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Fraudulent Intent and Conduct of A Company’s Director May be Imputed to the Company

In re Lyondell Chem. Co., No. 16cv518 (DLC), 2016 U.S. Dist. LEXIS 98057 (S.D.N.Y. July 27, 2016)

Debtor Lyondell Chemical Co. (Lyondell) was a large publicly-traded petrochemicals company based in the United States. Lyondell was the target of a leveraged buyout by an activist investor, Leonard Blavatnik for quite some time and finally in 2007 Blavatnik purchased Lyondell in a leveraged buyout (LBO). The LBO was 100% financed by debt secured entirely by Lyondell. Lyondell took on approximately $21 billion of secured indebtedness in the LBO provided by the lending banks, of which $12.5 billion was paid out to Lyondell shareholders, officers and directors. As a result of the LBO, Lyondell merged with a Blavatnik-controlled company, an affiliate of Basell AF SCA, creating a merged entity known as LyondellBasell Industries AF SCA (LBI). Within 13 months of the merger closing, Lyondell and its affiliates filed for bankruptcy. LBI also filed for bankruptcy protection thereafter. In early 2010, the bankruptcy court approved Lyondell’s plan of reorganization, which established the LB Litigation Trust and Edward Weisfelner was appointed the Trustee of the trust.

The Trustee alleged that Dan Smith, Lyondell’s CEO and chairman of the Lyondell board of directors allegedly presented false financial projections to the Lyondell board when it was considering the LBO and hence transfers worth $6.3 billion in distributions made to Lyondell shareholders through the LBO were intentional fraudulent transfers pursuant to Sec. 548 of the Bankruptcy Code. The Trustee further alleged that the Lyondell’s board of directors knew the projections prepared at Smith’s request were inflated, unreasonable, and unachievable and should have limited the company’s leverage. Still, they unanimously approved the merger and as a result, the debt undertaken by Lyondell resulting from the false projections left it undercapitalized and put creditors at significant risk. Thus, the Trustee argued that Lyondell’s transactions amounted to an actual fraudulent transfer under Section 548 of the Bankruptcy Code based on the imputed intent of Smith, who requested and manufactured false and misleading projections to defraud Lyondell’s creditors by stripping the company of assets to enrich himself and other Lyondell shareholders.

The Bankruptcy Court rejected the Trustee’s intentional fraudulent transfer claim under Sec. 548 (a) (1) (a) and held that Smith’s intent could not be imputed to Lyondell. The Court reasoned that since Delaware law requires that a corporation’s board of directors approve any merger or LBO, it was the intent of Lyondell’s Board and not of Smith that was critical to determine actual intent to defraud under Sec. 548. Smith’s intent may be imputed to Lyondell only if Smith was in a position to control the Board’s decision to proceed with the LBO. Since, there was no proof that Smith controlled his board on the LBO vote, or that a critical mass of directors intended to defraud creditors, Smith’s intent could not be imputed to the board. The bankruptcy court also held that the Trustee failed to plead facts supporting intent to hinder, delay or defraud on the part of a critical mass of the directors who approved the LBO or by Smith.

The Trustee appealed that the Bankruptcy Court erred by (1) ruling that the knowledge, conduct and intent of Lyondell’s CEO and Chairman and other members of Lyondell management in connection with the payments may not be imputed to Lyondell (2) ruling that the Trustee did not adequately allege that Lyondell incurred debt and transferred the shareholder payments with actual intent to hinder, delay or defraud its creditors.
Upon appeal, the District Court reversed the bankruptcy court’s decision and held that the Trustee’s actual fraudulent transfer claims against Lyondell’s shareholders can proceed on the basis that the alleged fraudulent intent of Lyondell’s former chairman and CEO could be imputed to the company.

On the first argument, the District Court held that the bankruptcy court’s conclusion was incorrect. The Court concluded that the requirement that the Trustee demonstrate Smith’s control over the Lyondell Board does not have any basis in Delaware law. Neither the Bankruptcy Court nor the shareholders cited any authority for the proposition that a corporate officer’s knowledge and intent may not be imputed to the corporation when the corporation’s board votes on the decision at issue. The Court ruled that there was no basis to infer, based on the fact that the LBO required the approval of the Board, that long established agency law principles should be altered. The Court stated that it is state law which supplies the governing law principles for assessing the imputation of a corporate officer’s intent to a corporation for purposes of Sec. 548. Since, Lyondell was a Delaware corporation and engaged in the merger pursuant to the Delaware law, the Delaware’s law of imputation governed and the Delaware courts adhere to the “general rule of imputation” and hold a corporation liable for the acts and knowledge of its agents” even when the agent acts fraudulently or causes injury to third persons through illegal conduct. Thus, the Court held that Smith’s knowledge and intent may be imputed to Lyondell. So, when Lyondell conveyed the shareholder payments, it did so with intent to defraud Lyondell creditors pursuant to Sec. 548 of the Bankruptcy Code.

On the second argument, the District Court ruled that the since the Bankruptcy Court failed to impute Smith’s knowledge and intent to Lyondell, it did not complete the appropriate analysis and determined whether a claim of intentional fraudulent inducement was adequately pled once Smith’s knowledge and intent were imputed to the corporation. The District Court concluded that the Trustee adequately pleaded a claim that Lyondell engaged in an intentional fraudulent transfer of its assets through the LBO. The Court found that as the majority of Lyondell’s assets were subject to liens after the LBO, the LBO had the effect of essentially stripping Lyondell of its assets. Smith knew that Lyondell was underperforming its projections and that Lyondell’s debt burden would deprive it of the flexibility it needed to face the challenging business and financial conditions it was experiencing. Accordingly, the Court concluded that the Trustee also pleaded sufficient facts from which it could properly be inferred that Smith not only recklessly disregarded the likelihood that the LBO would quite quickly injure creditors, but also contemplated and believed that Lyondell would default on its obligations to its creditors within a very short period of time. The Court further found that indeed, that was precisely what happened. Lyondell filed for bankruptcy roughly a year after the LBO.

The Court thus, concluded that the Trustee pleaded facts sufficient to create a strong inference that Smith acted with actual intent to hinder, delay and defraud Lyondell’s creditors. Accordingly, the District Court reversed the Bankruptcy Court’s decision and the Trustee’s intentional fraudulent conveyance claim was reinstated.