The Tribune Company (yes, the formerly-venerable Chicago Tribune newspaper) filed bankruptcy in 2008, after being crippled by a corporate raid in 2007
Here’s What Happened
Tribune’s dominant shareholders (they owned 33%) wanted to cash out their shares of stock. So they engineered a scheme, whereby Tribune borrowed money to buy its own stock at a premium price.
Under this scheme, Tribune purchased all its own stock shares from its shareholders, with borrowed money, for $8 billion. Here’s how the closing happened:
- Tribune sent the purchase money to a bank that agreed to act as a “Depository”;
- the Depository bank also received stock shares from shareholders on Tribune’s behalf; and
- then, the Depository bank distributed Tribune’s purchase price to tendering shareholders and the stock shares to Tribune.
At the close of the transaction, Tribune owed a total of $13 billion of debt—which Tribune could not repay.
Soon after closing, Tribune had to file bankruptcy. And the results of the bankruptcy thus far are that, (i) creditors remain unpaid, while (ii) former shareholders (including the engineers of the raid) retain their premium price.
Lawsuits and Equities
Many lawsuits have been filed to recover the purchase price payments from former shareholders under fraudulent transfer and similar theories. The idea is to recover and redistribute such payments to creditors, who hold a higher distribution priority under the Bankruptcy Code.
In looking at the ideal of fair-play in all this:
- Insider shareholders who engineered the corporate raid. This group enriched themselves by destroying a fine company and screwing its creditors. This group includes officers, directors and others who hold duties of loyalty and care to all Tribune’s constituencies, including its creditors. There is no excuse for letting these people damage the business and its creditors in this way, for their own enrichment and gratification—and get away with it!
- Innocent/passive shareholders. This group sold their stock in good faith, and without knowing participation in the corporate raid. These people are worthy of protection under the Bankruptcy Code.
- Creditors. This group extended credit to Tribune in reliance on its history of diligent repayments and fair dealing—and they got screwed by the corporate raid. The combination of their loss and the engineering insiders’ enrichment is unconscionable!
§ 546(e): the Bankruptcy Code’s Safe Harbor
Congress believes that stock sale processes are of highest importance to our economic well-being. So, Congress placed § 546(e) in the Bankruptcy Code to protect such processes.
Here is the operative safe-harbor language of § 564(e) (italics added for emphasis):
a “settlement payment . . . made by . . . [a] financial institution . . . in connection with a securities contract” cannot be avoided.
–The § 546(e) Issue
Creditors argue that neither Tribune nor its former shareholders qualify as a “financial institution” under § 546(e). Shareholders disagree, because the Depository bank that handled the closing does qualify as a financial institution.
–The U.S. Supreme Court’s Merit Management Opinion
On February 17, 2018, the U.S. Supreme Court offered an opinion on the § 546(e) issue in Merit Management Group, LP v. FTI Consulting, Inc., 583 U. S. ___ (2018) (Case No. 16-784). The Supreme Court ruled that § 546(e) did not protect the Merit Management transfers from avoidance. Here’s why:
“Because the parties do not contend that either Valley View or Merit [the parties to the transaction] is a ‘financial institution’ or other covered entity, the transfer falls outside of the §546(e) safe harbor.”
–Footnote 2 in Merit Management Opinion
Moreover, the Supreme Court’s opinion, in Footnote 2, quotes the Bankruptcy Code’s definition of “financial institution” in § 101(22)(A) and adds the following clarification in Footnote 2:
“The parties here do not contend that either the debtor or petitioner in this case qualified as a ‘financial institution’ by virtue of its status as a ‘customer’ under §101(22)(A). . . . We therefore do not address what impact, if any, §101(22)(A) would have in the application of the §546(e) safe harbor.”
–Justice Breyer’s Point
Justice Breyer emphasized this § 101(22)(A) issue during Merit Management’s oral arguments and insisted that, had the parties raised this issue, the result of the case would be different. Here’s the operative language of § 101(22)(A) (italics added for emphasis):
“(22) the term ‘financial institution’ means—(A) a . . . bank . . . and, when any such . . . bank . . . is acting as agent or custodian for a customer . . . in connection with a securities contract . . . such customer.”
Justice Breyer’s point in oral arguments and Footnote 2 is this: when the seller and buyer of corporate stock use a bank Depository to close the stock sale, both the seller and buyer qualify as a “financial institution” under the “such customer” language of § 546(e).
A New Tribune Opinion on Justice Breyer’s Point & Footnote 2
On April 23, 2019, the U.S. District Court for the Southern District of New York issues a new opinion in the Tribune bankruptcy saga. This new opinion follows and applies Justice Breyer’s point and Footnote 2 from Merit Management.
Here’s what District Judge Denise Cote decides about the § 546(e) safe harbor defense, in the new opinion, and the “such customer” clarification of § 101(22)(A):
- “The Bankruptcy Code defines a ‘financial institution’ to include not only traditional financial institutions, but also, in defined circumstances, the customers of traditional financial institutions.”
- It is undisputed that the Depository is a “bank.”
- So, the three dispositive questions are whether: (1) Tribune is a “customer” of the Depository? (2) The Depository acts as Tribune’s “agent or custodian”? and (3) Is the Depository acting “in connection with a securities contract”?
- All three of these questions must be answered in the affirmative; and
- Therefore, (i) Tribune qualifies as a “financial institution” under § 101(22)(A), and (ii) claims for avoidance of the stock transfers are, therefore, barred by § 546(e).
It looks like Justice Breyer and Judge Cote are right. Their explanations and application of § 546(e) and § 101(22)(A) appear to follow, precisely, what Congress said in those two Bankruptcy Code provisions and what Congress intended to accomplish. Good for them!
However, allowing a corporate raid to succeed . . . and prosper . . . at the expense of and harm to a venerable institution and its innocent creditors is appalling.
Accordingly, Congress needs to address the corporate raiding problem at once: there has to be a remedy—one that works!
Justice Breyer’s expressions of concern in Merit Management, as reflected in oral arguments and in Footnote 2 of the Supreme Court’s opinion, are persuasive.
That’s the upshot of the new opinion by Hon. Denise Cote, United States District Judge for the Southern District of New York, in the Tribune case.
It will be interesting to see, (i) whether other judges follow suit, and (ii) what action Congress might take to guard against future corporate raids.
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