A New Page in the Tribune Bankruptcy Diary
The Legal Intelligencer
Reprinted with permission from the February 9, 2017 issue of The Legal Intelligencer. © 2017 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
For the last nine years, the bankruptcy of media conglomerate Tribune Co. has produced a long diary of court opinions interpreting a variety of Bankruptcy Code provisions. It is time for a new entry. Last month, the U.S. District Court for the Southern District of New York dismissed with prejudice a fraudulent conveyance claim brought by a litigation trustee seeking recovery on behalf of the company's unsecured creditors in In re Tribune Fraudulent Conveyance Litigation, No. 11-md-2296, 2017 BL 5202 (S.D.N.Y. Jan. 6). This was no garden-variety fraudulent conveyance claim: the trustee sought to recover $8 billion that certain Tribune public shareholders received as part of the ill-fated leveraged buyout that took place prior to the company's December 2008 bankruptcy. The Tribune court dismissed the trustee's claim for several reasons, but most significantly for failure to sufficiently allege that the actions of the company's officers should have be imputed to the company for purposes of determining whether Tribune entered in the LBO with the requisite intent to defraud creditors. Judge Richard Sullivan's decision on this issue is important not only because of its applicability to fraudulent conveyance actions involving corporations, but also because he applied a different legal standard and reached a different conclusion than his colleague, Judge Denise Cote, in In re Lyondell Chemical, 554 B.R. 635, 638 (S.D.N.Y. 2016).
The events precipitating the Tribune bankruptcy are familiar by now but will be summarized briefly below. In June 2006, in the midst the company's deteriorating financial condition, Tribune's board of directors formed a special committee of independent directors to pursue a sale of the company, including through an LBO, in which a target company is acquired for a purchase price that is funded largely by a loan secured on the target company's assets. Notably excluded from the special committee were board members who owned significant amounts of company stock, CEO Dennis FitzSimons (13 percent owner) and three members who represented various trusts (collective 20 percent owners). In early 2007, an investment group led by Sam Zell reached an agreement in principle to acquire a controlling interest in Tribune through a two-step LBO. The board and special committee each engaged investment banks and other advisers to vet the transaction. After the banks and advisers issued initial fairness and "solvency opinions"—i.e., statements opining that post-transaction, the company would be able to pay its debts as they came due—the special committee unanimously recommended that the full board approve the transaction. The full board did so.
After board approval, Tribune engaged Valuation Research Co. (VRC) to issue additional solvency opinions before each step of the LBO occurred. As alleged by the trustee, Tribune's officers influenced the completion of the LBO in two ways: drafting the VRC engagement letter, which instructed VRC to issue its opinions using a definition of "fair value" that was less rigorous than the definition used in prior opinions; and drafting the financial projections on which VRC relied in issuing its solvency opinions. The LBO was completed after VRC issued its solvency opinions and Tribune's board, special committee, and shareholders voted in favor of each step.
Zell's Tribune lasted a little less than a year. The LBO was completed on Dec. 20, 2007, and on Dec. 8, 2008, the company filed for Chapter 11 bankruptcy in the District of Delaware, citing its inability to meet the management-prepared financial projections on which VRC relied.
One could write a textbook on the all the litigation that ensued. Indeed, there is space in these pages to address in detail only one of the important rulings in Sullivan's January 2017 opinion. Accordingly, for present purposes, it is enough to explain that in 2010, the committee of unsecured creditors set their sights on the $8 billion paid to certain Tribune shareholders in connection with the LBO. The unsecured creditors' claims were subsequently transferred to the litigation trustee, who pursued fraudulent conveyance claims against the shareholder defendants—a group of over 5,200 individuals who received $50,000 or more from the LBO.
Under Section 548 of the Bankruptcy Code, a trustee can avoid a transfer of the debtor's property—here, the money paid to the shareholder defendants—if the debtor made the transfer within two years of the bankruptcy filing and "with an actual intent to hinder, delay, or defraud" its creditors (11 U.S.C. Section 548(a)(1)(A)). Because the shareholder defendants could not credibly make a timeliness argument, they moved to dismiss on the ground that the trustee had not sufficiently pleaded that Tribune transferred the money with "actual intent" to defraud creditors.
Sullivan first clarified whose intent was relevant. Because the transferor (Tribune) was a corporation, and corporations act through their agents, he analyzed the actions of three groups of corporate agents—the shareholders, the special committee, and company officers—in order to determine whether their intent should be imputed to the company.
Sullivan did not have much difficulty answering this question for the shareholders and special committee. He noted that although the LBO could have proceeded without formal shareholder approval, the trustee alleged no facts suggesting that the shareholders acted with any intent to defraud, as they effectively rubber stamped the transaction after the special committee and board approved it. Sullivan reached the opposite conclusion for the special committee, holding that its intent was imputed to the company because the committee was "clearly in a position to control the outcome of the board's vote on the LBO and did in fact supply the necessary votes to approve the LBO." (Later in the opinion, Sullivan decided that the trustee had not alleged sufficient facts showing that the special committee acted with "actual intent" to defraud creditors.)
The harder question to answer was whether to impute to Tribune the intent of its corporate officers. In deciding what standard to apply, Sullivan reviewed several options. The bankruptcy court in Lyondell held that the proper test was to impute intent where the officers were "in a position to control the disposition of the [company's] property" that was transferred—for example, by exercising a majority vote in the corporation or effectively controlling the corporation's decision to transfer through other means. On appeal, Cote disagreed and imposed a less-stringent test, in which an officer's acts could be imputed to the corporation so long as the officer was acting within the scope of his or her employment.
Breaking with his colleague on the district court, Sullivan applied the "control" test articulated by the Lyondell bankruptcy court, because the test "appropriately accounts for the distinct roles played by directors and officers under corporate law, while also factoring in the power certain officers and other actors may exercise over the corporation's decision to consummate a transaction."
Having decided on the appropriate test, the Tribune court then reviewed whether the trustee sufficiently alleged that the company's officers wielded voting and managerial power so as to "control the disposition" of money paid to the shareholder defendants in connection with the LBO. Sullivan easily concluded that FitzSimon's 13 percent ownership did not amount to enough "control" over the special committee's decision. With respect to "managerial power," the trustee argued that the officers influenced the special committee's decision-making process by attending nearly all committee meetings and by "manipulating the information provided to the special committee" through preparing the financials on which VRC relied in issuing its solvency opinions and directing VRC to base those opinions on a "non-standard definition of fair value." The Tribune court held that attendance at meetings, without more, was not suggestive of untoward control over the special committee. As to the trustee's second argument—alleged manipulation of information provided to the special committee—the court highlighted that the committee had engaged its own adviser, which independently vetted the entire transaction, including the reliability of management's financial projections. Sullivan also contrasted the case with Lyondell, in which the "board allegedly plunged headlong into an LBO at the urging of its CEO, notwithstanding the board's failure to obtain a solvency opinion or obtain meaningful analysis from an independent advisor concerning the transferor corporation's ability to repay its debts." Sullivan also distinguished the Tribune special committee, which collectively received $6 million as a result of the LBO, with the membership of the approving board in Lyondell, which included a member who "stood to gain $326 million from the sale." Accordingly, Sullivan held that because Tribune's corporate officers lacked sufficient control over the special committee's decision-making process, their intent could not be imputed to the company.
Sullivan concluded his imputation analysis with a thought-provoking discussion of the repercussions of allowing the trustee's claim to move forward. Sullivan observed that the trustee's position—that Tribune's officers effectively controlled the special committee by influencing the VRC solvency opinions—"would undermine Congress' policy of protecting securities markets by introducing substantial uncertainty to the law governing actual fraudulent conveyance claims." Should multibillion-dollar transactions be put in jeopardy "given the ease with which one could allege that the misrepresentation of a material fact ... manipulated the board's decision-making?" According to Sullivan, this is appropriate only where corporate officers "deliberately and directly exert control inside the boardroom," but not where corporate officers attempt to sway board decisions in more subtle ways.
The Tribune court ruling has created a division of authority in the Southern District of New York, one of the busiest and influential bankruptcy venues in the country. Given that Sullivan dismissed the trustee's fraudulent transfer claim with prejudice, the trustee may seek to appeal the decision to the Second Circuit. Until then, courts in the Southern District of New York will have two approaches from which to choose when considering whether corporate transactions should be undone by the conduct of corporate officers.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.