In re Tribune: SDNY Rejects Fraudulent Conveyance Claims Regarding Leveraged Buyout

Practical Law Legal Update w-005-4461 (Approx. 6 pages)

In re Tribune: SDNY Rejects Fraudulent Conveyance Claims Regarding Leveraged Buyout

by Practical Law Bankruptcy & Restructuring

Background

In 2007, the Tribune Company (Tribune, Debtors), a large US media and entertainment company that owned radio and television stations and major newspapers, commenced a two-step process to complete an LBO, which involved Tribune borrowing approximately $7 million to purchase about 50% of Tribune's outstanding shares in a tender offer, and then purchasing its remaining shares by borrowing an additional $3.7 billion in a go-private merger, with Tribune becoming wholly owned by the new private entity.

The Board formed a special committee of independent directors (Special Committee), which was advised by Morgan Stanley to consider the LBO. The Board engaged Duff & Phelps to provide a solvency opinion. Duff & Phelps declined to provide a solvency opinion, but instead issued a viability opinion, concluding that the fair market value of Tribune's assets would exceed its liabilities.

On April 1, 2007, Merrill Lynch and Morgan Stanley each issued a fairness opinion to the Board and the Special Committee. The Special Committee unanimously recommended to approve the LBO, and the Board voted and accepted it. Before steps one and two of the LBO were executed, the Board enlisted Valuation Research Company (VRC) to render a solvency opinion. VRC issued an opinion that Tribune would be solvent after the LBO. Soon after the LBO was completed, Tribune experienced financial difficulties and did not meet its projected growth rate, and could not service its new debt.

On December 8, 2008, Tribune and its affiliated entities filed voluntary Chapter 11 petitions in the US Bankruptcy Court for the District of Delaware. On December 19, 2011, the Judicial Panel on Multidistrict Litigation consolidated 74 federal and state cases in the SDNY (MDL). Under the confirmed plan of reorganization, the creditors' committee's claims were transferred to Marc Kirschner, Tribune's litigation trustee (Trustee). In connection with MDL, the Trustee filed a motion alleging that the shareholder transfers involved in the LBO constituted an actual fraudulent conveyance. The defendants, who included Dennis J. Fitzsimons, CEO and Chairman of the Board, moved to dismiss the complaint.

Outcome

The SDNY granted the defendants' motion to dismiss and rejected the Trustee's motion to avoid the shareholder transfers.

Under section 548(a)(1)(A) of the Bankruptcy Code, the trustee may avoid any transfer of the debtor's property, if the transfer was made:

Within two years of a bankruptcy filing.
With an actual intent to hinder, delay, or defraud the debtor's creditors.

The Special Committee Had the Requisite Level of Intent to Effectuate the Transaction

The SDNY analyzed whose intent should be imputed to Tribune, and determined that only the Special Committee had the decision-making authority necessary to impute the intent of Tribune, as a corporation. Relying on In re Elrod Holdings Corp., the SDNY determined that the intent of a corporation in a fraudulent conveyance claim is imputed to the corporate actors who effectuate the transaction (421 B.R. 700, 712 (Bankr. D. Del. 2010)). The SDNY examined the following defendant groups from whom fraud can be imputed to Tribune:

Shareholders.
Board of Directors.
Officers.

The SDNY determined that:

The Special Committee had the authority to effectuate the transaction because it was a seven-member majority of the Board, and it was convened to assess the desirability of the LBO.
The officers did not have the authority to effectuate the transaction because they were not in a position to control the disposition of the property (see In re Roco Corp., 701 F.2d 978, 984 (1st Cir. 1983)). Because the officers did not have voting or managerial power, they did not control the disposition. In its analysis, the SDNY rejected the Trustee's arguments and determined that the officers:
- did not have voting power because only Fitzsimons, as CEO and Chairman of the Board, owned 13% of Tribune's outstanding stock;
- did not have managerial power because there was no evidence of their putting inappropriate pressure on the Board or Special Committee, and there is no alleged familial or other professional ties between the officers and the Board or Special Committee;
- did not control the disposition by manipulating the information provided to the Special Committee by creating inflated projections on which the LBO was based. The SDNY rejected this because the Special Committee enlisted its own financial advisor, Morgan Stanley, to assess Tribune's solvency;
- did not direct the valuation research to use a non-standard definition of fair value in its solvency opinions, when Duff & Phelps declined to include the potential tax savings. The SDNY rejected this because the Special Committee made an independent determination that relied on Duff & Phelps' valuation that Tribune's assets would exceed its liabilities; and
- did not misrepresent the valuation research that Morgan Stanley provided. The SDNY rejected this because Morgan Stanley separately assessed Tribune's solvency.
Though the shareholders did have the authority to effectuate the transaction because they consummated the LBO by either accepting the tender offer in step one, or voting in favor of the merger in step two, the Trustee failed to allege that any public shareholders had actual intent to support the claim. In fact, the Trustee acknowledged that the public shareholders' intent was irrelevant.

Therefore, only the Special Committee's conduct could be imputed to Tribune.

Special Committee's Intent Was Not Shown to Hinder, Delay, or Defraud Creditors

The SDNY held that the Special Committee did not exhibit the requisite intent necessary to establish a fraudulent conveyance under the badges of fraud (circumstantial facts giving rise to the inference of intent) and securities law (facts demonstrating motive and opportunity to defraud creditors or circumstantial evidence of conscious misbehavior or recklessness) tests. Courts in the Second Circuit typically use these tests to find fraudulent intent.

Badges of Fraud Test

The badges of fraud that give rise to actual intent to hinder, delay, or defraud creditors and were alleged by the Trustee are:

Lack of adequacy of consideration.
Family, friendship, or close relationship between the parties.
Retention of possession, benefit, or use of property or assets.
Financial condition of Tribune.
Course of conduct and chronology of events after the debt was incurred.
Concealment of facts and false pretenses.

(In re Kaiser, 722 F.2d 1574, 1582-83 (2nd Cir. 1983).)

The SDNY analyzed the Trustee's arguments and determined that:

The transactions were not between family, friends, or close associates that courts typically see in fraudulent conveyance cases. There was no close relationship among the parties to the LBO, and it was an arm's-length transaction among business people.
The transfer of property was not retained by the Special Committee or Tribune because the LBO involved Tribune transferring its shares in exchange for cash.
The Trustee merely restated the elements of the badges for inadequacy of consideration and financial condition. The SDNY noted that just because it was a bad deal did not mean there was fraud.
In regard to the course of conduct after the incurring of debt and general chronology of events and transaction under inquiry, the Trustee's allegation that the transfers were not made in the ordinary course of business was rejected because the LBO was the product of months of negotiations and received widespread publicity, which was contrary to a hasty, secretive transaction, not in the ordinary course of business that may support a strong inference of fraudulent intent.
The Trustee's allegation that the officers engaged in deceptive conduct, such as concealing financial projections from other officers, failed to be imputed to Tribune, the corporation, or the Special Committee, those directors who had been ruled by the SDNY earlier in its decision to have the authority to effectuate the transaction.

The district court concluded that the Trustee failed to establish the badges of fraud sufficient to show a strong inference of fraudulent intent by the Special Committee.

No Inference of Fraudulent Intent with Regard to the Securities Law Test

The Trustee also did not satisfy the requirements under the securities law test to establish a strong inference of fraudulent intent by the Special Committee. The Trustee did not show either motive and opportunity to commit fraud or strong circumstantial evidence of conscious misbehavior or recklessness by the Special Committee.

The SDNY rejected the Trustee's arguments and found that:

While the Special Committee's directors who voted to approve the LBO did receive a distribution under the LBO, this did not meet the scienter requirements of motive and opportunity (Kalnit v. Eichler, 264 F.3d 131, 139 (2nd Cir. 2001)).
The Special Committee did not act recklessly in approving the LBO despite Tribune's declining financial performance, the declining newspaper industry, negative public reaction to the LBO, and accepting management's aggressive financial projections. On the contrary, the Special Committee acted diligently in its efforts to assure itself of Tribune's solvency after the LBO transactions.

Practical Implications

This decision reiterates that to enforce its avoidance powers under section 548(a)(1)(A), a trustee must show actual fraudulent intent to hinder, delay, or defraud by a party whose conduct can be imputed to the company. Intent may be established by showing badges of fraud or under the securities law test.

In re Tribune: SDNY Rejects Fraudulent Conveyance Claims Regarding Leveraged Buyout | Practical Law