In re Keck, Mahin & Cate
Not Reported in F.Supp.2d (2002)
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Rule of Law:
Under 11 U.S.C. § 546(e), payments made to shareholders during a leveraged buyout (LBO) are considered 'settlement payments' and are exempt from avoidance as fraudulent conveyances, so long as the payment is made by or to a financial institution, regardless of whether the institution acts merely as an intermediary.
Facts:
- Hechinger Company, a home improvement retailer controlled by the Hechinger and England families, experienced a sustained financial decline starting in 1994 due to intense competition.
- By September 1997, Hechinger was allegedly insolvent and highly leveraged, with cash flow insufficient to meet its interest obligations.
- In mid-1996, Hechinger retained an investment firm to find a buyer, and in the summer of 1997, Leonard Green & Partners emerged as a bidder.
- Leonard Green structured a deal to acquire Hechinger and another struggling retailer, Builders Square, in an integrated, two-step leveraged buyout (LBO).
- In September 1997, the transaction was consummated: Hechinger acquired Builders Square and took on approximately $600 million in new secured debt.
- A portion of the loan proceeds, totaling over $100 million, was used to pay the Hechinger and England Family defendants for their shares, with the transfers facilitated by Chase Mellon Financial Services, L.L.C., a financial institution acting as a disbursing agent.
- The LBO left Hechinger with a significantly increased debt-to-capital ratio, and the company's financial condition continued to deteriorate.
- On June 11, 1999, less than two years after the LBO, Hechinger and its affiliates filed for Chapter 11 bankruptcy and ultimately liquidated.
Procedural Posture:
- After Hechinger filed for Chapter 11 bankruptcy, the Official Committee of Unsecured Creditors filed an adversary proceeding in the United States District Court for the District of Delaware.
- The Committee sued former directors and shareholders (Hechinger Defendants and England Family Defendants), lenders, and the acquirers.
- The claims included fraudulent conveyance, breach of fiduciary duty, and unjust enrichment.
- The Hechinger Defendants filed a motion to dismiss the claims against them pursuant to Federal Rule of Civil Procedure 12(b)(6).
- The England Family Defendants filed a separate motion to dismiss the same claims against them.
- The court heard oral argument on both motions to dismiss.
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Issue:
Does the 'settlement payment' exception under 11 U.S.C. § 546(e) of the Bankruptcy Code bar a fraudulent conveyance claim seeking to recover payments made to shareholders in a leveraged buyout (LBO) transaction when a financial institution acts as an intermediary?
Opinions:
Majority - McKelvie, District Judge
Yes. The 'settlement payment' exception under 11 U.S.C. § 546(e) bars a fraudulent conveyance claim to recover payments made to shareholders in an LBO. The court, bound by the Third Circuit's precedent in In re Resorts International, held that payments made to shareholders in an LBO are 'settlement payments' within the plain meaning of the statute. Section 546(e) protects such payments from avoidance if they are made 'by or to' a financial institution, and it does not matter if the financial institution is merely an intermediary or conduit that never acquires a beneficial interest in the funds. The court rejected arguments that the case was distinguishable from Resorts International because the recipients were corporate insiders or because a financial institution, rather than a stockbroker, was used. The court also dismissed the unjust enrichment claim as being preempted by § 546(e), as allowing it would circumvent the statute's clear purpose. However, the court denied the motion to dismiss the breach of fiduciary duty claim against the Hechinger Defendants (directors), finding they could be held liable for approving the LBO, but granted the motion for the England Family Defendants (shareholders), because they had relinquished their voting rights via a voting trust and thus were not 'controlling shareholders'.
Analysis:
This decision reinforces the Third Circuit's broad interpretation of the § 546(e) 'settlement payment' safe harbor, making it a powerful shield for former shareholders who receive payments in a failed LBO. By applying the Resorts International precedent, the court confirms that nearly any LBO using a financial intermediary to cash out shareholders will be insulated from constructive fraudulent conveyance claims in a subsequent bankruptcy. This ruling significantly curtails the ability of creditors' committees and bankruptcy trustees to recover funds from selling shareholders, shifting the risk of a failed LBO squarely onto unsecured creditors. It highlights a critical split among federal circuits and encourages structuring LBOs to include a financial institution as a conduit to ensure the payments are protected from avoidance.
