In re Lyondell Chemical Company: SDNY Rejects Litigation Trustee's Fraudulent Transfer, Preference, Luxembourg Civil Code, and Texas Law Claims | Practical Law

In re Lyondell Chemical Company: SDNY Rejects Litigation Trustee's Fraudulent Transfer, Preference, Luxembourg Civil Code, and Texas Law Claims | Practical Law

In Weisfelner v. Blavatnik (In re Lyondell Chemical Company), the US Bankruptcy Court for the Southern District of New York rejected the litigation trustee's actual fraudulent transfer, constructive fraudulent transfer, preference, Luxembourg Civil Code, and Texas law claims. The court upheld the Trustee's breach of contract claims for restitution damages only.

In re Lyondell Chemical Company: SDNY Rejects Litigation Trustee's Fraudulent Transfer, Preference, Luxembourg Civil Code, and Texas Law Claims

by Practical Law Bankruptcy & Restructuring
Published on 21 Jun 2017 • USA (National/Federal)
In Weisfelner v. Blavatnik (In re Lyondell Chemical Company), the US Bankruptcy Court for the Southern District of New York rejected the litigation trustee's actual fraudulent transfer, constructive fraudulent transfer, preference, Luxembourg Civil Code, and Texas law claims. The court upheld the Trustee's breach of contract claims for restitution damages only.
On April 21, 2017, in Weisfelner v. Blavatnik (In re Lyondell Chemical Company), the US Bankruptcy Court for the Southern District of New York rejected the litigation trustee's actual fraudulent transfer, constructive fraudulent transfer, preference, Luxembourg Civil Code, and Texas law claims. The court upheld only the litigation trustee's breach of contract claims for restitution damages ( (Bankr. S.D.N.Y. Apr. 21, 2017)).

Background

Leonard Blavatnik (Blavatnik) founded and owned Access Industries, Inc. (Access), a New York based corporation. In August 2005, Nell Limited, an Access subsidiary, acquired Basell B.V. (Basell), a Netherlands-based producer of commodity petrochemicals, for €4.5 billion. Twenty percent of the purchase price was financed by Access affiliates and 80 percent of the purchase price was financed with debt.
In 2006, Access contemplated a merger with Lyondell, the largest US producer of ethylene, as Access believed a merger would result in a more diversified portfolio and a larger global footprint. In April 2006 and on August 10, 2006, Access and Basell made offers to acquire Lyondell, which Lyondell rejected. On May 9, 2007, AI Chemical, an Access affiliate, acquired a toehold position in Lyondell stock.
In June 2007, Blavatnik met with Dan Smith (Smith), Lyondell's CEO, and offered Smith $48 per share to acquire Lyondell. In July 2007, Lyondell provided non-public due diligence materials to Access, Basell, and the financing banks. The banks conducted due diligence and Lyondell management made presentations to Access, Basell, and the banks about its business and its refreshed company projections.
On July 16, 2007, Basell and Lyondell entered into the Merger Agreement (Merger). The banks funded the Merger at $48 per share. Basell did not finance the merger with cash, but its equity value supported the combined equity of the companies. While there were conflicting calculations of Basell's equity valuation, it is undisputed that Basell's equity was worth billions of dollars at the time of the Merger. Basell and Lyondell combined to form LyondellBasell Industries AF S.C.A. (LBI).
In August 2007, an Access affiliate acquired additional Lyondell stock, bringing Access's toehold position to 9.84 percent. In September 2007, Lyondell informed the parties that it would miss its third and fourth quarter earnings projections by a considerable margin, in large part due to rising feedstock prices. The parties, however, were satisfied with Lyondell's financial condition and the Merger closed on December 20, 2007. The merger financing totaled $20.3 billion and LBI had approximately $2.3 billion of liquidity on the closing date.
In the year following the Merger, LBI faced several unforeseeable events and eventually filed for Chapter 11 bankruptcy protection on January 6, 2009. The debtors' plan of reorganization, confirmed on April 23, 2010, established the LB Litigation Trust and Edward S. Weisfelner was appointed as litigation trustee (Trustee). On September 29, 2011, on behalf of LBI creditors, the Trustee filed the Second Amended Complaint, bringing the following claims against Access-related entities and personnel, which arose from the Merger:
  • Actual fraudulent transfer.
  • Constructive fraudulent transfer.
  • Avoidable preference.
  • Breach of contract.
  • Breach of fiduciary duty and tort claims under Luxembourg law and aiding and abetting claims under Texas law.
The trial on these claims began on October 17, 2016 and concluded on February 2, 2017. The court entered a Memorandum Opinion and Order After Trial on April 21, 2017.

Outcome

The US Bankruptcy Court for the Southern District of New York held that the Trustee failed to prove that LBI was insolvent either when the Merger was closed on December 20, 2007, or when the loan repayments were made on October 16, 17, and 20, 2008. Therefore, the Trustee failed to meet his burden to demonstrate there was an actual fraudulent transfer, a constructive fraudulent transfer, an avoidable preference, or certain breach of fiduciary duty, tort, and aiding and abetting claims under Luxembourg and Texas law. The Trustee did, however, succeed on his breach of contract claim under Texas law because it did not require a demonstration of insolvency or fraudulent intent. The court awarded the Trustee $7.2 million in restitution damages on that claim.
In reaching its decision, the court analyzed:
  • Whether Smith and Lyondell's actions amounted to intent sufficient to prove an actual fraudulent transfer under section 548(a)(1)(A) of the Bankruptcy Code.
  • Whether LBI received reasonably equivalent value in exchange for the transfers, and was insolvent as of the date of the transfer, in order to establish a constructive fraudulent transfer (§ 548(a)(1)(B), Bankruptcy Code).
  • Whether LBI was insolvent at the time of the transfer such that the transfer would be avoidable under section 547(b) of the Bankruptcy Code.
  • Whether the material and adverse change (MAC) clause in the Access Revolving Credit Agreement (Credit Agreement) excused AI Chemical's performance when it refused to fund the requested draw in December 2008.
  • Whether Basell and LBI were insolvent at the time of the transaction such that there would be liability under Luxembourg and Texas laws for breach of fiduciary duty, for tort claims, and for aiding and abetting.

Actual Fraudulent Transfer

In addressing the Trustee's claim of an actual fraudulent transfer, the court evaluated the intent of the transferor (Weisfelner v. Blavatnik (In re Lyondell Chem. Co.), 543 B.R. 417, 425 n.36 (Bankr. S.D.N.Y. 2016)). The court applied the preponderance of the evidence standard to the evaluation of this claim.
The court concluded that Smith and Lyondell's actions did not amount to intent sufficient to prove an actual fraudulent transfer claim under section 548(a)(1)(A) of the Bankruptcy Code. The court held that Smith's mere request that a subordinate review the company's projections did not amount to fraudulent intent, nor did the fact that Smith expressed his opinion about the refreshed projections to this subordinate. The court rejected the Trustee's arguments that Lyondell's process of re-reviewing the company's projections prior to the merger amounted to fraudulent intent. The court found that Lyondell's employee credibly testified that Smith did not tell the employee to alter the numbers in the refreshed projections. Therefore, the court concluded that the Trustee failed to prove his actual fraudulent transfer claim by a preponderance of the evidence.

Constructive Fraudulent Transfer Claim

In order to demonstrate that a constructive fraudulent transfer under section 548(a)(1)(B) of the Bankruptcy Code occurred in connection with the Merger, the Trustee had to establish that LBI both:
  • Did not receive a reasonably equivalent value for the transfer.
  • Was insolvent as of the date of the transfer or was rendered insolvent as a result of the transfer. Insolvency can be shown by demonstrating that LBI was:
    • unable to pay its debts when they became due;
    • balance sheet insolvent; or
    • was left with unreasonably small capital for the operation of the business after the transfer.
The court concluded that because the Trustee failed to demonstrate that the debtor was insolvent under any of the financial tests, it did not need to establish whether there was reasonably equivalent value. The court then addressed each of the three solvency tests.
First it found that there was no evidence that any of the parties intended for LBI to incur debts that it could not repay or that the parties believed LBI would fail.
Second, the Trustee failed to prove that the debtor was balance sheet "insolvent on the date that [the] transfer was made or [when the] obligation was incurred, or became insolvent as a result of such transfer" (Mellon Bank, N.A. v. Metro Commc'ns, Inc. 945 F.2d 635, 648 (3d Cir. 1991) as amended (Oct. 28, 1991) (quoting 11 U.S.C. § 548) because the testimony from the Trustee's expert witness was not credible. The court found that the expert's testimony:
  • Relied on unreproducible methods.
  • Contained an admitted error in subtracting roughly $500 million from LBI's cash reserves.
  • Applied a flat 35 percent tax rate in his valuation analysis when LBI's actual tax rate was much lower.
  • Contained a valuation analysis that was highly inconsistent with the financing banks' analysis.
The court concluded, therefore, that the value of LBI's assets was greater than its debts and it was not balance sheet insolvent as of the date of the transfer.
Finally, the Trustee failed to prove that LBI had unreasonably small capital on December 20, 2007, as a result of the Merger. In reaching this conclusion, the court found that:

Avoidable Preference

Under section 547(B) of the Bankruptcy Code, a trustee may avoid certain transfers of an interest in the debtor's property so long as each element of the preference is proven by a preponderance of the evidence. One of the required elements is insolvency at the time of the transfer.
Here, the court held that the Trustee failed to prove that Lyondell was insolvent at the time of the transfers. The court found the Trustee's expert's testimony to be unreliable, and held that company emails in which a potential bankruptcy filing was mentioned were not sufficient to establish balance sheet insolvency.
For the entirety of the trial, the Trustee asserted LBI's insolvency on a consolidated basis and it was only in the Trustee's post-trial brief and closing arguments that the Trustee asserted that Lyondell was the debtor for this claim. The court held that the relevant debtor for the preference claim was ultimately Lyondell.

Breach of Contract

In December 2009, AI Chemical refused to fund the requested draw under the Credit Agreement. AI Chemical's defense to the refusal was that because LBI's Chapter 11 filing was impending, that was a material adverse change under the Credit Agreement's MAC Clause. The court held that because the Credit Agreement's MAC clause did not include a solvency requirement at the time of the loan draw, AI Chemical's performance was not excused and the Trustee may recover restitution damages.
While the Credit Agreement was drafted with a solvency clause at the time of the closing, it did not include a solvency clause at the time of the draw. In reviewing the Credit Agreement claim, the court examined the MAC clause in the context of the entirety of the agreement, rather than independently. The fact that there was at one time a solvency requirement and then there was not at the time of the draw, indicated that the parties intentionally left out such a requirement. In addition, the court did not find any case law inferring a solvency requirement from a MAC clause and, therefore, rejected the defendant's argument that a significant revenue shortfall constituted a MAC change.
LBI paid a commitment fee in the amount of $12 million. Based on this, the court calculated restitution damages by subtracting 40% from the $12 million sum, representing the value of the benefits that LBI had received. The court held that the Trustee may recover $7.2 million in restitution damages.

Claims Under Luxembourg and Texas Law

The Trustee raised several liability claims under the Luxembourg Civil Code, including claims for tort and breach of fiduciary duty, and a claim for aiding and abetting under Texas law, all of which the court rejected.

Practical Implications

The court's rejection of the majority of the Trustee's claims highlights the challenge parties face in blaming a leveraged buyout for a company's failure and tumble into bankruptcy. It also demonstrates the weight that courts will give to unforeseeable catastrophic events, such as the financial crisis of 2007-2008.
This decision shows the extensive factual analysis a court is required to undertake in order to determine whether management should have known that a leveraged transaction would leave a business inadequately capitalized to the point where it would fold. In this case, neither the facts nor the testimony of the Trustee's expert were sufficient to demonstrate such knowledge.
The Trustee announced on May 5, 2017, that his clients intend to appeal certain aspects of this ruling.