to the purpose and objectives of Congress in enacting the section 546(g) safe harbor. The purpose of section 546(g) is to provide certainty to counterparties of settled swap transactions and minimize volatility in the commodities and securities markets in the event of a major bankruptcy affecting those industries. The Court noted that Congress' intent was demonstrated by, among other things, the Bankruptcy Code's extremely broad definition of "swap transactions" to protect all swap counterparties from avoidance actions.

The Court found that the purpose and intended effects of section 546(g) would be undermined if the state law avoidance actions were allowed to proceed. If a bankruptcy trustee that was prohibited from avoiding swap transactions under section 546(g) could simply wait and successfully bring these avoidance actions on behalf of creditors under state law, section 546(g) would fail to provide any stability to swap markets. Moreover, the Court found that:

Here, the Portfolio constituted 20% of the nation's crude oil inventory. Unwinding the transfer of the Portfolio would certainly create destabilizing market volatility, would function to circumvent section 546(g) of the Bankruptcy Code and would change the circumstances under which the Bankruptcy Court approved the plan of reorganization. As all of these consequences would be obstacles to achieving Congress' intent in enacting section 546(g), the Court held that the section 546(g) safe harbor impliedly preempts state law fraudulent transfer actions seeking to avoid swap transactions where these actions are brought by a litigation trust organized pursuant to a Chapter 11 plan.

This decision is the first to reject an attempt to circumvent a section 546(g) safe harbor under principles of federal preemption. Courts have rejected similar attempts to circumvent the safe harbor of section 546(e), which protects margin payments and settlement payments made by or to (or for the benefit of) certain financial market participants.

The holding in this case is consistent with the trend of the broad judicial interpretation of the Bankruptcy Code's safe harbors, reflecting Congress' intent to promote stability in the financial markets. For example, in a decision issued just one day earlier, the US Court of Appeals for the Second Circuit affirmed a broad interpretation of the "securities contract" safe harbor found in section 546(e) of the Bankruptcy Code (see Legal Update, In re Quebecor World (USA) Inc.: Second Circuit Broadly Applies Section 546(e) "Securities Contract" Safe Harbor).

For more information on fraudulent transfers, see Practice Notes, Fraudulent Conveyances in Bankruptcy: Overview and Fraudulent Conveyances: Issues and Strategies for Lenders and Private Equity Sponsors.