In re Tronox, Inc., 2013 Westlaw 6596696 (Bankr. S.D.N.Y 2013)
In re Tronox, Inc., 2013 Westlaw 6596696 (Bankr. S.D.N.Y 2013). A bankruptcy court decision, but the reasoning as to why there was a fraudulent conveyance could be very important, in future, if additional courts in future agree with this reasoning:
Facts: An oil, gas, and chemical company was burdened with enormous “legacy liabilities,” primarily due to environmental contamination. The company developed a plan to spin off its viable assets, leaving the legacy liabilities with a newly-formed successor entity. The complex asset divestiture proceeded over a period of several years. A few years after the completion of the transaction, the successor entity responsible for the legacy liabilities filed a Chapter 11 petition and then brought suit against the spinoff participants, claiming that the entire series of transactions had constituted fraudulent transfers under Oklahoma law. The estate asked for roughly $15 billion in damages.
Reasoning: Following a lengthy trial, the court held that the transactions, when collapsed, constituted fraudulent transfers, under both the “actual fraud” and “constructive fraud” prongs of the fraudulent transfer statutes:
[The former corporate entity] acted to free substantially all its assets—certainly its most valuable assets—from 85 years of environmental and tort liabilities. The obvious consequence of this act was that the legacy creditors would not be able to claim against "substantially all of the [former company’s] assets," and with a minimal asset base against which to recover in the future, would accordingly be "hindered or delayed" as the direct consequence of the scheme. This was the clear and intended consequence of the act, substantially certain to result from it . . . . [A] principal goal of the separation of the [petrochemical exploration and production] assets from the chemical business was to cleanse [those] assets of every legacy liability resulting from the 85–year history of the company and to make the cleansed company more attractive as a target of an acquisition.
The defendants argued that there was nothing in the record to show that the participants specifically intended to leave the “legacy creditors” without recourse. But the court held that the absence of certain evidence in the record was highly significant: “[O]ne of the most compelling facts in the enormous record of this case is the absence of any contemporaneous analysis of [the successor entity’s] ability to support the legacy liabilities being imposed on it.” The court later reiterated that key point: “[N]either the Board nor management ever reviewed a contemporaneous analysis of the effect of the transactions on the legacy liability creditors, and there is no evidence that one was ever prepared.”
The court later held that the company did not receive “reasonably equivalent value” in exchange for the assets and that it was insolvent as a result of the transfers, thus justifying liability under the “constructive fraud” prong of the statute.
Turning to the issue of damages, the court held that the gross liability of the defendants was roughly $14.5 billion. However, the defendants claimed the right to an offset under 11 U.S.C.A. §502(h). That statute permits defendants in avoidance-powers claims to assert offsetting claims against the estate under certain circumstances. The court declined to decide whether the defendants in this case were entitled to such an offset and, if so, how much of an offset would be appropriate, seeking further briefing. The court noted, however, that even under the best-case scenario, the defendants would still be liable for more than $5 billion. In discussing the offset, the court pondered the problem of whether the §502(h) claim should be valued at its face amount (as the defendants urged) or whether the dilution of the total pool of creditors’ claims due to the inclusion of the offset should be used to discount the effect of the claim. Under the latter scenario the defendants’ liability would still exceed $14 billion.
Finally, the court discussed the defendants’ belated assertion of the “settlement payment” defense under §546(e), which some courts have used to insulate transfers made during complex corporate transactions. The court refused to allow the defendants to assert this defense, holding that it had been waived due to the defendants’ failure to timely assert it and that the defense would not have applied in any event. In a footnote, the court mentioned that although the §546(e) settlement payment defense would not protect a fraudulent transfer defendant in an “actual fraud” case prosecuted under §548 (the federal fraudulent transfer statute), the statute “inexplicably” protects a defendant prosecuted in an “actual fraud” case under §544(b), which empowers the trustee to avoid transfers under state fraudulent transfer statutes.
Comment: Here, the participants in the asset spinoff prepared elaborate documentation regarding the fairness of the transaction, in anticipation of fraudulent transfer litigation; yet they did not prepare any analysis of the post-transaction entity’s ability to pay the “legacy liabilities.” The court seized upon that gap in the record to show that the participants either knew or must have known that the “legacy creditors” would end up with nothing at the end of the day. Given the multi-billion dollar magnitude of this transaction, one can be sure that the participants received top-notch legal advice and that the attorneys specifically recommended that the participants not prepare such an analysis because the result would have been overwhelmingly unfavorable.
For whatever it’s worth, could end up that the court will later adopt the “dilution solution,” resulting in a total liability of roughly $14 billion. Prediction is based on dicta contained in footnote 130. The court (in text) noted that the courts should not “reassess equity among the parties based on subsequent events.” Then, in footnote 130, the court stated:
Valuation of a claim on the basis of subsequent information unknown at the time of confirmation of [the debtor’s] plan would also appear inconsistent with the argument that Defendants’ §502(h) claim should be valued without inclusion of its claim included in the creditor base, or stated differently, that it should have the benefit of the facts known and relied on at the time of confirmation, and not as they developed subsequently.
The court’s observation that the §546(e) “settlement payment” defense might “inexplicably” protect “actual fraud” defendants prosecuted under state law is both acute and disturbing. It is almost certain that Congress never intended such an anomalous result, but the plain language of the statute seemingly denies protection to “actual fraud” defendant prosecuted under federal law but not under state law. Perhaps this statutory glitch could be cured with a minor amendment to the statute. This technical issue would not appear to be one that would divide Congress along partisan lines.
This analysis appeared in the CA State Bar Insolvency Committee e-newsletter of 1/24/14