In In re Lyondell Chemical Company, et al., 2014 WL 118036 (Bankr.S.D.N.Y. Jan. 14, 2014), the United States Bankruptcy Court for the Southern District of New York held that the safe harbor provision found in Section 546(e) does not apply to, or preempt suits brought pursuant to, state fraudulent transfer laws. This decision is significant in that Section 546(e) may no longer provide an obstacle to recovery for a debtor’s creditors.

In late December 2007, a Luxembourg entity acquired Lyondell Chemical Company through a leveraged buyout (LBO). The LBO was financed by $21 billion of debt secured by the assets of Lyondell, of which $12.5 billion was paid out to Lyondell’s shareholders. Less than 13 months after the LBO, Lyondell filed for bankruptcy.

The creditor trust established during Lyondell’s bankruptcy brought a state-law fraudulent transfer suit in state court against the former Lyondell shareholders. The suit alleged that the $12.5 billion paid was made without a reasonable return in value and that the payment rendered Lyondell insolvent. The creditor trust did not assert any claims under the Bankruptcy Code. The defendants removed the case to the District Court for the Southern District of New York, where it was referred to the Bankruptcy Court.

In the Bankruptcy Court, defendants sought dismissal of the state-law fraudulent transfer claims by arguing, inter alia, that transfers that are protected by Section 546(e) from avoidance under certain provisions of the Bankruptcy Code are also protected by that section from recovery under state fraudulent transfer laws once the transferor is a debtor in a bankruptcy case. The shareholders asserted two arguments under Section 546(e): (i) that the section provides the same substantive defense to individual creditors’ purely state law claims as it would to claims brought under Sections 544 or 548 of the Bankruptcy Code once bankruptcy intervenes; and (ii) because states have not included a similar safe harbor provision in their legislation, states’ fraudulent transfer laws are preempted by Section 546(e).

Section 546(e) Does Not Bar State-Law Fraudulent Transfer Claims Brought by Individual Creditors

Citing the analysis in In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. 310 (S.D.N.Y. 2013), the Lyondell court held that Section 546(e) does not apply to state-law fraudulent transfer claims brought on behalf of individual creditors. The court examined the plain language of Section 546(e) and found that Congress limited the applicability of Section 546(e) to causes of action asserted by a trustee or debtor in possession. The court also noted that plaintiff’s claims were not being brought on behalf of the bankruptcy estate or under any provision of the Bankruptcy Code. Because the plaintiff in this case was an assignee of the individual creditors appointed by the plan, and not a bankruptcy trustee or debtor in possession or an assignee or person standing in the place of either, defendants could not invoke the safe harbor provision of Section 546(e).

State-Law Constructive Fraudulent Transfer Claims are not Preempted by Section 546(e)

Again relying upon the analysis in Tribune, the court denied the defendant’s argument that Section 546(e) preempted state constructive fraudulent transfer laws. The court began with an overview of preemption jurisprudence before addressing the three separate areas of preemption: express, field and conflict. There was no allegation that Congress expressly preempted state fraudulent transfer laws so the court summarily dismissed express preemption as a means by which Section 546(e) barred the creditor trust’s claims. The Court also quickly dismissed any argument that by enacting Section 546(e), Congress had preempted the field of fraudulent transfers. In its analysis, the court found that “the states and federal government have long had a shared interest in protecting the legitimate desire of creditors to be repaid, and in avoiding transactions parting with debtor property for inadequate consideration when such comes at creditors’ expense.” In support of its proposition, the court cited Section 544 of the Bankruptcy Code, which provides trustees with avoidance powers available to creditors under state law in addition to the avoidance powers provided under the Bankruptcy Code.

The court moved on to conflict preemption: impossibility and obstacle. Impossibility preemption occurs when state law penalizes what federal law requires. The court found that impossibility preemption did not apply because federal law did not require stockholders to accept payments while state law forbade receiving such payments and that the state law at issue did not regulate conduct but simply provided a remedy for unpaid creditors who were injured as the result of a fraudulent transfer.

Obstacle preemption occurs when state law is asserted as an obstacle to Congress’ objectives. To prevail on an obstacle preemption argument, the movant must show “the repugnance or conflict is so direct and positive that the two acts cannot be reconciled or consistently stand together.” After a thorough examination of Congress’ intent in enacting the Bankruptcy Code and Section 546(e) specifically, the Bankruptcy Court concluded that Congress did not intend for Section 546(e) to preempt state law fraudulent transfer claims. The court noted that Congress had enacted provisions where individual creditor’s state law claims were preempted and because Section 546(e) contained no such express preemption, but other provisions of the Bankruptcy Code did, an intent to preempt could not be read into Section 546(e). The court held that express preemption in certain areas of the code but silence in Section 546(e) was indicative of Congress’ intent and concluded that “Congress failed to expressly preempt state law constructive fraudulent transfer claims” in Section 546(e).

Turning to Congress’ intent regarding Section 546(e), specifically, the court traced the evolution of Section 546(e) to show that it was passed to prevent a possible ripple effect if the bankruptcy of a customer or broker could lead to subsequent bankruptcies and noted that throughout the different evolutions, the focus was market intermediaries and the markets themselves, not individual investors.

The defendant shareholders also asked the bankruptcy court to rely upon a recent decision by the District Court for the Southern District of New York, Whyte v. Barclay’s Bank PLC, 494 B.R. 196 (S.D.N.Y. 2013). In Barclay’s, the district court held that Section 546(g) impliedly preempted state-law fraudulent conveyance actions seeking to avoid swap transactions. Relying on the Tribune court’s interpretation of the Barclay’s decision, the court noted that in Barclay’s, the plaintiff was a single trust established by the plan that was a representative for both the estate and outside creditors. The Tribune court read the Barclay’s opinion as reasoning that since the plaintiff, in its capacity as a representative of the estate, would be barred from avoiding the transaction under Section 546(g), it could not then bring the state law fraudulent transfer claims as a representative of the creditors. Applying the Barclay’s decision to the facts before it, the bankruptcy court found that since the plaintiff was a representative of individual creditors, and not the estate, it was not barred by Section 546(e).

This decision is an important victory for creditors of companies that seek bankruptcy protection in the wake of an LBO. To circumvent the potential obstacle presented by Section 546(e), state law fraudulent transfer claims should be assigned to a trust created for the sole purpose of pursuing such claims. Further, to comply with the limitations the Lyondell decision imposes on Section 546(e), the trust may need to abandon any claims under Section 548 of the Bankruptcy Code.