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Federal Preemption of State Constructive Fraudulent Transfer Law: David Kupetz Authors Norton Annual Survey of Bankruptcy Law Article

In Deutsche Bank Trust Co. v. McCormick (In re Tribune Co. Fraudulent Conveyance Litig.), the Second Circuit Court of Appeals stated that “once a party enters bankruptcy, the Bankruptcy Code constitutes a wholesale preemption of state laws regarding creditors’ rights”— a conclusion that appears to be at odds with U.S. Supreme Court precedent. In the article “Federal Preemption of State Constructive Fraudulent Transfer Law Applied to Financial Institutions Serving as Conduits in the Tribune Company Case,” authored for Norton Annual Survey of Bankruptcy Law’s 2017 issue, David Kupetz discussed this ruling and the contrary ruling of the Seventh Circuit in FTI Consulting v. Merit Management Group, L.P., currently pending before the Supreme Court.  The broad application of implied preemption of state law in Tribune raises concerns that the conventional presumption has been jettisoned by the Second Circuit.

Bankruptcy Code Section 546(e) provides a safe harbor for certain transferees of constructive fraudulent transfers.  The courts of appeals have ruled inconsistently on whether section 546(e) applies to intermediaries merely serving as conduits.  Four circuits, including the Second Circuit in Tribune, have held that financial institutions serving simply as conduits are protected by the safe harbor.

The Tribune court inferred preemption based not on statutory language, but rather based on what it identified as strong policy reasons for protecting shareholders. However, creditors’ longstanding power to pursue state law fraudulent transfer claims derives from state law, and whether Congress stripped away that power without expressly saying so is a serious question. Kupetz concludes the article by noting that under the Tribune approach, transactions could simply be structured (as many are) to insulate shareholders from fraudulent transfer liability simply by passing payment through a financial intermediary. Under these circumstances, protecting creditors’ rights seems to be the stronger bankruptcy policy concern.

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