Tuesday, May 29, 2012

How Safe Is Safe Harbor?

In the run-up to the spectacular Lehman Brothers Holdings Inc. bankruptcy case and the immediate aftermath of the filing, JP Morgan Chase (“JPMC”) received over $8.6 billion dollars from the Lehman entities.  As a result of those transfers the Lehman entities and their Official Committee of Unsecured Creditors brought suit against JPMC to recover the transfers.

On April 19, 2012, the Honorable James M. Peck entered his opinion granting in part and denying in part JPMC’s motion to dismiss.  The extensive and lengthy decision contains three broad groups of holdings.  First, the Court held that the transfers could not be avoided as either preferences or constructively fraudulent transfers because the safe harbor of 11 U.S.C. §546(e) immunizes the transfers from avoidance under those provisions as they constituted settlement payments made by a covered entity for the benefit of a financial institution in connection with a securities contract.  While the Court noted that the occurrence of obligations was not immunized, that was a “pyrrhic victory” for the plaintiffs as the transfers themselves would still be exempt from avoidance (slip op at 45).

The second main holding was the Court’s ruling that transfers might be as actually fraudulent under 11 U.S.C. §548, since actually fraudulent allowable transfers were not immunized under §546(b).  The motion to dismiss sought to have these claims dismissed on the grounds that fraud was not pled with sufficient specificity under Federal Rules of Civil Procedure 9(b), as that standard has been modified by the Supreme Court’s pleading cases of Twombly & Iqbal.

Traditionally in determining actual fraud for purposes of fraudulent transfer liability, courts focus on “badges of fraud,” indicia that are presumed to raise a strong inference of fraudulent intent.  JPMC argued that Twombly & Iqbal and their heightened pleadings standards should prevent a complaint from surviving a motion to dismiss where it merely relies on badges of fraud.  JPMC also argued that a relaxed pleading standard relying on badges of fraud should be appropriate only when claims are brought by a bankruptcy trustee, who has a disadvantage in that he lacks firsthand knowledge of the facts.

The Court found that the facts and circumstances of Lehman were so complicated and complex that the same disadvantage of pleading existed as would be faced by a trustee.  The Court further held that pleading badges of fraud would be sufficient of purposes of Rule 9(b).

In the third major portion of the Court’s ruling, however, the plaintiffs were successful.  Twenty-five other counts (such as for common law fraud, constructive trusts, unjust enrichment, conversion, coercion, duress, lack of authority, lack of consideration, violation to imply good faith and fair dealing plus bankruptcy related claims such as turnover and setoff claims and equitable subordination) would survive a motion to dismiss.  JPMC asserted that these claims should be dismissed based on (i) preemption under §546, (ii) failure to allege fraud with particularity, (iii) failure to plead sufficient facts to support the claim and (iv) failure to state a claim upon which relief could be granted.

While noting the complaint represents “something of a laundry list approach to litigation,” the Court held that §546 is only a limited immunity from suit and does not bar the plaintiff from maintaining all other common law claims.  While some courts have extended the scope of preemption, in this Court’s view that was because in those cases the common law claims were closer to constructively fraudulent than the actual fraud claims pled in the Lehman Brothers case.  Since the Court found that fraud had been pled with sufficient specificity, the Court felt that Lehman was different and thee plaintiffs’ claims survived the motion to dismiss.

Attached to the opinion is a thirty-three page exhibit where the Court goes through each of the remaining claims, summarizes the parties’ main contentions and states why the Court believed the claims survive a motion to dismiss.  The Court’s approach here, finding the claims to be more akin to actual fraud which is not preempted, may be unique to Lehman.  However it is possible that this approach could be extended to other cases such as Ponzi cases or even LBO and similar cases if plaintiffs assert actual fraud.  The difficulty for defendants is that despite Twombly & Iqbal, the Lehman Court has significantly reduced the standard for pleading fraud based on its holding that merely pleading that badges of fraud is sufficient.

Eckert Seamans Cherin & Mellott, LLC

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