District Judge Jed Rakoff has delivered the latest blow to the efforts of creditors to avoid the safe harbor that prohibits a bankruptcy trustee from unwinding “securities settlements” and similar transfers. Whyte v. Barclays Bank et al, No. 12 Civ. 5318 (S.D.N.Y. June 11, 2013).
Since their enactment, the broad safe harbors in section 546 of the Bankruptcy Code, for “securities settlements” (section 546(e), enacted in 1982), “swap transfers” (section 546(g) added by amendment in 1990), and certain other transfers, have protected from avoidance an extensive class of otherwise avoidable transfers, including, most notably, transfers of securities for cash that would otherwise be constructive fraudulent transfers.
Numerous plaintiffs have challenged these safe harbors in various contexts, arguing that they do not apply to leveraged buy-outs, see Lowenschuss v. Resorts Int’l, Inc., 181 F.3d 505 (3d Cir. 1999), private transactions, see Official Comm. of Unsecured Creditors of Quebecor World (USA) Inc. v. Am. United Life Ins. Co., 480 B.R. 468 (S.D.N.Y. 2012), aff’d, No. 12-4270-bk (2d Cir. June 10, 2013), preferential transfers that retire debt, see Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011), and parallel causes of action such as breach of fiduciary duty, see In re Hechinger Inv. Co. of Del., Inc., 274 B.R. 71 (D. Del. 2002). All have failed.
Most recently, creditor groups have sought to pursue avoidance claims outside of bankruptcy, typically under a structure in which a chapter 11 plan “disclaims” or assigns the causes of action to creditors or a litigation trust, which then pursue them free and clear — or so the plaintiffs argue — of a section 546 bar. Because section 546 applies by its term to a bankruptcy trustee asserting bankruptcy claims, and the claims in these arrangements are at least nominally pursued by creditors (or creditor groups) asserting state-law fraudulent transfer claims outside of the bankruptcy process, plaintiffs contend that the safe harbors do not apply.
This theory has been advanced most notably in the Lyondell and Tribune cases, where motions to dismiss are pending under section 546(e). On June 11, 2013, Judge Rakoff dealt the theory a serious blow, ruling that, as defendants have argued in other cases, the doctrine of implied federal preemption bars just such a work-around of section 546(g)’s safe harbor.
In Whyte, the Court granted a motion to dismiss a constructive fraudulent transfer action brought by a litigation trustee appointed under the Chapter 11 plan of SemGroup. The suit challenged certain swap transfers. The Court held that the litigation trustee’s action was barred by section 546(g) of the Bankruptcy Code, even though the litigation trustee purported to be asserting state-law claims, concluding that the state-law claims were impliedly preempted by section 546(g) of the Bankruptcy Code because they stood as “an obstacle to the accomplishment and execution of the full purposes and objectives of Congress” in enacting section 546(g).
SemGroup was a large energy transport storage company. On June 15, 2008, Barclays Bank PLC and Barclays Capital, Inc. entered into a novation agreement with SemGroup, by which, in return for approximately $143 million, Barclays acquired SemGroup’s portfolio of commodities derivatives. Following the novation, the commodities portfolio became profitable.
On July 22, 2008, SemGroup filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. The Bankruptcy Court confirmed SemGroup’s Chapter 11 plan of reorganization a little over a year later, on October 28, 2009.
SemGroup’s plan established a litigation trust empowered to liquidate certain of SemGroup’s assets and to prosecute claims relating to the SemGroup bankruptcy, for the benefit of certain of SemGroup’s creditors. This included avoidance actions arising under the Bankruptcy Code and state-law causes of action of certain SemGroup creditors who transferred their claims to the litigation trust.
Following confirmation of the plan, SemGroup’s litigation trustee filed a complaint against Barclays, seeking to avoid the novation of SemGroup’s commodities portfolio on the ground that the transaction was a fraudulent conveyance. The litigation trustee brought these claims not under the Bankruptcy Code, but under New York law.
Judge Rakoff noted that the litigation trustee could not have brought the fraudulent transfer action against Barclays under the Bankruptcy Code, both because the statute of limitations had expired and because such an action is barred by section 546(g) of the Bankruptcy Code. Section 546(g) bars 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 did not dispute that the novation agreement qualified as a swap transfer under the Bankruptcy Code and was protected by section 546(g)’s safe harbor.
Barclays moved to dismiss the litigation trustee’s action, arguing that section 546(g) of the Bankruptcy Code barred her from seeking to avoid the novation as a constructively fraudulent transfer. The litigation trustee argued that section 546(g) was inapplicable to the action because she was asserting state-law fraudulent transfer claims of certain of SemGroup’s creditors, which remained property of the creditors during the bankruptcy and had been transferred to the trust under the Chapter 11 plan. Since section 546(g) applies only to a bankruptcy trustee who is exercising federal avoidance powers under the Bankruptcy Code, she argued, the safe harbor did not apply to bar her state-law claims after the bankruptcy concluded without a release of such claims.
The Court concluded that the litigation trustee’s “clever” argument would effectively render section 546(g) of the Bankruptcy Code a nullity. Consequently, the Court held that, under well-established principles of federal preemption, section 546(g) impliedly preempted the litigation trustee’s attempt to “resuscitate fraudulent avoidance claims as the assignee of certain creditors where … she would be expressly prohibited by section 546(g) from asserting those claims as assignee of the debtor-in-possession’s rights (or, indeed, as the functional equivalent of a bankruptcy trustee).”
The Court held that section 546(g) impliedly preempted the litigation trustee’s state law claims because those claims “actually conflict with federal law” by standing as “an obstacle to the accomplishment and execution of the full purposes and objectives of Congress” in enacting section 546(g). The purpose of that safe harbor, the Court noted, is to protect securities markets from the disruptive effects that unwinding such transactions in bankruptcy would inevitably create. “Congress intended to place swap transactions totally beyond the inherently destabilizing effects of a bankruptcy and its attendant litigation.”
This purpose 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 found that permitting the litigation trust to delay bringing state-law fraudulent transfer claims to avoid the novation until it was able to stand solely in the shoes of SemGroup’s creditors would “make a mockery of Congress’s purpose of minimizing volatility in the swap markets.”
Thus, the Court held that the section 546(g) safe harbor impliedly preempts state-law fraudulent transfer actions seeking to avoid “swap transactions,” as defined in the Bankruptcy Code, where such actions are brought by a litigation trust organized pursuant to a Chapter 11 plan.
Whyte is the first decision to hold that one of section 546’s safe harbors bars state-law fraudulent transfer claims brought by creditors or their representative after confirmation of a Chapter 11 plan under principles of federal preemption. Given the similar attempts to circumvent the Bankruptcy Code’s safe-harbors now underway in Tribune, Lyondell, and other cases, Whyte is an important precedent, and well in line with the trend to interpret the safe harbors broadly.
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