Taking Sides—Lyondell Limits The Use Of The Section 546(e) Safe Harbor In Fraudulent Transfer Litigation

In Weisfelner v. Fund 1 (In re Lyondell Chem. Co.), 503 B.R. 348 (Bankr. S.D.N.Y. 2014), the U.S. Bankruptcy Court for the Southern District of New York held that the "safe harbor" under section 546(e) of the Bankruptcy Code for settlement payments made in connection with securities contracts does not preclude claims brought by a chapter 11 plan litigation trustee on behalf of creditors under state law to avoid as fraudulent transfers pre-bankruptcy payments to shareholders in a leveraged buyout ("LBO") of the debtor. By its ruling, the Lyondell court contributed to a split among the courts in the Southern District of New York, aligning itself with the district court in In re Tribune Co. Fraudulent Conveyance Litig., 499 B.R. 310 (S.D.N.Y. 2013), and against the district court in Whyte v. Barclays Bank PLC, 494 B.R. 196 (S.D.N.Y. 2013). Lyondell and Tribune appear to signal that even in the Second Circuit, where courts have liberally interpreted the scope of the Bankruptcy Code's financial safe harbors, the reach of section 546(e) is not without bounds.

Bankruptcy Avoidance Powers and Limitations

The Bankruptcy Code gives a bankruptcy trustee or chapter 11 debtor-in-possession ("DIP") the power to avoid, for the benefit of the estate, certain transfers made or obligations incurred by a debtor, including fraudulent transfers, within a specified time prior to a bankruptcy filing. Fraudulent transfers include transfers that were made with "actual" fraudulent intent—the intent to hinder, delay, or defraud creditors—as well as transfers that were "constructively" fraudulent, because the debtor received less than "reasonably equivalent value" in exchange and, at the time of the transfer, was insolvent, undercapitalized, or unable to pay its debts as such debts matured.

Fraudulent transfers can be avoided by a bankruptcy trustee or DIP for the benefit of the estate under either: (i) section 548 of the Bankruptcy Code, which creates a federal cause of action for avoidance of transfers made or obligations incurred up to two years before a bankruptcy filing; or (ii) section 544, which gives the trustee or DIP the power to avoid transfers or obligations that may be avoided by creditors under applicable nonbankruptcy law. Some state fraudulent transfer laws that may be utilized under section 544 have a reach-back period longer than two years.

Section 546 of the Bankruptcy Code imposes a number of limitations on these avoidance powers. Specifically, section 546(e) prohibits, with certain exceptions, avoidance of transfers that are margin or settlement payments made in connection with securities, commodity, or forward contracts. The purpose of section 546(e) and other financially focused "safe harbors" in the Bankruptcy Code is to minimize "systemic risk" to the securities and commodities markets that could be caused by a financial contract counterparty's bankruptcy filing. Like sections 544 and 548, section 546(e)...