Second Circuit Extends Safe Harbor Protection to Creditors’ State Law Claims

On March 29, 2016, the Second Circuit held that Section 546(e) of the Bankruptcy Code preempts state law claims by creditors seeking to recover certain constructively fraudulent transfers made in connection with a securities contract. In re Tribune Co. Fraudulent Conveyance Lit., 2016 WL 1226871 (2d Cir. Mar. 29, 2016). Section 546(e) explicitly bars such claims by a bankruptcy trustee, but the Second Circuit ruling inTribune extends its “safe harbor” protections to claims brought by creditors and their representatives. The ruling therefore provides transferees with additional protections by further limiting plaintiffs’ claw back rights with respect to certain constructively fraudulent transfers.

A constructive fraudulent transfer is a transfer of property for less than reasonably equivalent value made at a time when the transferor is insolvent, or where it becomes insolvent as a result of the transfer. A bankruptcy trustee is empowered to avoid and recover such transfers so long as they are made within two years of the filing of the bankruptcy petition. However, Section 546(e) provides transferees with a safe harbor by precluding the recovery of such transfers so long as they were margin or settlement payments made by specified financial transferors in connection with a securities contract.

The appellants in Tribune were unsecured creditors who sought to recover moneys received by former shareholders in connection with a Leveraged Buyout. The appellants argued that, while Section 546(e) precluded such constructive fraudulent transfer claims by the trustee under the Bankruptcy Code, it did not bar such claims by creditors brought pursuant to state law. The Second Circuit rejected their argument, finding that their state constructive fraudulent transfer claims were preempted by Section 546(e). In reaching its conclusion, the Second Circuit noted the strong federal interest in regulating creditors’ rights and the securities markets, as well as the practical difficulties of barring such claims by a trustee only to allow unsecured creditors to assert the same claims instead.

The ruling in Tribune provides transferees with additional certainty by applying the safe harbor protections of Section 546(e) to constructive fraudulent transfer claims made by creditors pursuant to state law. While the Second Circuit did not rule on the ability of creditors to bring state law claims arising from transfers beyond the scope of Section 546(e), the holding of Tribune is a welcome development for securities investors and securities markets.

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E-Alert is a newsletter that features the latest thinking from Tannenbaum Helpern's various departments.

05.01.2016  |  PUBLICATION: E-Alert  |  TOPICS: Bankruptcy, Litigation

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