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Tuesday, October 30, 2012
Southern District Affirms Judge Peck’s Quebecor Decision, Broadly Interpreting “Settlement Payments” as Including Payments to Redeem Outstanding Notes
At issue in Quebecor was a $371
million redemption payment made to a class of subordinated noteholders
during the ninety-day preference window. The notes included a covenant
restricting Quebecor’s debt-to-capitalization ratio to, at most,
fifty-five percent, and were redeemable upon payment of outstanding
principal and interest, along with an additional “make-whole” premium.
Breach of the covenant was imminent, a result Quebecor could not afford
because of cross-default clauses in its other agreements; however,
strapped for cash, it also wanted to avoid redeeming all of the
outstanding notes at a premium. Its solution was to make a limited
tender offer for a controlling share of the notes, in exchange for an
agreement by consenting noteholders to loosen the required
debt-to-capitalization ratio to sixty-five percent. In response, the
noteholders unanimously rejected this offer, entering a separate
agreement amongst themselves and preventing the transfer of notes to any
party that was not then a noteholder. This tactic effectively blocked
any attempt by Quebecor to renegotiate the restrictive covenant, and as a
result it had no choice but to redeem all of the outstanding notes.
Shortly thereafter Quebecor’s US subsidiary, which had guaranteed the
notes, petitioned for chapter 11.
The redemption payment was almost certainly a preferential transfer under Bankruptcy Code section 547(b), i.e., a payment made by an insolvent debtor on account of an antecedent debt within the ninety days preceding bankruptcy.
Though such payments would ordinarily be clawed back under the
trustee’s avoidance power, the noteholders argued that the redemption
payment fell within the safe harbor of 546(e), which shields “settlement payments”
from avoidance. Judge Peck heard expert testimony on the meaning of
“settlement payment” in the securities industry (and whether the term
would apply to the redemption payment); however, before he came to a
decision the Second Circuit issued an opinion on section 546(e) in the Enron case. The Enron court
held that under the plain language of the Bankruptcy Code a “settlement
payment” was “a transfer of cash to a financial institution to complete
a securities transaction.” As a result of the decision, Judge Peck
declared his hands tied and ruled that the contested transfers were
The decision was appealed to the District Court for the Southern
District of New York, where the appellants argued that the bankruptcy
court had misinterpreted the Second Circuit’s Enron decision
and improperly expanded the decision to cover redemption payments. The
District Court, like the Bankruptcy Court, reviewed the Enron
decision and found that the Second Circuit’s opinion was controlling.
It found that the simple test was whether the redemption payments were
“a transfer of cash to a financial institution to complete a securities
transaction.” Walking through the facts, the court noted that 1)
pursuant to the redemption Quebecor had transferred over $376 million,
2) the cash was transferred to the noteholders’ trustee, a financial
institution, and 3) because the redeemed notes qualified as securities
under the Bankruptcy Code, the payment completed a securities
transaction. The safe harbor was thus satisfied and the payments could
not be avoided.
As a result of this decision, creditors of a company on the verge of
bankruptcy now have greater certainty that a redemption of debt
instruments will be safe from challenge as a preference or fraudulent
transfer if the issuer later files for bankruptcy—at least issuers who
file in bankruptcy courts within the Second Circuit. The decision has
broader implications as well, suggesting that notes, bonds, debentures,
and other any obligation recognized by the Bankruptcy Code as a “security”
can be repaid during the preference window without the threat of
avoidance (as long as the funds are initially paid to a financial
institution, as was the case in Quebecor).
Perhaps with these consequences in mind, the District Court expressed
some misgivings with the outcome. The District Court approvingly
quoted sources critical of the Enron decision, including Judge
Peck’s opinion, and noted that if it were “writing on a blank slate, it
might conclude that [the appellant’s arguments] called for a narrower
definition of ‘settlement payment’ that excluded the payments here.”
However, bound by Enron’s extremely broad definition of
“settlement payment,” Judge Furman noted that any change in the rule
would have to come from the Second Circuit—or the Supreme Court.