WILMINGTON, Del. (Reuters) - The U.S. Supreme Court on Tuesday trimmed a key legal defense that has frustrated creditors who try to claw back potentially dubious payments made before a corporate bankruptcy in a ruling that will reignite litigation over the 2007 buyout of Tribune Co.
At issue is a federal bankruptcy provision, called the safe harbor, that prevents certain securities transactions, including payments to shareholders, from being unwound by representatives of a bankrupt company’s estate.
Creditor attorneys have increasingly complained that bankrupt companies structure payments to take advantage of the safe harbor, which U.S. Bankruptcy Judge Christopher Sontchi called a “too good to be true” defense in 2014 testimony to Congress.
In a unanimous decision, the high court ruled that safe harbor did not protect payments if financial institutions were merely conduits, reversing the law in the key bankruptcy courts in Delaware and New York.
“The safe harbor defense was getting raised all over the place,” said Edward Weisfelner, a bankruptcy lawyer with Brown Rudnick who represents creditors. “For those of us on the plaintiffs side ... it’s about time.”
In the case before the Supreme Court, racetrack operator Valley View Downs LP borrowed $55 million to buy all the shares of Bedford Downs Management Corp.
Valley View filed for bankruptcy protection soon after, and its trustee sought to claw back the funds paid to Bedford shareholders, arguing that Valley View was insolvent at the time of the deal.
The Supreme Court rejected the argument of Merit Management Group LP, one of the shareholders, that the payments were protected by the safe harbor. The court found that the banks that handled the funds were conduits.
The ruling will have an immediate effect on the long-running litigation stemming from the leveraged buyout of the Tribune media company in 2007, a deal that was led by real estate mogul Sam Zell.
Less than a year after the deal closed, Tribune filed for bankruptcy, saddled with unsustainable debt taken on to buy out shareholders.
A litigation trustee has been trying to claw back some of the $8 billion in payments to Tribune’s 5,500 shareholders, and made a settlement offer in January that will now be withdrawn in the wake of Tuesday’s ruling.
“I am gratified that the Supreme Court corrected the mistaken view of the law,” said Marc Kirschner, the Tribune litigation trustee.
The Tribune settlement varied, depending on the amount of stock sold into the two-step buyout. For example, shareholders who sold between $1 million and $10 million in stock could have settled for 27.5 percent of the payments received in step one and for 55 percent received in step two.
Some of the largest shareholders included the Chandler Trusts and the McCormick Foundation, according to court records.
Reporting by Tom Hals in Wilmington, Delaware; Editing by Jeffrey Benkoe