Part one of a two-part series of articles written by Robert Dremluk, a partner in Culhane Meadows’ New York City office, entitled “Turbulence Continues in Safe Harbors” was recently published in the April 2014 issue of The Bankruptcy Strategist.  This article discusses the prosecution of post-confirmation state law fraudulent transfer claims in the Lyondell Chapter 11 case and highlights conflicting views coming from within the United States Bankruptcy and District Courts for Southern District of New York.  Part 2, which will be published in May 2014, will consist of an article about a recent decision in the Lehman Brothers Holdings Inc. Chapter 11 case regarding the enforceability of contractual terms contained in a master agreement and accompanying schedule to liquidate and calculate amounts due under swap agreements. Both of these decisions demonstrate how courts are applying the so-called safe harbor provisions contained in the Bankruptcy Code to a variety of different factual circumstances and provide some valuable lessons and insights.

In Lyondell, certain shareholder defendants sought to dismiss the state law fraudulent transfer actions regarding  a LBO transaction on five grounds, namely that: (i) after a company files for bankruptcy, stockholder recipients of proceeds of leveraged buyouts are immunized from constructive fraudulent transfer claims by the Bankruptcy Code’s section 546(e) safe harbor, even when the constructive fraudulent transfer claims are not brought by a trustee under the Bankruptcy Code, and instead are brought on behalf of individual creditors under state law, (ii), the creditor trust cannot recover because the transferred funds were not property of the debtors, (iii) many of the shareholder defendants were merely nominees, non-beneficial holders, or conduits (iv) the creditor trust lacked standing to sue on behalf of the lenders, who must be found to have ratified the transfers in question, and (v) the creditor trust failed to satisfactorily plead its claims for intentional fraudulent transfer. In Lyondell, the Bankruptcy Court denied the motion to dismiss as to grounds (i), and (ii) rejecting the defendants’ arguments that such claims are immunized by the safe harbor provision contained in Section 546(e) of the Bankruptcy Code or are preempted by the Bankruptcy Code, granted the motion to dismiss as to grounds (iii) and (iv) and as to (v) granted the creditor trust leave to replead.

Dremluk writes that “Lyondell makes it clear that in order to survive a motion to dismiss fraudulent transfer claims that a plan should at least provide that creditors holding state law fraudulent transfer claims agree that they be assigned to a separate trust and that such trust only prosecute the state law claims. Another option to consider may be to have bankruptcy estate either waive or expressly agree not to simultaneously pursue chapter 5 avoidance claims to the extent such claims are protected by safe harbor provisions contained in section 546 of the Bankruptcy Code. This strategy may be useful to counter the argument that segregation and separate prosecution of state law claims should be disregarded where either (i) the right to pursue constructive fraudulent transfer chapter 5 estate claims exists even though such claims are not being prosecuted or (ii) such chapter 5 claims are actually being separately pursued by the estate.”

He further notes that “[a] dual track prosecution of constructive fraudulent transfer claims by a creditor trust and the estate raises a troublesome issue under section 362(a) with respect to the standing of a litigation trust to pursue state law claims, especially where chapter 5 constructive fraudulent transfer claims have either not been waived by or are being pursued by or on behalf of the estate.

Finally, Dremluk points out that in the context of a LBO there are two takeaways coming fromLyondell. “First, despite attempts to create conduits to isolate transferees from potential fraudulent transfer liability courts will still seek to collapse such transactions where the facts show that an insolvent or undercapitalized transferor incurred debt and pledged its assets with the intent that the proceeds of the transaction be paid to shareholders. That said, to the extent that the LBO transaction uses a financial institution as an intermediary to receive payments, some protection from constructive fraudulent attack may remain although Lyondell and other cases {which are discussed in the]  article seem to suggest otherwise. Second, the expectation that the safe harbor provision in section 546 of the Bankruptcy Code will protect such transactions from fraudulent transfer attack must be reevaluated, especially if the narrow reading of that provision in cases like Lyondell, Tribune and Irving Tanning continues.

On May 1, 2014, the second part of Mr. Dremluk’s two-part article was published in The Bankruptcy Strategist. In Part 2 Mr. Dremluk analyzes a recent decision in the Lehman Chapter 11 case, where the bankruptcy court held that the methodology to be used to calculate amounts due in connection with the liquidation of certain swap transactions under Bankruptcy Code section 560 is governed by the contractual terms of the relevant master swap agreement and accompanying schedule and such terms are not invalidated by ipso facto provisions contained in the Bankruptcy Code. See Michigan State Housing Dev. Auth. v. Lehman Bros. Deriv. Prods. Inc. (In re Lehman Bros. Holdings Inc.), No. 08-13555, —B.R. —-, 2013 WL 6671630 (Bankr. S.D.N.Y. Dec. 19, 2013).

The bankruptcy court held that the alternative approach to liquidation of collateral used by MSHDA is effective even though it is contained in an ipso facto provision because that alternative is protected by the safe harbor of section 560 and, as a consequence, is not subject to the ipso facto limitation contained in section 365(e)(1). The bankruptcy court concluded that when dealing with a swap agreement, the exercise by a swap participant (here, MSHDA) of a contractual right to cause a liquidation of the swap agreement in question is a unified concept because the act of causing a liquidation calls for the collection of market data in a particular manner from specified sources to obtain pricing information. For that reason, the plain meaning of this safe harbor protects both the act of liquidating and the manner for carrying it out. The act of causing liquidation and the methodology converge to the point of being one and the same. Accordingly, the procedures followed by MSHDA in determining the settlement amount were protected by the safe harbor of section 560.