Expanding the Settlement Payments Exception in LBOs

By: Matthew McNamara

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

The Delaware district court has affirmed a bankruptcy court decision extending the settlement payment exception to the trustee’s avoiding powers to insulate from attack a leveraged buyout (“LBO”) involving a non-public company in Brandt v. B.A. Capital LP (In re Plassein International Corporation).

[1]

 The Plassein trustee sought to avoid transfers to the selling shareholders under Delaware fraudulent transfer law and section 544 of the Bankruptcy Code.

[2]

  Section 546(e), however, states that a settlement payment falls under an exemption to section 544 and thus the trustee may not void the transfer.

[3]

  Plassein follows and expands upon a line of cases adopting a broad interpretation of the term “settlement payment”.  The Third Circuit has adopted an extremely broad interpretation of the term, noting that it encompasses “almost all securities transactions”.

[4]

  Earlier decisions imposed policy based limitations on the section 546(e) settlement payment exemption in order to exclude payments made to shareholders as part of an LBO.

[5]

  The court in In re Resorts International

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, however, made it clear that “a payment for shares during an LBO is obviously a common securities transaction, and [the court] therefore [held] that it is also a settlement payment for the purposes of section 546(e)”.

[7]

  The shares in question in In re Resorts, however, were securities of a publicly traded company.  The court failed to specify whether the settlement payment exemption in an LBO was limited to shares of publicly traded companies or might also protect LBO’s involving non-public companies. 

That issue was addressed in Plassein

[8]

where five privately held corporations were acquired by Plassein International Corporation by purchasing shares from the respective companies’ shareholders in an LBO.

[9]

  The Plassein Corporation filed Chapter 11 and later converted to Chapter 7.   Brandt, the Chapter 7 trustee, sought to recover the payments made in the course of the LBO to shareholders of the non-public companies, claiming the payments failed to qualify for the section 546(e) settlement payment exemption.

[10]

 Acknowledging that the Resorts decision established that payments made to shareholders in an LBO fell under the broad umbrella definition of “settlement payment” pursuant to section 546(e), Brandt nonetheless argued that Resorts only applied to publicly-traded securities and not to non-public securities.

[11]

 

The bankruptcy court rejected Brandt’s argument and held that payments made to shareholders of non-public companies should be treated the same as payments made to shareholders of public companies for purposes of the “settlement payment”.

[12]

  The court based its holding on the reasoning of earlier cases, which made it clear that “settlement payment” should “be applied broadly to any transaction of stock or cash to pay for stock.”

[13]

  Additionally, the court relied on In re Loranger Manufacturing Corp.

[14]

, which found payments to shareholders of a private company in an LBO to be settlement payments protected by section 546(e).

[15]

  The Plassein bankruptcy court stated that the “broad application of what constitutes a settlement payment . . . covers even transactions which, as here, are LBO purchases of non-public securities.”

[16]

 

Upheld on appeal, the ruling in Plassein makes it clear that the section 546(e) exception to avoidable transfers is subject to increasingly broad interpretation, raising questions as to what policy-based limitations, if any, will be applied to the term “settlement payment.”

[17]

  The apparent intent of the section 546(e) exemption was not to provide a loophole for any and all transfers involving securities, but to protect the public markets from the disruption of avoidable transfers.

[18]

  Interpreting section 546(e) to provide a safe harbor for payments made to shareholders of private companies in an LBO is not necessary to avoid risk to the public securities market.  Expanding the scope of the exception beyond original congressional intent, the question the courts will now have to answer is what are the limits and boundaries to the 546(e) “settlement payment” exemption of avoidable transfers.