Parting Advice: Judge Drain Rules That Dividends Paid From The Proceeds Of Safe-Harbored Transactions Are Not Safe-Harbored In In Re Tops Holding II Corp.

• Published date: 07 November 2022
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Financial Services, M&A/Private Equity, Financial Restructuring, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Bracewell
• Author: Mr Mark Dendinger and Jonathan Lozano

In his final opinion, Judge Robert D. Drain of the United States Bankruptcy Court for the Southern District of New York held that dividends paid from proceeds of safe-harbored transactions under section 546(e) of the Bankruptcy Code are not safe-harbored. While only approximately 15 pages of Judge Drain's 109-page final opus are dedicated to consideration of the section 546(e) issue, the relevant analysis ends with a pressing question to Congress and an appeal to modify section 546(e) to "restrict to public transactions its currently overly broad free pass . . . that has informed the playbook of private loan and equity participants to loot privately held companies to the detriment of their non-insider creditors with effective impunity."¹ The logic of the opinion poses a clear hurdle to private equity participants looking to protect their dividends by arguing that such dividends are part of an integrated transaction that is otherwise safe-harbored under section 546(e).

The salient facts leading up to the opinion are as follows: debtor Tops II Holding Corporation ("Tops") owned and operated 169 supermarkets in upstate New York, northern Pennsylvania and Vermont, employing about 14,000 people, including 12,300 union members. In 2007, a group of private investors (the "PE Group") acquired the stock of Tops' predecessor for approximately $300 million, $200 million which was funded with secured debt incurred by Tops.

Known to the PE Group, in 2007 Tops' financial health was questionable due to its significantly underfunded pension plan, for which Tops' withdrawal liabilities grew from $85 million in 2007 to over $515 million in 2013. During the same six years under the PE Group's controlling ownership, Tops' funded debt also grew from $227 million to $649 million. Despite these growing contingent and funded liabilities, Tops paid four dividends (2009, 2010, 2012 and 2013) to the PE Group totaling $375 million funded from (a) the proceeds of secured loans and (b) severely restrained capital expenses. After receiving their final dividend in 2013, the PE Group entered into a purchase and sale agreement under which they sold their stock to an entity controlled by Tops' senior management for approximately $16.6 million (of which Tops funded $12.3 million and management funded $4.3 million).

Tops filed for bankruptcy in February 2018 and the Court confirmed Tops' chapter 11 plan approximately nine months later, pursuant to which Tops terminated one of its pension plans and settled another, leaving over $1 billion in creditor claims left to recover from a litigation trust which included potential avoidance...