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The Future of LBO-Related Bankruptcy Litigation

Andrew McLure Toft

The Future of LBO-Related Bankruptcy Litigation
Pgiam via Getty Images

Whereof what’s past is prologue; what to come,
In yours and my discharge.

—William Shakespeare, The Tempest, act II, scene I

The Great Recession produced a lot of work for bankruptcy lawyers. Issues arising out of Great Recession cases filed during and after 2008 are the subject of opinions written as recently as 2019 ago (see, e.g., In re Tribune Co. Fraudulent Conveyance Litig., Nos. 13-3992-cv, 13-3875-cv, 13-4178-cv, 13-4196-cv (2d Cir. 2019)), and litigation continues. As the economic toll from COVID-19 and the impact of government restrictions on businesses, stay-at-home orders and guidelines, and social distancing worsens, issues contested in Great Recession bankruptcies are likely appear again in bankruptcies filed in the coming weeks, months, and perhaps years. If companies that were targets of leveraged buyouts (LBOs) in the recent past are among the filers, cases involving 11 U.S.C. § 546(e) safe harbors, preemption, and standing will again come before the courts when fraudulent conveyance litigation is filed. The cases discussed below are examples of experienced judges looking at similar facts and the same or similar legal issues and reaching entirely different conclusions regarding how the Bankruptcy Code should be interpreted. The cases discuss 11 U.S.C. § 362, 11 U.S.C. § 546, or both, and how those sections of the Bankruptcy Code should be interpreted and applied in fraudulent conveyance litigation arising out of failed LBOs.

My goal when I began writing this article was to provide analysis that would reconcile these decisions and provide some guidance for the coming wave of bankruptcy litigation. That has proven to be beyond the scope of this article, and I instead chose to limit the article to a discussion of the cases and issues to provide a starting point for your own research. An excellent resource analyzing the issues discussed in this article in far greater depth is an article by Peter V. Marchetti, “A Note to Congress: Amend Section 546(e) of the Bankruptcy Code to Harmonize the Underlying Policies of Fraudulent Conveyance Law and Protection of the Financial Markets,” 26 Am. Bankr. Inst. L. Rev. 1 (2018).

In the discussion of the Tribune Company litigation below, Tribune I refers to U.S. District Judge Sullivan’s 2013 decision in the Southern District of New York. Tribune II refers to the Second Circuit’s opinion issued on March 29, 2016, affirming Tribune I but on different grounds. Tribune III refers to the Second Circuit’s opinion issued on December 19, 2019, amending and vacating Tribune II (but still affirming Tribune I). While the fact that Tribune III vacates Tribune II suggests Tribune II can and should be ignored, in my opinion the chronology is important in light of Lyondell and Merit Management, both discussed below, and In re Physiotherapy Holdings, Inc., No. 13-12965, 2016 WL 3611831 (Bankr. D. Del. June 20, 2016). Physiotherapy Holdings is not further discussed because it is not published, but the opinion should be reviewed if section 546(e) is at issue in a failed LBO case.

Lessons from the Tribune Cases—Tribune I

In re Tribune Co. Fraudulent Conveyance Litigation (Tribune I), 499 B.R. 310 (S.D.N.Y. 2013), saw the Official Committee of Unsecured Creditors[1] and numerous individual creditors trying to claw back funds distributed as part of the LBO of the Tribune Company in 2007 (the bankruptcy was filed in 2008). The individual creditors targeted the same transactions (LBO shareholder payouts) as the committee, but the individual creditors pursued state law constructive fraudulent conveyance claims, while the committee pursued intentional fraudulent conveyance claims. The defendants filed a Rule 12(b)(6) motion to dismiss on the following issues:

  • Whether section 546(e) of the Bankruptcy Code prohibits the individual creditors’ state law constructive fraudulent conveyance claims in bankruptcy, and
  • If not, whether the individual creditors have standing to pursue their constructive fraudulent conveyance claims outside of bankruptcy while the committee asserts intentional fraudulent conveyance claims in bankruptcy to avoid the same transactions.

After a detailed preemption analysis under section 546(e), the first issue was decided in favor of the individual creditors. That victory was short-lived because the court then concluded that section 362(a)(1) deprived the individual creditors of standing to avoid the same transactions that the committee was trying to avoid.

The defendants’ arguments and the court’s response are summarized below:

Argument Ruling
Individual creditors’ state law fraudulent conveyance claims are permanently stayed by a bankruptcy filing. The court pointed out that under section 546(a)(1)(A), the trustee has only two years to commence avoidance actions after a debtor files for bankruptcy. Once that period expires, a creditor regains standing to pursue a state law fraudulent conveyance action.
The court must take affirmative action before state law fraudulent conveyance claims revert to individual creditors after the two-year period in section 546(a)(1)(A) expires. “[A] fraudulent conveyance claim is not treated as property of the bankruptcy estate because the debtor has no personal recourse against the transferee in a fraudulent conveyance.” Because a fraudulent conveyance claim is not estate property, once the section 546(a)(1)(A) two-year period expires, the claims revert without action by the bankruptcy court.
Because the committee was pursuing intentional fraudulent conveyance claims against the beneficiaries of the Tribune LBO, the individual creditors’ coextensive state law constructive fraudulent conveyance claims were held in abeyance under section 362. The court viewed this as a standing argument and agreed section 362(a)(1) deprived the individual creditors of standing to avoid transactions the committee was contemporaneously trying to avoid, even though on a different theory. The court reviewed sections 544, 546, and 548 and related case law, concluding that because the committee was pursuing an avoidance action, the individual creditors could not also pursue an avoidance action targeting the same shareholder payouts.


Post-confirmation, the committee’s claims were transferred to a litigation trust.

Lessons from Lyondell

Several months after Tribune I was issued, Lyondell Chemical Co. v. LB Creditor Trust, 503 B.R. 348 (Bankr. S.D.N.Y. 2014), was issued by now former bankruptcy judge Robert E. Gerber. In Lyondell, discussion of the standing issue was limited, as Judge Gerber focused primarily on preemption under section 546(e) and interpretation of the term “trustee” as used in section 546(e). Note that while interpretation of the term “trustee” as used in section 546(e) is discussed in Lyondell, Tribune II, and Tribune III, the opinions never cite 11 U.S.C. § 321, § 322, or § 323.

The LB Creditor Trust was created for the benefit of unsecured creditors as part of Lyondell’s confirmed plan of reorganization. The trust was the assignee of unsecured trade claims, funded debt claims, and senior and subordinated secured deficiency claims. The plan provided in part:

On the Effective Date, the Abandoned Claims shall be discontinued by the Debtors without prejudice and the Debtors shall be deemed to have abandoned, pursuant to section 554 of the Bankruptcy Code, any and all right to further pursue Abandoned Claims. Upon the effectiveness of the aforesaid discontinuance and abandonment, each holder of Allowed 2015 Notes Claims, General Unsecured Claims, and holders of the Deficiency Claims . . . shall contribute to the Creditor Trust any and all State Law Avoidance Claims. The Creditor Trust shall be authorized to prosecute the State Law Avoidance Claims that are contributed to the Creditor Trust. . . .

The claims were not brought by a trustee under the code but by the Creditor Trust on behalf of individual creditors under state law. The defendants were former Lyondell stockholders, primarily institutional, who received LBO payments in excess of $100,000. The defendants argued that section 546(e) applied and, by implication, preempted state law rights. The opinion states:

The Court cannot agree. Rather, it agrees with the recent holdings in the Tribune Company Fraudulent Conveyance Litigation [footnote omitted] [Tribune I] and the Irving Tanning Company chapter 11 case [footnote omitted] that section 546(e) does not apply to suits under state fraudulent transfer laws. And it agrees with the holding in Tribune that state fraudulent transfer laws are not preempted. Dismissal premised on the asserted applicability of section 546(e) to state law claims, and on implied preemption by section 546(e), is denied.

The opinion points out that section 546(e) provides that “the trustee may not avoid a transfer.” It is not applicable to claims by or on behalf of individual creditors. Judge Gerber agreed with Judge Sullivan in Tribune I that if Congress intended section 546(e) to be more broadly applicable, “it could simply have said so.”

In Irving Tanning, a litigation trust asserted fraudulent transfer claims after a failed LBO. The trust acted as the assignee of individual creditors (as in Lyondell) but also as the assignee of the estate. The defendants moved to dismiss the complaint, arguing in part that section 546(e) barred even the claims that were asserted solely on behalf of individual creditors under state law. In a dictated opinion, the Tanning court held:

It is alleged that the Plaintiff is the Trustee under the Debtor’s Plan of Reorganization, with two hats. One, assignee of creditors by agreement of the creditors and court approval of the Plan and, two, that the trustee, the liquidating trustee, is the successor in interest to the debtor in possession or the statutory trustee.
The Defendants would have it that these are mutually exclusive roles. I hold otherwise. I believe that the liquidating trustee, as assignee of creditors, may assert these actions, and that being so, that 546(e) does not apply.

In Lyondell, the Creditor Trust was not asserting claims on behalf of the Lyondell estate. Rather, the Creditor Trust held only creditor claims—with respect to which the estate abandoned section 544 rights on behalf of creditors generally—and the creditors who owned the underlying avoidance claims contributed them to the Creditor Trust. The court stated that the case was analytically the same as the situation in Tribune, in which individual creditors asserted their claims personally.

Lessons from the Tribune Cases—Tribune II

In re Tribune Company Fraudulent Conveyance Litigation (Tribune II), 818 F.3d 98 (2d Cir. 2016), affirmed Tribune I on preemption grounds, rather than standing, and analyzed the “trustee” issue arising out of section 546(e) much more narrowly than Lyondell. Tribune II cites or references Lyondell eight times. While Tribune II does not expressly disapprove of Lyondell, it is readily apparent the Second Circuit disagreed with Judge Gerber’s preemption analysis.

We address two issues: (i) whether appellants are barred by the Bankruptcy Code’s automatic stay provision from bringing state law, constructive fraudulent conveyance claims while avoidance proceedings against the same transfers brought by a party exercising the powers of a bankruptcy trustee on an intentional fraud theory are ongoing; and (ii) if not, whether the creditors’ state law, constructive fraudulent conveyance claims are preempted by Bankruptcy Code Section 546(e).

On issue (i), we hold that appellants are not barred by the Code’s automatic stay because they have been freed from its restrictions by orders of the bankruptcy court and by the debtors’ confirmed reorganization plan. On issue (ii), the subject of appellees’ cross-appeal, we hold that appellants’ claims are preempted by Section 546(e). That Section shields from avoidance proceedings brought by a bankruptcy trustee transfers by or to financial intermediaries effectuating settlement payments in securities transactions or made in connection with a securities contract, except through an intentional fraudulent conveyance claim.

No trustee was appointed, and the debtors operated the businesses as debtors in possession. Foreshadowing its broad interpretation of the word “trustee” in section 546(e) and its ruling on preemption, the court cited section 1107(a) for its description of the rights, powers, and duties of a debtor in possession. It went on to state that in discussing the powers a bankruptcy that can be exercised by a trustee or parties designated by the bankruptcy court, it would refer to “trustee et al.” There was no reference to sections 321 through 323. For reasons that are not clear, the court discussed the standing issue first and held, contrary to the trial court, that the state law fraudulent conveyance claims were not barred by section 362. The court then discussed the preemption issue at some length and reversed the trial court and held that the state law claims were preempted by 546(e). It is clear the court was troubled by the fact the creditors brought their state law constructive fraudulent conveyance claims (similar to 548(a)(1)(B)) while the committee was pursuing a 548(a)(1)(A) intentional fraudulent conveyance claim against some or all of the same defendants arising out of the same transactions. The court’s determination that “a preemptive effect may be inferred where it is not expressly provided,” among other things, leads to a broad reading of section 546(e).

Lessons from Merit

Merit Management Group, LP v FTI Consulting, Inc., 183 S. Ct. 883 (2018), is another failed LBO case. The LBO closed in 2007 and there was a further disbursement in 2010 after a holdback period expired. The bankruptcy of the target, Valley View Downs, LP, and its parent, Centaur, LLC, followed.

Justice Sotomayor’s opinion framed the issue in Merit as follows:

[T]his Court is asked to determine how the safe harbor operates in the context of a transfer that was executed via one or more transactions, e.g., a transfer from A→D that was executed via B and C as intermediaries, such that the component parts of the transfer include A→B→C→D. If a trustee seeks to avoid the A→D transfer, and the § 546(e) safe harbor is invoked as a defense, the question becomes: When determining whether the § 546(e) securities safe harbor saves the transfer from avoidance, should courts look to the transfer that the trustee seeks to avoid (i.e., A→D) to determine whether that transfer meets the safe-harbor criteria, or should courts look also to any component parts of the overarching transfer (i.e., A→B→C→D)?

Merit interpreted 11 U.S.C. § 546(e) without ever using the words “preemption” or “standing,” so critical to the analysis in Lyondell and the Tribune cases. Further, FTI Consulting had been appointed trustee of the Centaur Litigation Trust, so this was not a case in which the bankruptcy trustee pursued fraudulent conveyance claims. Unlike in Lyondell and Tribune II, there was no analysis of “trustee,” as that term is used in section 546(e). Footnote 1 in Merit does state:

Avoiding powers may be exercised by debtors, trustees, or creditors’ committees, depending on the circumstances of the case. See generally C. Tabb, Law of Bankruptcy §6.1 (4th ed. 2016) (Tabb). Because this case concerns an avoidance action brought by a trustee, we refer throughout to the trustee in discussing the avoiding power and avoidance action. The resolution of this case is not dependent on the identity of the actor exercising the avoiding power.

The “trustee” in Merit was the trustee of a post-confirmation litigation trust, not a trustee as the term is used in 11 U.S.C. §§ 321–323.

The Supreme Court concluded the relevant transfer for purposes of the section 546(e) safe harbor is the transfer the trustee seeks to avoid, not the “component” or “conduit” transactions by which money was transferred. Part II-B of the opinion discusses when the component parts of a transfer may be considered and when the component parts are irrelevant, stating that “[i]f a trustee properly identifies an avoidable transfer, . . . the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power, where that limit is defined by reference to an otherwise avoidable transfer. . . .”

Lessons from the Tribune Cases—Tribune III

After Merit was decided, Justice Kennedy and Justice Thomas issued a statement suggesting the Second Circuit might wish to recall its mandate or provide other relief in light of Merit. Deutsche Bank Tr. Co. Ams. v. Robert R. McCormick Found., No. 16-317, 2018 WL 1600841 (Apr. 3, 2018). (A motion to recall the mandate was filed and the mandate recalled in anticipation of further panel review.) This seems odd because nowhere in the Merit opinion are either the word “preemption” or the word “standing” used in any context. Indeed, in In re Tribune Co. Fraudulent Conveyance Litigation (Tribune III), 946 F.3d 66 (2d Cir. 2016), the Second Circuit specifically states Merit does not control the decision on the preemption issue. Further, “safe harbor,” a term used throughout Merit, is mentioned only four times and only in conjunction with Merit. Indeed, Tribune III does not alter much of the reasoning in Tribune II. Tribune III does add an argument and that the debtor Tribune qualified as a financial institution under section 101(22)(A). Footnote 2 of Merit specifically states the Court was not addressing “what impact, if any, § 101(22)(A) would have on the application of the § 546(e) safe harbor.” The reason the Court was not going to address the issue was explained in footnote 2. Notwithstanding the Court’s reasoned refusal to address the issue, it left a gaping hole in section 546(e) jurisprudence that Tribune used to its advantage in Tribune III.


The length of the opinions in the cases discussed makes it difficult to cover all the important issues in a newsletter-length article. In the event you become involved in LBO litigation following a target company’s bankruptcy, Lyondell, the three Tribune decisions, Merit, Physiotherapy, and Professor Marchetti’s article are a starting point for your research, and further relevant opinions should be forthcoming in Tribune. As is clear from the case descriptions above, there are no clear answers to all the issues arising out of section 546(e), but with these cases being the prologue for what is to come in LBO-related bankruptcy litigation, more decisions may clarify some of those answers.