Fraudulent Transfer Avoidance Recovery Not Limited to Total Amount of Creditor Claims

posted in: Avoidance, fraudulent transfer | 0

By Jane Rue Wittstein and Mark G. Douglas (Jones Day)

Courts disagree as to whether the amount that a bankruptcy trustee or chapter 11 debtor-in-possession can recover in fraudulent transfer avoidance litigation should be capped at the total amount of unsecured claims against the estate. The U.S. Bankruptcy Court for the District of Delaware recently weighed in on this issue in PAH Litigation Trust v. Water Street Healthcare Partners, L.P. (In re Physiotherapy Holdings, Inc.), 2017 WL 5054308 (Bankr. D. Del. Nov. 1, 2017). Noting the absence of any guidance on the question from the U.S. Court of Appeals for the Third Circuit, the bankruptcy court ruled that, unlike most state fraudulent transfer laws, which limit a creditor’s recovery to the amount of its unpaid claim against the transferor, section 550 of the Bankruptcy Code imposes no such limitation on the estate’s recovery. The ruling reinforces the idea that federal and state fraudulent transfer avoidance laws are intended to be remedial rather than punitive. Under state law, this understandably means that an avoidance recovery is limited to the amount necessary to make an injured creditor whole. Under federal bankruptcy law, recoveries must benefit the bankruptcy estate, which includes the interests of creditors and other stakeholders.

The article is available here.

Applying Jevic: How Courts Are Interpreting and Applying the Supreme Court’s Ruling on Structured Dismissals and Priority Skipping

By Shane G. Ramsey and John T. Baxter (Nelson Mullins).

The U.S. Supreme Court in Czyzewski v. Jevic Holding Corp., 137 S.Ct. 973 (2017), addressed the issue of chapter 11 debtors using structured dismissals to end-run the statutory priority rules. The Court’s ruling preserved the priority system, holding that the bankruptcy court could not approve a structured dismissal of a chapter 11 case that provided for distributions that failed to follow the standard priority rules unless the affected creditors consented to such treatment. Although the Bankruptcy Code does not expressly apply its priority distribution scheme to a structured dismissal, the Court clarified that courts should do so.

As a way to track how bankruptcy courts across the country are applying the ruling in Jevic, the Nelson Mullins Bankruptcy Protector has introduced a new periodic series: the Jevic Files. As of February 19, 2018, the Jevic Files has collected and summarized thirteen cases across twelve jurisdictions. While the majority of the cases involved structured dismissals in the context of a chapter 11 case, courts have also applied the ruling in Jevic to the dismissal of chapter 13 plans; the priority of trustee payments in a chapter 7 case; and even a state court foreclosure hearing that came on the heels of a dismissed chapter 11 case. As Jevic continues to be interpreted and applied in bankruptcy (and other) courts throughout the country, we will continue to keep an updated summary of cases through the Jevic Files.

The article is available here.

The Roundtable has posted on Jevic before, including a report of the case by Melissa Jacoby & Jonathan Lipson and a roundup of law firm perspectives on the Court’s decision and an initial scholarly take on the opinion from Nicholas L. Georgakopoulos. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that the Jevic opinion referred to.

Justice Scalia’s Bankruptcy Jurisprudence: The Right Judicial Philosophy for the Modern Bankruptcy Code?

By Megan McDermott (Lecturer, University of Wisconsin School of Law).

The late Justice Scalia is best known among mainstream audiences for his originalist approach to the Constitution, as well as his polarizing views on various civil rights issues. But anyone who has cracked open a bankruptcy casebook also knows Justice Scalia for his many contributions to the bankruptcy field — both through sturdy majority opinions in interpretive cases like Timbers, Nextwave, and Radlax, and through his biting dissents and concurrences in watershed decisions like Dewsnup and Stern.

My recent article, Justice Scalia’s Bankruptcy Jurisprudence: The Right Judicial Philosophy for the Modern Bankruptcy Code?, seeks to both quantify and qualify Justice Scalia’s contributions to bankruptcy law. I show that during his three decades on the Court, Justice Scalia wrote in more bankruptcy cases than any other justice (followed closely by Justices Stevens and Thomas).

I also identify four predominant themes that emerge from Justice Scalia’s bankruptcy oeuvre: (1) a holistic approach to the Bankruptcy Code; (2) a commitment to textualism, regardless of outcome; (3) disdain for legislative history; and (4) a desire for clear boundaries regarding the scope and authority of bankruptcy courts.

Finally, the article explores the impact of his jurisprudential legacy on the bankruptcy field. Of particular note are the ways in which Justice Scalia’s approach often favored ordinary consumers over creditor interests. I conclude that while Justice Scalia did not always live up to the ideals that he advocated, he nonetheless offered a unifying vision that fits well with both the purpose and the design of the Bankruptcy Code.

The full article is available here.

Third Circuit Dismisses Crystallex’s Fraudulent Transfer Claim But Potential Liability Remains for PDVSA

By Richard J. Cooper and Boaz S. Morag (Cleary Gottlieb Steen & Hamilton, LLP).

On January 3, 2018, the United States Court of Appeals for the Third Circuit dealt a significant blow to Crystallex International Corporation’s long-running effort to recover its $1.2 billion arbitral award and judgment against the Republic of Venezuela for appropriating Crystallex’s rights to the Las Cristinas gold mine. In a 2-1 decision, the Third Circuit reversed a decision of the Delaware district court that had allowed Crystallex to allege a Delaware fraudulent transfer claim against a Delaware corporation wholly owned by the Venezuelan state-owned oil company PDVSA. Instead, the Third Circuit decided that a non-debtor transferor cannot be liable for a fraudulent transfer under the Delaware Uniform Fraudulent Transfer Act (“DUFTA”).

For PDVSA’s secured 2020 bondholders, the decision is welcome news, and makes the chances of any of those transactions being unwound, and the liens granted to 2020 bondholders set aside, even more remote. While Crystallex’s chance at a recovery against PDVSA remains alive if it is successful in its alter ego claims, PDVSA 2020 bondholders can rest easier knowing that they will retain their liens and priority to any proceeds from a sale of their collateral ahead of Crystallex or similar claimants even if such claimants successfully pursue alter ego claims against PDVSA. For other Republic creditors considering a similar strategy to Crystallex, the chances of jumping ahead of the 2020 secured PDVSA bonds or even debt below PDV Holding are now less likely, and with each passing day of litigation, the challenge of collecting any award from the cash-strapped nation only increases.

The article is available here.

The First Circuit Joins Several Other Circuit Courts in Finding That Creditors’ Committees Have an Unconditional Right to Intervene in Adversary Proceedings

By Todd E. Phillips, Kevin C. Mackley and Sally J. Sullivan (Caplin & Drysdale).

In September, the First Circuit Court of Appeals joined several other Circuits in holding that section 1109(b) of the Bankruptcy Code provides an official creditors’ committee with an “unconditional right to intervene” in an adversary proceeding related to a bankruptcy. The case, Promesa Financial Oversight and Management Board, was the appeal of an order from the District Court for the District of Puerto Rico, which had denied an intervention motion in a debt adjustment case brought under the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”). The First Circuit reversed the order, distinguishing the case from the First Circuit’s own precedent In re Thompson upon which the District Court had relied.  The Promesa Financial Oversight and Management Board decision aligns the First Circuit with the Second and Third Circuits and evidences a growing Circuit trend toward recognizing the unconditional right of a creditors’ committee to intervene, rejecting the Fifth Circuit’s contrary analysis in the Fuel Oil case, which had previously represented the prevailing view for many years.

The full paper can be found here.

 

Merit Management v. FTI: Law Firm Perspectives

On February 27, the Supreme Court decided Merit Management Group, LP v. FTI Consulting, Inc., holding unanimously that the § 546(e) safe harbor does not protect allegedly fraudulent transfers “in which financial institutions served as mere conduits.” The Court’s decision resolves a circuit split on the reach of § 546(e). In reaching its conclusion, the Court focused on the “end-to-end transfer” that the trustee seeks to avoid, rather than any “component parts of the overarching transfer.” In FTI, because the overarching transfer was made between two parties not otherwise shielded by the safe harbor, the transfer will now fall outside the safe harbor.

As many law firms recognize, this decision will have wide-ranging implications on the finality of securities transactions effected through financial institutions, especially leveraged buyouts. Mayer Brown notes that as the decision enhances a trustee’s ability to recover fraudulent transfers, it also increases the bankruptcy estate’s leverage against recipients of pre-petition transfers. Cleary observes that “debtors or trustees may strategically frame avoidance actions in order to limit the scope of the safe harbor.” Mayer Brown concludes that the decision may also expose investors, investment funds and similar entities to fraudulent transfer litigation risks.

The bottom line, as Davis Polk notes, is that the § 546(e) safe harbor is no longer a blanket safe harbor for the recipients of transactions that pass through financial institutions. But the safe harbor will still shield financial institutions operating as escrow agents or clearinghouses, as the Court expressly stated that a financial institution under § 546(e) is protected whether the institution acts as a principal or as an intermediary.

Firms have noted that the decision also left open some ambiguities. First, Schulte Roth & Zabel writes that the Court leaves open possible arguments that any “customer” of a “financial institution” is also itself a “financial institution” under § 546(e). Second, Mayer Brown points out that the Court did not address whether the transaction at issue actually qualified as a transfer that is a “settlement payment” or made in connection with a “securities contract” under § 546(e). These ambiguities will draw the attention of defendants in future fraudulent transfer litigation.

Finally, Weil notes that the decision raises the question of how the preemption of state-law creditor remedies under § 546(e) will be applied in light of the Supreme Court’s now-narrow construction of the safe harbor.

By Jianjian Ye, Harvard Law School, J.D. 2018.

The roundtable has posted on FTI before. Some of those posts are: an analysis of the FTI oral argument, the Amici Curiae Brief of Bankruptcy Law Professors, an article by Ralph Brubaker on the meaning of § 546(e), and a roundup of law firm perspectives on the Seventh Circuit’s decision in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016).