January 30, 2017

Fraudulent Transfers: SDNY Now Split On “Imputed Intent”

Section 548 of the Bankruptcy Code gives a bankruptcy trustee the ability to avoid any transfer that was made with actual intent to hinder, delay, or defraud present or future creditors.  In last year’s Lyondell decision, a federal court in the Southern District of New York held that under agency law, the acts of a corporation’s agent are imputed to it – “even when the agent acts fraudulently or causes injury to third persons through illegal conduct.’”  In other words, one bad apple’s intent can be imputed to the corporation & establish actual fraud.

This Cleary memo reports that another SDNY judge has taken a different view on imputed intent.  Here’s the intro:

In a recent decision in the Tribune fraudulent conveyance litigation in the Southern District of New York, the court dismissed claims of actual fraudulent conveyance, holding that an officer’s intent could not be imputed to the company where he did not control the challenged transaction. The holding creates a split among Southern District authorities over the appropriate test for determining when an individual’s intent can be imputed to a companyto prove an actual fraudulent conveyance.

Lyondell created a potentially big problem for public shareholders in bankruptcies. These shareholders are usually protected under Section 546(e) of the Bankruptcy Code, which generally provides a safe harbor for transactions – like transfers of securities in a brokerage account – that involve a financial institution.

Courts have been fairly tough on efforts by creditors to do an end run on this safe harbor in the public company context, but there’s one exception to it that looks much more daunting in the wake of the Lyondell case. You guessed it – the Section 546(e) safe harbor does not extend to cases of actual fraud. So if one bad apple can result in a finding of actual fraud, any shareholder who receives a payout in an LBO has reason for some concern about whether they’ll get to keep the money. The standard adopted by the Tribune court would lower that risk significantly – but it remains to be seen what standard for imputed intent will ultimately prevail.

John Jenkins