The Second Circuit Again Addresses Issues In Connection With The Leveraged Buyout That Sparked The Tribune Chapter 11 Cases

• Published date: 27 September 2021
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy, Shareholders
• Law Firm: Arnold & Porter
• Author: Mr Benjamin Mintz and Justin Imperato

The United States Court of Appeals for the Second Circuit (Second Circuit) issued another decision in the Tribune Company Fraudulent Transfer Litigation¹ on August 20, 2021, partially upholding the United States District Court for the Southern District of New York's (District Court) dismissal of certain claims filed against the Tribune Company's (Tribune) shareholders stemming from Tribune's buy-back of outstanding shares pursuant to a 2007 leveraged buy-out transaction (LBO) to go public and the financial firms that advised Tribune in connection with the LBO.

Of note, the Second Circuit: (1) held that Tribune's LBO structured in two steps should not be collapsed into a single transaction for purposes of analyzing the claims asserted by the bankruptcy litigation trustee (Trustee); (2) held that factual questions existed as to whether two financial advisory firms provided "reasonably equivalent value" for their "success fees" in connection with the Trustee's constructive fraudulent transfer claims against such firms; (3) adopted the "control" test to determine whether a company's officers' intent to defraud creditors could be imputed to an independent special committee for purposes of analyzing intentional fraudulent transfer claims asserted by the Trustee against shareholders; and (4) denied the Trustee leave to add a constructive fraudulent transfer claim against shareholders on the basis of futility in light of the Bankruptcy Code's safe harbor and the Second Circuit's Tribune II (as defined below) decision.

Relevant Factual Background

Tribune Retained Financial Advisors

Prior to the LBO in 2007 and as a result of the media industry's changing landscape in the digital age, Tribune's board of directors (Board) formed a special committee (Special Committee) to address potential ways to return value to Tribune's shareholders. In October 2005, prior to formation of the Special Committee, the Board hired Citigroup Global Market, Inc. (Citigroup) and Merrill, Lynch, Pierce, Fenner, and Smith, Inc. (Merrill Lynch) as financial advisors to analyze and propose possible responses to the ongoing changes in the media industry. Merrill Lynch and Citigroup each signed engagement letters that promised each a "Success Fee" of $12.5 million if a "Strategic Transaction" was completed.

The LBO's Structure

Before execution, the Special Committee consulted several large shareholders holding approximately 33% of Tribune's shares (Large Shareholders) in connection with the proposed LBO. Concerned Tribune's share price would drop before the Large Shareholders could sell their shares, the Large Shareholders informed the Special Committee that they would only vote for a two-step LBO that allowed them to cash out during step one regardless of whether step two subsequently occurred. Ultimately, in consultation with Merrill Lynch and Citigroup, the Board approved a two-step LBO transaction. In step one, Tribune borrowed money to buy back roughly half of its shares (Step One). In step two, Tribune would borrow more money to purchase all remaining shares outstanding (Step Two). Step One contemplated the possibility that Step Two might not occur.

The LBO's Implementation

On April 11, 2007, Tribune retained Valuation Research Company (VRC) to provide two solvency opinions for the LBO, one for Step One and the other for Step Two. On May 24, 2007, VRC issued an opinion that Tribune would be solvent after completing Step One. According to the Trustee, however, after VRC issued this solvency opinion, Tribune's management learned that the financial projections, upon which VRC's solvency opinion was based, were no longer an accurate forecast of Tribune's 2007 second half performance. According to the Trustee, no one alerted VRC that Tribune was unlikely to meet its 2007 second-half financial projections. In fact...