On January 14, 2014, Judge Robert E. Gerber of the United States Bankruptcy Court for the Southern District of New York issued a long-awaited decision denying in large part the motion to dismiss state law fraudulent conveyance claims brought on behalf of Lyondell creditors against thousands of shareholders who received proceeds from Lyondell’s ill-fated leveraged buyout. Judge Gerber ruled that the “safe harbor” protections afforded to certain securities transactions under Section 546(e) of the Bankruptcy Code do not apply to shield the Lyondell shareholders from liability under state law fraudulent transfer causes of action.
The decision draws heavily from the recent holding in the Tribune Company Fraudulent Conveyance Litigation, 499 B.R. 310 (S.D.N.Y. 2013) (Sullivan, J.), which also declined to extend the safe harbor protections of 546(e) to state law fraudulent transfer actions. The Lyondell and Tribune decisions run counter to other recent decisions, including a decision in the SemGroup bankruptcy, in which the Court found that 546(e) preempts the state law claims. Both the Tribune decision and the SemGroup decision have been appealed to the Second Circuit and will be heard in the coming months.
After finding that the plain language of Section 546(e) does not apply to state law fraudulent transfer causes of action brought by individual creditors (as opposed to fraudulent transfer causes of action brought pursuant to the Bankruptcy Code on behalf of the bankruptcy estate), Judge Gerber dedicated a substantial portion of his decision to addressing, and ultimately rejecting, the shareholders’ argument that federal bankruptcy law in general, and Section 546(e) of the Bankruptcy Code in particular, preempts state fraudulent transfer law.
Judge Gerber analyzed the legislative history and rationale underpinning Section 546(e) of the Bankruptcy Code. Echoing the Tribune decision, Judge Gerber noted that although the main purpose of Section 546(e) is to protect the stability of the nation’s financial markets by containing a “ripple effect” caused by the insolvency of one securities firm spreading to another, this primary purpose is only one of many competing concerns in federal bankruptcy law. Judge Gerber found that there was no subject matter preemption in this area of the law because the state and federal fraudulent transfer statutes had coexisted for centuries, and Section 544 of the Bankruptcy Code explicitly recognizes and incorporates the state law causes of action. Further, the Court found that there was no conflict preemption in this area either. Congress was well aware of the state law fraudulent transfer laws and chose not to expressly preempt them with respect to Section 546(e). Indeed, Congress had done so in connection with charitable contributions, so it would certainly have been possible if Congress so intended, according to Judge Gerber.
Although the Court found that 546(e) did not protect the defendants from the state law causes of action alleged by the Lyondell Creditor Trust, the decision contained several rulings in the defendants’ favor, including a ruling that the Creditor Trust could not assert claims on behalf of the LBO lenders who were also creditors, since those parties had “ratified” the transaction. This ruling may substantially reduce the amount of money the Creditor Trust ultimately recovers from Lyondell shareholders if the Creditor Trust ultimately prevails.
The Lyondell litigation remains in its early stages as the parties assess the impact of Judge Gerber’s decision on the motion to dismiss. In the interim, the Second Circuit will soon consider appeals brought in two cases involving the application of Section 546(e) to protect shareholders from actions brought by creditors under state law. The parties in the Lyondell Creditor Trust litigation will be watching the Second Circuit closely as it considers this important issue, which will no doubt impact the outcome in Lyondell.