Liquidating Trustees Not Allowed to Wear Their Non-Bankruptcy Hats to Avoid Swap Transactions as Fraudulent Conveyances

By: Aura M. Gomez Lopez

St. John’s University Law Student

American Bankruptcy Law Review Staff

In a case of first impression, in Whyte v. Barclays,[1] the United States District Court for the Southern District of New York recently held that a trustee for a litigation trust, created pursuant to a confirmed chapter 11 plan, could not use state law to avoid a swap agreement as a fraudulent conveyance.  In Whyte, SemGroup, filed for bankruptcy in 2008.[2] On October 28, 2009, the court approved the creation of a litigation trust charged with the responsibility to liquidate SemGroup’s assets.[3] Prior to filing for bankruptcy, SemGroup entered into a novation with Barclays, by which Barclays acquired SemGroup’s portfolio of commodities derivatives.[4] However, soon after the novation was completed, the portfolio became profitable.[5] As a result, the litigation trustee sought to avoid the swap agreement on the grounds that the transaction between SemGroup and Barclays was a fraudulent conveyance under New York law.[6]  The litigation trustee, however, did not attempt to avoid the swap agreement under section 544 of the Bankruptcy Code due to the safe harbor provision of section 546(g).[7] Notwithstanding the litigation trustee’s attempt to circumvent the safe harbor provision of section 546(g), the district court dismissed the trustee’s complaint and held that section 546(g) preempted the state-law fraudulent conveyance claims.[8]

Section 546(g) provides that a bankruptcy trustee cannot avoid “a transfer, made by or to (or for the benefit of) of a swap participant or financial participant, under or in connection with any swap agreement and that is made before the commencement of the case.”[9]  “The [Bankruptcy] Code’s definition of swap agreements is ‘extremely broad, covering several dozen enumerated contracts and transactions, as well as combinations of them, options on them, and similar contracts and transactions.’”[10] Under this broad interpretation, and since the litigation trustee did not dispute that the novation qualified as a swap agreement, the Whyte court found SemGroup’s agreement with Barclays was subject to the safe harbor provision section 546(g).[11] In holding that “section 546(g) impliedly premept[ed] the [litigation t]rustee’s attempt to resuscitate fraudulent avoidance claims as the assignee of certain creditors where . . . she would be expressly prohibited by section 546(g) from asserting those claims as assignee of the debtor-in-possession right’s . . . ,”[12] the Whyte court reasoned that using state law to avoid swap agreements would nullify section 546(g) and thereby circumvent Congress’s goal of creating stability in financial markets.[13]  The Whyte court’s holding that section 546(g) preempted the litigation trustee’s state law fraudulent conveyance claims is consistent with the reasoning advanced by other courts interpreting section 546(e), which protects “settlement payments” in securities transactions from avoidance by a trustee. 

Courts interpreting section 546(e) have held that section 546(e) preempted a trustee’s state law unjust enrichment claims, which sought to recover otherwise unavoidable settlement payments made to shareholders in connection with various LBOs.[14] In their decisions refusing to allow recoveries that would require undoing settled securities transactions, these courts have reasoned that a trustee cannot assert state law unjust enrichment claims in order to circumvent the safe harbor provision of section 546(e) because “[a]llowing recovery on these claims would render the [section] 546(e) exemption meaningless, and would wholly frustrate the purpose behind that section.”[15]

Whyte is the first decision to hold that the safe harbor provision of section 546(g) preempts, and therefore bars, a trustee’s state law fraudulent conveyance claim that is commenced after a chapter 11 plan is confirmed. Whyte is significant because it indicates that trustees cannot file state law actions in an effort to circumvent safe harbor provisions guaranteed under section 546(g).[16]  Whyte is also significant because in light of the recent decision from the In re Tribune Co. Fraudulent Conveyance Litig.[17]  In Tribune, the court held that the safe harbor provision of section 546(e) did not preempt state law fraudulent conveyance actions brought by individual claimants because the statute only explicitly prohibits a “trustee” from bringing such actions.[18]  As such, although the issue has yet to arise, a court may similarly determine that section 546(g) similarly does not preempt state law fraudulent conveyance claims asserted by individual creditors.

[18] Id. at 320.