Second Circuit Finds Bankruptcy Safe Harbor Trumps State Law Fraudulent Transfer RightsThe U.S. Court of Appeals for the Second Circuit recently ruled in In re Tribune Co. Fraudulent Conveyance Litigation that the safe harbor under Section 546(e) of the Bankruptcy Code preempts creditors’ claims under state fraudulent transfer laws.

The Tribune Media Company was purchased via a leveraged buyout (LBO) in 2007 that involved borrowing more $11 billion, most of which was used to restructure Tribune’s debt and to buy out former shareholders. Following the LBO, Tribune filed for bankruptcy in the District of Delaware. The Delaware court authorized the unsecured creditors to pursue an intentional fraudulent transfer action to recover payments made to shareholders during the LBO, as intentional fraudulent transfer claims are not barred by Section 546(e) of the Bankruptcy Code.

Two groups of unsecured creditors — former Tribune employees with retirement benefit claims and successor indenture trustees for Tribune’s pre-buyout debt — brought suit, claiming that the transfers were constructive fraudulent conveyances under state law. Tribune argued for dismissal, stating that the creditors were prohibited from pursuing their claims due to the automatic stay and that Section 546(e) preempted state law constructive fraudulent transfer claims.

A district court held that the creditors’ claims were barred by the automatic stay but that Section 546(e) only applied to the claims of a bankruptcy trustee and not to state law governing fraudulent transfer claims.

On appeal, the Second Circuit reversed, holding that creditors were not enjoined by the automatic stay from pursuing their claims. However, the Court dismissed those claims, finding that Section 546(e) preempted the claims under state fraudulent transfer laws. The Court noted, “Once a party enters bankruptcy, the Bankruptcy Code constitutes a wholesale preemption of state laws regarding creditors’ rights.”

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