The National Law Forum

The Blog of the The National Law Review

Section 550 of the Bankruptcy Code Won’t Cap the Flow of Avoidance Action Liability

Recently The National Law Review published an article by Renée M. Dailey and Mark E. Dendinger of Bracewell & Giuliani LLP regarding Bankruptcy Codes:

Tronox Incorporated and certain affiliates (the “Debtors”) emerged from Chapter 11 in February 2011 armed with a new capital structure and operational game plan, but that’s yesterday’s news. The flavor of the month is last Friday’s decision by Justice Allan L. Gropper (located here) in a still pending adversary proceeding in the United States Bankruptcy Court for the Southern District of New York (the “Court”) filed by the Debtors against Anadarko Petroleum Corporation and certain affiliates (“Anadarko”) seeking to recover an alleged fraudulent transfer. The Court dismissed Anadarko’s summary judgment motion, holding that while section 550 of the Bankruptcy Code provides a floor for creditor recoveries, it does not impose a cap on creditor recoveries following the determination of avoidance action liability.

In the adversary complaint, the Debtors alleged that in a prepetition transaction their predecessor corporation separated profitable oil and gas exploration and production assets from multi-billion dollar environmental and tort liabilities, in order to permit Anadarko to acquire the cleansed assets all while leaving behind significant environmental liabilities. The Debtors’ extensive environmental liabilities finally caught up with them and in January 2009 the Debtors filed for Chapter 11 protection. The Debtor’s plan of reorganization incorporated a settlement agreement by and amongst the Debtors, the environmental and tort plaintiffs and general unsecured creditors that handed general unsecured creditors the keys to the car (i.e., 100% of the Debtors’ equity) and left the environmental and tort creditors looking for alternate transportation – proceeds from the pending adversary proceeding – as the main source of their recovery. With the adversary proceeding trial starting in May, Anadarko and the Debtors filed competing motions for partial summary judgment on the limited issue of damages. The issue at hand was the interpretation of section 550(a), specifically the clause “for the benefit of the estate” and whether it places a damage cap on prospective fraudulent transfer liability.

By way of background, section 550 prescribes the damages owed by a transferee once a fraudulent transfer is avoided by a bankruptcy court. Specifically, subsection (a) permits the debtor in possession to recover either the value of the property or the property itself “for the benefit of the estate.” 11 U.S.C. § 550(a). In its motion for partial summary judgment, Anadarko argued that this language capped its liability, if any, in the fraudulent conveyance litigation to the total claims of the environmental and tort plaintiffs that would benefit from any fraudulent transfer litigation judgment. Specifically, Anadarko argued that the Debtors were inappropriately seeking to recover approximately $15.5 billion, despite the fact that the total amount of the environmental and tort claims at the time of prepetition transfer of assets was no more than $2 billion. The Debtors, on the other hand, asserted that the plain language of section 550(a) and relevant case law imposed no such ceiling on the Debtors’ potential recovery in the litigation.

The Court found no support for a damage cap in the plain words of section 550, and instead noted that the concept of the bankruptcy estate was broad and not limited to the interests or quantum of claims of creditors. The Court further focused on judicial interpretation of the “benefit of the estate” language and what other courts had determined constituted a “benefit” to the estate in order to permit the litigation to go forward. The Court determined that a “benefit” could either be direct (e.g., increased distribution to creditors) or indirect (e.g., increased chance of a successful Chapter 11 reorganization) and that the prospect of a recovery in the adversary proceeding had already benefited the Debtors’ estate by paving the way for a confirmable plan and raising the recovery for general unsecured creditors. Having established some benefit to the estate that could be (and here had been) obtained by bringing the avoidance action, the Court found no case law support for reading a cap on recovery into the same language. Indeed, the Court noted the significance that section 550 does not provide that a transfer can be avoided only “to the extent of the benefit to the estate.”

Anadarko further argued that because the Debtors relied on Oklahoma fraudulent transfer law – as incorporated by section 544(b) of the Bankruptcy Code – as the basis for a liability determination, the limitation under Oklahoma’s law that a creditor may not recover more than the amount of its claim should apply. The Court rejected this argument noting that such limitation was only relevant where an individual creditor was seeking to recover in a non-bankruptcy scenario and noted that the language of section 550 preempted relevant state law in this regard.

The Court noted that whether other relevant law would mitigate any ultimate finding of liability would require a full trial to drill down on the merits. All that is clear now is that section 550 does not cap the flow of damages from the liability well . . .

© 2012 Bracewell & Giuliani LLP

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