Article courtesy of Margaret G. Parker-Yavuz (Akin Gump) and Chanwon (Pio) Yoon (Akin Gump)
Kirschner v. Large S’holders (In re Tribune Co. Fraudulent Conveyance Litig.), 10 F.4th 147 (2d Cir. 2021)
Bankruptcy litigation trustee brought fraudulent conveyance and other claims on behalf of creditors against shareholders who sold their stock in the Tribune Company’s leveraged buyout in 2007 and against financial advisors that assisted the Tribune Company with the leveraged buyout process. In several orders and decisions, the district court dismissed the trustee’s claims for failure to state a claim. The Second Circuit affirmed the dismissal of the claims against the Tribune Company’s shareholders. The Second Circuit also affirmed the dismissal of the claims against the financial advisors except in the case of the intentional fraudulent conveyance claim against the solvency opinion provider, Valuation Research Company, and the constructive fraudulent conveyance claims against the Tribune Company’s financial advisors, Citigroup and Merrill Lynch.
Prior to its bankruptcy in 2008, the Tribune Company (“Tribune”) was the largest media conglomerate in the U.S. and owned numerous radio and television stations and major national newspapers. As the newspaper publishing industry declined, in September 2006, Tribune’s board of directors (the “Board”) created a special committee (the “Special Committee”) to consider ways to return value to Tribune’s shareholders. The Special Committee was comprised of all seven of the Board’s independent directors (the “Independent Directors”).
In early 2007, Sam Zell, an investor, proposed to take Tribune private. Holders of approximately 33% of Tribune’s publicly-held shares (collectively, the “Large Shareholders”) were concerned that Tribune’s stock price would fall before they could sell their shares and indicated that they would only vote for a two-step leveraged buyout (“LBO”) that would allow them to cash out during the first step. Zell suggested a two-step LBO in which, during the first step, Tribune would borrow money to buy back roughly half of its shares and, during the second step, Tribune would borrow more money to purchase the remaining shares. Tribune had engaged two financial advisors, Merrill, Lynch, Pierce, Fenner, and Smith, Inc. (“Merrill Lynch”) and Citigroup Global Markets, Inc. (“Citigroup”), to conduct a strategic review and recommend possible responses to the changes in the industry; under their engagement letters, each was promised a success fee of $12.5 million if a strategic transaction was completed. The Board consulted Merrill Lynch and Citigroup in considering whether to approve the LBO. The two-step LBO was recommended by a unanimous vote of the Special Committee and was ultimately approved by the Board.
After having difficulty obtaining a solvency opinion to secure financing for the LBO, Tribune approached Valuation Research Company (“VRC”) to provide two solvency opinions, one opinion for each step of the LBO. VRC issued a solvency opinion that Tribune would be solvent after the first step. However, after VRC issued this opinion, Tribune’s management team realized that the financial projections upon which VRC’s opinion was based were no longer accurate. No one alerted VRC that Tribune was unlikely to meet the projections. Tribune delivered the solvency opinion to the financing banks and borrowed $7 billion to pay off its existing bank debt and to buy back approximately 50% of its publicly held shares. The Large Shareholders sold all of their shares and the Board members appointed by them resigned.
Prior to the second step of the LBO, Tribune’s financial projections forecasted that its performance would improve, but VRC was reluctant to issue a second solvency opinion because it did not appear that Tribune would be able to repay its debts without refinancing its existing debts. Tribune’s management incorrectly represented to VRC that Morgan Stanley & Co. LLC (“Morgan Stanley”), the Special Committee’s financial advisor, believed that Tribune would be able to refinance its debts. VRC then issued a solvency opinion that Tribune would be solvent after the second step. The Board’s financial advisors, Citigroup and Merrill Lynch disagreed with VRC’s solvency analyses (their own analyses indicated that Tribune would be insolvent by more than $1.4 billion and $1.5 billion, respectively), but neither advisor tried to stop the transaction. The second step of the LBO closed and Tribune borrowed an additional $3.7 billion to buy back its remaining publicly held shares. From this two-step LBO, Tribune’s directors and officers received approximately $107 million from selling their stock and from bonuses, and Citigroup and Merrill Lynch each received a $12.5 million success fee.
After the second step of the LBO closed in December 2007, Tribune had roughly $13 billion in debt. Less than one year after the closing, Tribune filed for chapter 11. Various claims were filed in the Delaware bankruptcy court on behalf of creditors, including for fraudulent conveyance. In addition, around 74 federal and state lawsuits asserting fraudulent conveyance and related claims were filed by Tribune’s creditors in other courts. Following Tribune’s emergence from bankruptcy in 2012, the bankruptcy claims and the federal and state actions were transferred to the Southern District of New York and consolidated.
This Second Circuit opinion followed proceedings in the district court, the Second Circuit and the Supreme Court and earlier opinions issued by the Second Circuit, including (1) a 2016 opinion in which the Court affirmed the district court’s dismissal of the state law fraudulent conveyance claims, In re Tribune Co. Fraudulent Conv. Litig., 818 F.3d 98 (2d Cir. 2016) and (2) a 2019 opinion in which the Court issued an amended opinion affirming the district court’s dismissal of the state law constructive fraudulent conveyance claims on the basis that they were preempted by section 546(e) of the Bankruptcy Code (which provides that a trustee may not avoid a transfer made by or to a “financial institution” in connection with “a securities contract”), In re Tribune Co. Fraudulent Conv. Litig., 946 F.3d. 66 (2d Cir. 2019).
In this decision, the following categories of claims brought by the bankruptcy litigation trustee (the “Trustee”) were before the Court for review following the district court decisions: (i) intentional fraudulent conveyance claims against the shareholders based on the buy-back of their shares; (ii) breach of fiduciary duty and aiding and abetting breach of fiduciary claims against those shareholders alleged to be controlling shareholders, (iii) aiding and abetting breach of fiduciary duty, professional malpractice, intentional fraudulent conveyance and constructive fraudulent conveyance claims against Citigroup, Merrill Lynch, Morgan Stanley and VRC (collectively, the “Financial Advisors”) and (iv) request for leave to amend.
Intentional Fraudulent Transfer Claims
The Court first addressed whether the district court erred in dismissing the Trustee’s intentional fraudulent transfer claims against the shareholders whose shares were bought-back as part of the LBO. The Court noted that section 548(a)(1)(A) of the Bankruptcy Code allows a bankruptcy trustee to recover fraudulent transfers where a transfer has been made with “actual intent to hinder, delay, or defraud” creditors. The Court noted that the issue of whether a company’s officers’ intent to defraud can be imputed to an independent special committee, as the Board delegated its authority to approve a merger and redemption of Tribune’s stock to the Special Committee in this case, for purposes of a fraudulent conveyance claim under the Bankruptcy Code is a question of first impression in the Second Circuit. The Court then applied the “control test” used by the First Circuit which provided that “a company’s intent may be established only through the ‘actual intent’ of the individuals ‘in a position to control the disposition of [the transferor’s] property.” In re Roco Corp., 701 F.2d 978 (1st Cir. 1983); In re Lehman Bros. Holdings, Inc., 541 B.R. 551 (S.D.N.Y. 2015).
Here, the Trustee argued that Tribune’s senior management (not the Special Committee) had the necessary fraudulent intent and that this intent must be imputed to the Special Committee. The Court rejected this argument and concluded that the district court properly applied the control test as the Trustee failed to plausibly allege that the intent of Tribune’s senior management should be imputed to the Special Committee because the Trustee failed to plausibly allege that Tribune’s senior management controlled the transfer of the property in question. The Court also found that the district court properly held that the Trustee failed to plead “badges of fraud” sufficient to raise a strong inference of actual fraudulent intent on the part of the Special Committee. The Court disagreed with the Trustee’s argument that the Independent Directors’ profit motive in approving the LBO was sufficient to give rise to a strong inference of actual fraudulent intent and further noted that it would be “unreasonable to assume actual fraudulent intent whenever the members of a board of directors . . . stood to profit from a transaction they recommended or approved.” Similarly, the Court found unpersuasive the argument that the Independent Directors were aware (i) that Tribune was unlikely to be able to service its debt and (ii) of the risky nature of the LBO. The Court noted that even assuming that the Independent Directors were wrong in believing that Tribune’s financial situation would improve, their approval of a risky transaction would support a negligence or constructive fraud claim, but not an intentional fraudulent transfer claim.
State Law Fiduciary Duty Claims
The Court next addressed the Trustee’s claim that the Large Shareholders breached their fiduciary duties under Delaware law by pushing for the LBO based on projections they knew to be false and by causing Tribune to incur debt they knew would leave Tribune insolvent. The Trustee also claimed that the Large Shareholders aided and abetted senior management’s own breach of fiduciary duty and were unjustly enriched. The Court agreed with the district court decision dismissing the Trustee’s claims and concluding that the Trustee’s claims failed at the first step of the LBO because the Trustee could not plausibly argue that Tribune was insolvent at that point. While the district court concluded that the Trustee had adequately pleaded Tribune’s insolvency at the second step of the LBO, it held that the fiduciary duty claims nevertheless failed because, after step one of the LBO, the Large Shareholders no longer owned any Tribune stock and their appointed directors had resigned from the Board. The Trustee also argued that the two steps of the LBO should be collapsed so that the LBO is viewed as a single unitary transaction. The Court, however, found it significant that the first step of the LBO was able to stand alone and that there was no binding commitment to undertake the second step, and affirmed the district court’s conclusion that the two steps must be considered independently.
Claims Against Financial Advisors
Next, the Court addressed whether the district court erred in dismissing the Trustee’s claims against the Financial Advisors for (1) aiding and abetting breaches of fiduciary duty and professional malpractice, (2) intentional fraudulent conveyance and (3) constructive fraudulent conveyance.
With respect to the first category, the Trustee alleged that the Financial Advisors aided and abetted Tribune’s directors and officers in breaching their fiduciary duty when they hid Tribune’s true financial projections in order to complete the LBO. The Court reviewed the in pari delicto doctrine that acts as an affirmative defense to an aiding and abetting claim by barring a plaintiff from suing for aiding and abetting a breach of fiduciary duty if the plaintiff’s hands are not clean. As applied to corporations, the doctrine imputes the illegal actions of a corporation’s officers and directors to the corporation.. The Court noted that the in pari delicto doctrine applied to the Trustee’s aiding and abetting and professional malpractice claims and, since the Court found that Tribune received some benefit from the LBO and the Financial Advisors were independent advisors, none of the exceptions to the in pari delicto doctrine applied. Therefore, the Court affirmed the district court’s dismissal of the aiding and abetting and professional malpractice claims as to all Financial Advisors.
With respect to the second category, as discussed above, section 548(a)(1)(A) of the Bankruptcy Code allows a bankruptcy trustee to recover transfers made with “actual intent to hinder, delay, or defraud” creditors. The Court agreed with the district court’s conclusion that the Trustee did not sufficiently show that Morgan Stanley, Citigroup and Merrill Lynch had actual intent to defraud. However, the Court disagreed with the district court as to the intentional fraudulent conveyance claims against VRC. The Court noted that the fact that (a) VRC was hastily hired after other prominent firms declined to provide a favorable solvency opinion, (b) VRC charged Tribune the highest fee it had ever charged and (c) VRC agreed to define “fair value” inconsistently with the industry standard upon which VRC had relied for its previous opinion supported the conclusion that the Trustee sufficiently pleaded that VRC had actual fraudulent intent. The Court therefore affirmed the district court’s dismissal of the intentional fraudulent conveyance claims as to Morgan Stanley, Citigroup and Merrill Lynch and vacated the dismissal of these claims as to VRC.
With respect to the constructive fraudulent transfer claims against the Financial Advisors, the Court cited section 548(a)(1)(B) of the Bankruptcy Code, which provides that a trustee may recover constructive fraudulent transfers where the debtor received less than a reasonably equivalent value in exchange for the transfer and one or more other factors applied, such as the debtor was insolvent when the transfer was made. The Court noted that the Bankruptcy Code does not define “reasonably equivalent value” and, therefore, courts must examine the totality of the circumstances. Here, the Court explained that the various Financial Advisors were differently situated. As to Citigroup and Merrill Lynch, the Trustee alleged that the $12.5 million success fees paid to each firm upon consummation of the LBO were a constructive fraudulent conveyance. The Court found that since the firms were entitled to their success fees only upon consummation of the LBO, the success fees were not unavoidable antecedent debt. The Court concluded that the district court’s dismissal of the constructive fraudulent conveyance claims against these parties was “premature” because the factual question of whether Citigroup and Merrill Lynch provided reasonably equivalent value for their success fees cannot be decided without first assessing whether they satisfactorily performed their duties. The Court therefore vacated the dismissal of the constructive fraudulent transfer claims against Citigroup and Merrill Lynch. In contrast, the Court found no error in the district court’s dismissal of the constructive fraudulent transfer claims against Morgan Stanley and VRC because those firms did not have a financial stake in the LBO’s consummation (they earned their fees upon delivery of their contracted-for opinions) and their fees were due before the first step of the LBO closed. The Court thus affirmed the dismissal of the constructive fraudulent conveyance claims against Morgan Stanley and VRC.
Leave to Amend
Finally, the Court addressed the district court’s denial of the Trustee’s request for leave to amend the complaint as to the shareholders in two respects: (1) to add allegations in support of the intentional fraudulent conveyance claims and (2) to add a constructive fraudulent conveyance claim. The Court agreed with the district court’s denial with respect to the intentional fraudulent claims given that the Trustee failed to propose any amendments that would cure the pleading defects. The Court also agreed with the district court’s denial with respect to the constructive fraudulent conveyance claims on the grounds that the shareholders would suffer substantial prejudice and the proposed amendments would be futile. The Court therefore affirmed the district court’s denial of the Trustee’s motion for leave to amend.
After issuing its above decision, on October 7, 2021, the Second Circuit issued an order denying a petition of the Trustee for a panel rehearing or a rehearing en banc. On January 5, 2022, the case was appealed to the U.S. Supreme Court; the appeal focuses on whether a corporate agent “must be ‘in a position to control’” a transfer in order for an agent’s intent to be “imputable” to the corporation under section 548(a)(1)(A) of the Bankruptcy Code.