The LyondellBasell refinery in Houston.
It has been almost 10 years since you sold shares in a large and valuable company as part of a leveraged buyout. You are rich and life is good. Suddenly, in the mailbox of your Florida home, you receive a letter from a U.S. law firm informing you that you are a defendant in a "fraudulent conveyance" lawsuit that threatens to unwind the sale and force you to pay back all of the cash you received for your shares.
Suddenly, Florida felt much hotter.
This hypothetical is a reality for the former shareholders of Lyondell Chemical Co., who are in the midst of a fight to prevent the trustee for the now bankrupt company from using a 500-year old legal doctrine to take back a portion of the $12.5-billion (U.S.) they received in 2007 for their shares in Lyondell's merger with Basell AF to form LyondellBasell. The trustee is attempting to use what is known as fraudulent conveyance law as a legal version of the DeLorean time machine to go back to the day before the merger. Moreover, this action raises serious issues with one of the most famous M&A strategies out there, and could affect Canadian companies engaged in U.S. leveraged buyouts (LBOs).
Less than two years after the completion of the Basell-Lyondell merger, LyondellBasell filed for bankruptcy. The acquisition was financed using an LBO structure, which involves the purchaser taking on significant debt, secured by the assets of the merged company, to pay shareholders of the acquired company for their shares. At the end of the LBO, Basell had Lyondell's shares, the shareholders had cash and the merged company was saddled with substantial debt.
Too much debt, as it turned out. At the end of the day, the creditors of LyonellBasell suffered losses while the former shareholders of Lyondell did quite well. Even the architect of the deal, Basell's primary shareholder Len Blavatnik, netted a handsome $333-million tax windfall due to his 10-per-cent stake in Lyondell.
Now, this sucks for creditors, but it is also the risk of being a creditor – lenders should protect their loans through contractual limits on a company's ability to lever itself, and by not lending to fragile companies in the first place. Unless the creditors were defrauded, bankruptcy is a creditor's risk.
Fraudulent conveyance law recognizes that bankrupt debtors may sell (or give away) assets to friendly parties to evade creditors. If you sell your engagement ring to your husband for $5, your creditors end up with recourse over the $5, not the ring. The law allows courts to unwind such fraudulent transfers.
The standard threshold for a fraudulent conveyance having occurred involves a transfer with an actual intent to defraud creditors. The more complicated claim is "constructive," which, instead of requiring actual fraud, requires the creditor to show that the debtor didn't receive appropriate value for the asset and that the debtor is unable to pay its debts either before or after a transfer.
Since the Great Recession, creditors have found that a lot of prerecession LBOs gone wrong look a lot like fraudulent transfers. LyondellBasell incurred substantial debt and transferred $6.3-billion of debt finance to shareholders in exchange for shares in, what it turned out, was a company with too much debt.
Luckily for the shareholders, the U.S. Court of Appeals for the Second Circuit threw out the constructive fraudulent transfer claim on a technicality (in essence holding that the limitation period in the Federal Bankruptcy statute, which had expired, defeated the state law fraudulent conveyance claim) but, due to some unfortunate language on the part of Lyondell executives suggesting that creditors were getting a bad deal and therefore potentially suggesting that creditors were being defrauded, the standard claim survived.
However, in July, in a different litigation, the Delaware Bankruptcy Court found the opposite, leaving U.S. circuits split as to constructive fraudulent transfer claims.
With the split, constructive fraudulent transfer claims of this kind will continue in friendly jurisdictions. Ultimately, the U.S. Supreme Court may have to decide the issue.
This is all pretty technical, but the implications are stark. The LyondellBasell LBO was completed by the most sophisticated of sophisticated parties, each one receiving elite legal advice, including an independent board of directors. The upshot of the recent fraudulent conveyance litigation is that both constructive and actual fraudulent conveyance claims are potentially viable weapons for creditors against long closed, and otherwise properly executed, transactions.
Pretty good for a 500 year-old legal doctrine, though not very good for pre-LBO shareholders looking to spend the rest of their days on the beach.
Adrian Myers