A Bankruptcy Giant's Swan Song: Judge Drain Expands The Lookback Period To Bring Avoidance Actions & Calls On Congress To Curtail The Safe Harbor Exception

• Published date: 14 December 2022
• Subject Matter: Finance and Banking, Criminal Law, Insolvency/Bankruptcy/Re-structuring, Financial Services, Insolvency/Bankruptcy, White Collar Crime, Anti-Corruption & Fraud
• Law Firm: Arnold & Porter
• Author: Mr Benjamin Mintz and Justin Imperato

In the final written opinion of his illustrious career, Judge Robert D. Drain of the U.S. Bankruptcy Court for the Southern District of New York issued a decision in Halperin v. Morgan Stanley Investment Management, Inc. (In re Tops Holding II Corporation)¹ that imposes greater risk on targets of fraudulent transfer claims. This article analyzes the Tops Holding decision and its go-forward impact.

Introduction

The Bankruptcy Code provides mechanisms for trustees to avoid and recover certain transfers made by debtors before bankruptcy. These avoidance powers are subject to certain limitations. One limitation is the statutory lookback period during which purportedly fraudulent transfers can be avoided. Generally, the lookback period is two years for fraudulent transfer avoidance actions brought under Bankruptcy Code section 548, and four or six years if the trustee employs state law through Bankruptcy Code section 544. Following a recent trend among some bankruptcy courts, Judge Drain applied a ten-year lookback period, relying on the IRS's applicable statute of limitations, thereby allowing a fraudulent transfer claim to be asserted in respect of a transaction ten years before the petition date.

Another limitation on a trustee's avoidance powers is the safe harbor contained in Bankruptcy Code section 546(e) (the Safe Harbor Provision), which precludes the avoidance of: (i) a "settlement payment" or a transfer "in connection with a securities contract; (ii) made by or to (or for the benefit of) a "financial institution." Because qualifying transactions are shielded from avoidance, the questions of: (i) what qualifies as a transfer made "in connection with a securities contract" or as a "settlement payment;" and (ii) who meets the statutory definition of a "financial institution" have been the subject of much litigation in recent years, resulting in a safe harbor that some critics say is now so broad that it swallows a trustee's general avoidance powers Indeed, in Tops Holding, not only did Judge Drain hold that the dividend payments at issue were not safe-harbored, he directly called for Congress to narrow the Safe Harbor Provision's applicability.

Tops' and Tops Holding's Background

Notwithstanding its continually increasing liabilities and lackluster operating revenues, Tops II Holding Corporation (Tops) paid dividends to a group of private investors (the Investor Group) in 2009, 2010, 2012 and 2013 totaling $375 million (the Dividend Payments). On February 21, 2018, Tops and its affiliated debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. On November 9, 2018, the Court confirmed Tops' Chapter 11 plan. The trustee for the litigation trust established under the plan (the Litigation Trustee) subsequently sued the former equity investors to avoid the Dividend Payments as actual and constructive fraudulent transfers under New York Debtor and Creditor Law (the DCL) and Bankruptcy Code section 544(b). The Investor Group moved to dismiss the fraudulent transfer claims, asserting, among other defenses, that the Litigation Trustee's claims with respect to the 2009 and 2010 Dividend Payments were time-barred and that the Dividend...