In re Tribune Co: Individual Creditors Lack Standing to Assert State-Law Fraudulent Transfer Claims, but Not Barred by Section 546(e) Safe Harbor

Practical Law Legal Update 7-543-8525 (Approx. 7 pages)

In re Tribune Co: Individual Creditors Lack Standing to Assert State-Law Fraudulent Transfer Claims, but Not Barred by Section 546(e) Safe Harbor

by Practical Law Finance and Practical Law Bankruptcy & Restructuring

Background

In 2007, Tribune Company (Debtor), the media corporation that publishes the Chicago Tribune, approved a leveraged buyout (LBO) that paid out more than $8.2 billion to its public shareholders, among others, in exchange for their Tribune shares. In 2008, the Debtor filed for Chapter 11 bankruptcy protection in the US Bankruptcy Court for the District of Delaware.

The Bankruptcy Court created the Official Committee of Unsecured Creditors (Committee) to stand in the shoes of the bankruptcy trustee and to file adversary proceedings for the benefit of the Debtor's creditors. The Committee filed claims against Tribune shareholders and other parties who received payments in connection with the LBO (Defendants), asserting that these transfers constituted intentional fraudulent conveyances. However, the Committee did not assert constructive fraudulent conveyance claims.

In March 2011, hundreds of the Debtor's individual creditors (Creditors) requested permission from the Bankruptcy Court to file state-law constructive fraudulent conveyance (SLCFC) claims outside of bankruptcy. The Bankruptcy Court conditionally lifted the automatic stay because the Committee had not asserted the SLCFC claims within the applicable two-year period required under section 546(a)(1)(A) of the Bankruptcy Code for trustees to bring such actions. However, the Bankruptcy Court explicitly stated it had not ruled whether the Creditors had standing to bring the SLCFC claims or whether the claims were preempted by section 546(e) of the Bankruptcy Code. The Creditors then filed SLCFC actions in more than 20 state and federal courts to unwind the LBO and avoid the LBO payments made to Tribune shareholders.

After the Judicial Panel on Multidistrict Litigation consolidated the Creditors' actions and the Committee's actions in the US District Court for the Southern District of New York, the Defendants filed a motion to dismiss the Creditors' SLCFC actions. The Defendants made the following arguments as to why the SLCFC actions were barred by section 546(e):

The section 546(e) safe harbor applies to the Creditors, as well as to the Committee.
Even if section 546(e) does not expressly bar the SLCFC claims, Congress impliedly preempted these claims with its enactment of section 546(e) because recognizing the SLCFC claims would frustrate the statute's purpose. The Shareholders urged the District Court to consider Congress' policy goals in enacting section 546(e), which included protecting the nation's financial markets from the instability caused by reversing settled securities transactions. The Shareholders also noted that the District Court recently accepted this reasoning in a similar case applying the section 546(g) safe harbor (see Legal Update, Whyte v. Barclays Bank: Court Rejects Attempt to Circumvent Section 546(g) Safe Harbor for Swap Transactions).

The Defendants also argued that the Creditors lacked standing to bring the SLCFC for the following reasons:

Once the Debtor's bankruptcy proceedings began, the automatic stay operated to give the Committee complete dominion and control over any creditor's state law claims and the Creditors permanently lost the right to assert SLCFC claims on their own behalf.
According to section 349(b)(3) of the Bankruptcy Code, the Bankruptcy Court must dismiss the Debtor's bankruptcy before the SLCFC claims can revert to the Creditors. Section 349 states that a court's dismissal of a bankruptcy case returns estate property to the entity that owned the property immediately before the commencement of the case.
While the Committee's intentional fraudulent conveyance action is still pending, the automatic stay deprives the Creditors of standing to pursue the SLCFC claims against the same transactions.

Outcome

The District Court granted the Defendants' motion to dismiss. Although the District Court held that section 546(e) did not preempt the Creditors' SLCFC claims, it concluded that the automatic stay deprived the Creditors of standing to avoid the same transactions that the Committee was simultaneously suing to avoid.

First, the District Court examined the plain language of section 546(e) and found that by its terms, it only prohibits a trustee from asserting a constructive fraudulent conveyance claim to unwind LBO payouts. The District Court stated that Congress spoke clearly about section 546(e)'s sole application to trustees. Therefore, the Defendants could not use section 546(e) to bar the Creditors' SLCFC claims.

The District Court also concluded that Congress did not impliedly preempt SLCFC claims because:

Despite a petition from the CFTC, Congress declined to expressly preempt SLCFC claims when it enacted section 546(e).
Congress did not add an express preemption provision on each of the eight occasions it amended section 546(e), even after the Bankruptcy Court held in PHP Liquidating, LLC v. Robbins that section 546(e) permits creditors to assert SLCFC claims under certain circumstances.
Congress did not extend section 546(e) to prepetition SLCFC claims or to postpetition intentional fraudulent conveyance claims, despite the fact that these claims also pose the same threat to the stability of securities markets.
Congress has demonstrated elsewhere in the Bankruptcy Code that it is able and willing to preempt an individual creditor's state law claims, so had it intended to preempt SLCFC claims, it would have done so explicitly.

Second, the District Court rejected the Defendants' first two arguments related to the Creditors' standing, explaining that:

The automatic stay does not permanently divest creditors' of their SLCFC claims, but only applies while the trustee has a viable cause of action, which it has two years from the date of the bankruptcy to commence under section 546(a)(1)(A) of the Bankruptcy Code. If the trustee has not exercised its avoidance powers within that time, creditors regain standing to pursue their SLCFC claims.
Because a fraudulent conveyance claim is not estate property, it is not subject to section 349 of the Bankruptcy Code. Therefore, the Bankruptcy Court did not need to discharge the debtor from bankruptcy for the avoidance claims to revert. Instead, the SLCFC claims automatically reverted to the Creditors once the two-year limitation period on the trustee's right to bring avoidance claims expired.

However, the District Court accepted the Defendants' last argument that the Committee's intentional fraudulent conveyance action deprived the Creditors of standing to simultaneously pursue their SLCFC claims. The District Court explained that Congress did not intend the automatic stay under section 362(a)(1) to apply differently based on the theory or Bankruptcy Code provision under which the trustee brings a fraudulent conveyance claim. The bankruptcy process is intended to promote a comprehensive and orderly resolution of the debtor's affairs by consolidating claims in one entity. Therefore, unless and until the Committee actually and completely abandons its claims, the automatic stay deprives the Creditors of standing to bring SLCFC claims against the same transactions being targeted by the Committee.

Practical Implications

The District Court's decision appears inconsistent with its recent decision in Whyte v. Barclays Bank PLC, in which it 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 claims that creditors or their representatives may pursue after bankruptcy. However, the District Court distinguished Whyte on the basis that the plaintiff in Whyte served in the capacity of both the bankruptcy trustee and the representative of outside creditors, whereas in this case, the plaintiffs were individual creditors. Even so, this aspect of the Tribune decision may be considered mere dicta, as the Creditors were ultimately denied standing. Tribune also stands in contrast to most recent decisions regarding the section 546(e) safe harbor, which have generally interpreted it expansively.

Tribune highlights a loophole in the effectiveness of the Bankruptcy Code's safe harbors from avoidance actions for financial transactions. It may encourage individual creditors to bring numerous SLCFC claims in many forums instead of consolidating these actions in one forum through a committee or litigation trustee. It may also cause debtors and committees to consider abandoning fraudulent conveyance claims that would otherwise be protected by the section 546(e) safe harbor, so that individual creditors would not be precluded from bringing these actions themselves. Therefore, potential defendants in avoidance actions should carefully limit their exposure to SLCFC actions by individual creditors when negotiating releases and assignments of claims to litigation trusts.

For more information on the section 546(e) safe harbor, see Practice Note, Bankruptcy Code Avoidance Action Safe Harbors: Section 546(e) Safe Harbor: Stockholder's Defense and on the Bankruptcy Code's safe harbors generally, see Guide to Bankruptcy Code Safe Harbors for Financial Contracts: Checklist.

In re Tribune Co: Individual Creditors Lack Standing to Assert State-Law Fraudulent Transfer Claims, but Not Barred by Section 546(e) Safe Harbor | Practical Law