Saving Fraudulent Transfer Law
41 Pages Posted: 14 Sep 2011 Last revised: 10 Jul 2012
Date Written: July 22, 2011
Private equity firms rely on leveraged buyouts in order to acquire target companies. Though leveraged buyouts were a wildly popular acquisition method in the last decade, the process tends to burden target companies with staggering debt obligations. In the event that cash flow contracts, companies acquired through a leveraged buyout can find themselves unable to service their debt, and many file for bankruptcy. Unfortunately, once in bankruptcy, creditors face diminished recoveries because the target companies have secured debt well in excess of their assets’ value. In an effort to bring funds into the bankruptcy estate, creditors are likely to rely on fraudulent transfer law to attack the leveraged buyout that precipitated the debtor’s fall. By convincing the bankruptcy court to avoid the leveraged buyout, creditors can recover funds (the “Settlement Payments”) that were transferred to former shareholders as part of the acquisition. In response to such creditor suits, defendant-shareholders of privately held corporations have increasingly argued that section 546(e) of the Bankruptcy Code exempts Settlement Payments from fraudulent transfer law and effectively creates a shield that precludes courts from deciding suits on the merits. These shareholders have relied on a literal reading of the section; a reading that contravenes the section’s legislative history. Despite this contravention, courts have become increasingly receptive to this defense. The Second, Third, Sixth, Eighth and Tenth Circuit Courts of Appeals have relied on the plain language of the section in protecting these shareholders. But the Eleventh Circuit Court of Appeals and the majority of bankruptcy courts have considered the policy objectives behind the section and refused to apply it in a manner that they believe undermines Congressional intent. The Supreme Court has failed to resolve this circuit split.
This article proposes an unprecedented solution to this problem and reexamines how section 546(e) should be applied in light of the prominent role the section will play in upcoming years. Through a more exact exploration of section 546(e)’s legislative history and the securities clearing system Congress sought to protect, this article proposes the elimination of excess protections that eviscerate the remedial effects of fraudulent transfer law and fail to serve the policy goals of section 546(e) in any meaningful way. The comprehensive changes advocated herein will better align the section with the policies that supported its enactment and prevent a nominal number of shareholders from receiving windfall profits to the detriment of thousands of unsecured creditors.
Ultimately, there are few legal issues that precipitate multi-billion dollar lawsuits. This is one of them.
Keywords: Fraudulent Transfer Law, Leveraged Buyouts, Section 546(e), Securities Clearing System, Bankruptcy
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