<b><I>Lyondell Chemical</I></b>: A Long and Winding Roadmap for Creditors in Leveraged Transaction Cases

In July 2009, the LyondellBasell Litigation Trustee commenced litigation arising out of the merger of Lyondell and Basell, seeking the recovery of billions of dollars for the benefit of unsecured creditors. And, as Bankruptcy Judge Martin Glenn observed, the Trustee “threw the kitchen sink” at the defendants. Actual and constructive fraudulent transfer claims. Preference claims. Breach of contract claims. Even claims alleging breaches of Luxembourg law.

Eight years of litigation and two bankruptcy judges later, we have a decision. On April 21, 2017, the United States Bankruptcy Court for the Southern District of New York, in Weisfelner v. Blavatnik (In re Lyondell Chemical Company), 2017 BL 131876 (Bankr. S.D.N.Y. Apr. 21, 2017), dismissed all but a $7.2 million judgment on a breach of contract claim. Here's the story.

Background

In August 2005, Nell Limited, a subsidiary of billionaire Len Blavatnik's Access Industries Inc., acquired Basell, a Netherlands-based petrochemicals company, for roughly €4.5 billion. Blavatnik employed a number of individuals at Access who testified at trial, including Philip Kassin, Head of M&A and Financing, and Lincoln Benet, Access CEO. Certain newly created Luxembourg holding companies were established in connection with the Nell-Basell acquisition. Post-acquisition, Basell's equity was worth billions of dollars.

In May 2007, an Access affiliate, AI Chemical, acquired a toehold position in Lyondell stock. Settlement of the acquisition of the toehold position was in two payments: 1) the first payment of approximately $524 million (Toehold Payment 1) was transferred from non-debtor Basell Funding to Nell; and 2) a second payment of approximately $674 million (Toehold Payment 2) was paid by LB Finance to Merrill Lynch. Following Access's acquisition of the toehold position, Lyondell CEO Dan Smith requested that a member of Lyondell's corporate development group prepare updated projections (Refreshed Projections). The “refreshing” process took place over a period of several days, with limited input from others at the company, and the projections were not meant to entail the same detail-oriented analysis that was involved in the production of Lyondell's long-range plan.

On July 16, 2007, Basell and Lyondell entered into a merger agreement to form LyondellBasell Industries (LBI). In August 2007, an Access affiliate acquired additional Lyondell stock. Goldman Sachs, Merrill Lynch, Citibank, ABN Amro and UBS Securities each committed billions to finance the merger; each carried out in-depth analyses of the transaction; and each prepared its own projections. The merger closed on Dec. 20, 2007, the financing of which totaled $20.3 billion. The funds were used as follows: 1) $11.3 billion payment to Lyondell shareholders; 2) $523.5 million payment to Nell on account of Toehold Payment 1; 3) $674.3 million payment to Merrill Lynch on account of Toehold Payment 2; 4) $7.2 billion for the repayment of Lyondell debt; 5) $447 million for the repayment of Basell debt; 6) $219 million for closing costs and professional fees; and 7) $14.2 million for other uses. LBI was left with approximately $2.3 billion of liquidity, which LBI's CFO testified was sufficient to operate the business. By February 2008, however, LBI's liquidity was $895 million, prompting LBI and other entities to execute a $750 million revolving credit facility (Access Revolver) with Access Industries Holdings (AIH). The Access Revolving Credit Agreement (ARCA) contained a Material Adverse Change (MAC) clause. To further boost liquidity, LBI “upsized” its existing ABL Facilities by $600 million. The result was that by the end of April, LBI had added $1.5 billion of liquidity.

During the year following the merger, LBI suffered a series of unforeseeable events, including: 1) a deadly crane collapse; 2) two unusually destructive hurricanes affecting its Houston refinery; 3) wildly fluctuating oil prices (from $145 per barrel, to less than $30, to over $100); and 4) the effects of the Great Recession. These events diminished LBI's available liquidity, forcing it to draw $300 million on the Access Revolver on Oct. 15, 2008 (October Draw). The October Draw was repaid in full within a matter of days (October Repayment).

On Dec. 30, 2008, LBI requested the full $750 million under the Access Revolver. The request went to AI International, which had been assigned the Access Revolver. AI International, concerned about an imminent bankruptcy filing, declined the draw request on Dec. 31.

LBI filed Chapter 11 on Jan. 6, 2009, just over a year after the closing date of the merger. The LyondellBasell Litigation Trust was created under the confirmed plan of reorganization, and was designed to prosecute claims assigned to it by the former Chapter 11 debtors in possession, including LBI and Lyondell Chemical Company. The Trustee initiated the adversary proceeding by filing a complaint against Blavatnik and numerous other defendants on July 22, 2009.

A first amended complaint was filed in July 2010, and a second amended complaint was filed in September 2011. The second amended complaint asserted claims alleging: 1) actual fraudulent transfer; 2) constructive fraudulent transfer; 3) avoidable preference; 4) breach of contract; and 5) breach of fiduciary duty and tort claims under Luxembourg law, with aiding and abetting under Texas law. What follows is an overview of how the court addressed each of the Trustee's claims.

The Constructive Fraudulent Transfer Claims

The Trustee brought three constructive fraudulent transfer claims: 1) to avoid and recover Toehold Payment 1; 2) to avoid and recover fees paid to Nell and Perella Weinberg (for advisory services) in connection with the merger; and 3) to recover an extraterritorial dividend issued to NAG Investments on Dec. 7, 2007.

In order to have prevailed on its constructive fraudulent transfer claims, the Trustee needed to prove that, in connection with the merger: 1) LBI did not receive reasonably equivalent value; and 2) the debtor was insolvent on the date of the transfers by satisfying one of three alternative financial condition tests: balance-sheet insolvency (whether debts in the aggregate are greater than assets in the aggregate), unreasonably small capital (inability to generate sufficient profits to sustain operations) or the inability to pay debts as they come due. Judge Glenn did not need to consider whether the debtors received reasonably equivalent value because the Trustee failed to meet any of the financial condition tests. The court's analysis of the three financial tests follows.

The parties did not devote much effort to the “inability to pay debts when due” test other than conclusory assertions, and so the court held that this test was not satisfied. Regarding the balance sheet test, the Trustee argued that LBI was insolvent on the merger date, relying primarily on his expert's balance sheet solvency analysis. The court, however, did not find the expert testimony to be credible for a number reasons, including the fact that the valuation analysis was inconsistent with the analyses prepared by the financing banks. The defendants' expert, on the other hand, did produce a valuation range that was consistent with those developed by the financing banks and industry experts at the time of the merger, and determined that, as of the merger date, LBI's assets exceeded its debts by over $8 billion. The court accepted the testimony of the defendants' expert and, as a result, concluded that the Trustee failed to establish that LBI was insolvent under the balance-sheet test.

The Trustee focused primarily on the “unreasonably small capital” test and the court conducted a five-part analysis focusing on: 1) the historical performance and forward-looking projections of Lyondell and Basell; 2) industry outlook at the time of the merger; 3) the banks' projections; 4) expert testimony; and 5) additional considerations.

First, the Trustee argued that the Refreshed Projections, which were central to the analysis that resulted in the merger, were not reasonable and should not be relied upon. But the court commented that just because the Refreshed Projections proved wrong — due to unforeseen events — did not make them actionable, and the ultimate issue was whether such projections were reasonable when made. The court concluded that in fact they were reasonable when made.

Second, the court focused its attention on the industry outlook at the time the merger was consummated. That the price of oil dropped from a peak price of over $145 to below $40 in the summer and fall of 2008 — and that volatility would impact LBI's borrowing capacity — was not predicted by anyone. Thus, the court concluded that the industry outlook was “largely in line with management's and the bank's projections,” and noted that nearly all parties involved in the merger viewed the industry outlook to be “largely positive and conducive to a healthy LBI.”

Third, the court considered the financing banks' projections and concluded that, “as sophisticated investors and market participants” who put billions of dollars at risk, they were satisfied that LBI would prosper as a “a powerful company with a global footprint and competitive advantages.”

Fourth, the court considered the testimony of the experts who testified at trial, and concluded that: 1) the defendants' solvency expert credibly presented an analysis of LBI's required minimum liquidity; and 2) the testimony of the Trustee's experts was flawed because the experts “cherry-picked downside cases,” which produced distorted and misleading results.

Finally, the court determined that the unforeseen events that significantly affected LBI's financial condition post-merger, including the crane collapse, two large hurricanes and the Great Recession, needed to be considered when determining whether the merger left LBI adequately capitalized. As a result, the court concluded that the “unreasonably small capital” test was not satisfied, the Trustee therefore failed to prove that LBI was insolvent on the relevant dates, and the constructive fraudulent transfer claims necessarily failed.

The Intentional Fraudulent Transfer Claims

Actual fraudulent transfer claims were asserted to avoid and recover Toehold Payments 1 & 2, as well as the $48 per share distributions (approximately $12 billion) to Lyondell shareholders paid as the merger consideration. Three earlier decisions dealt with these claims: 1) in 2014, Judge Robert Gerber dismissed these claims in the shareholder cases with leave to amend; 2) after the Trustee amended the complaint, Judge Gerber, in 2015, once again dismissed these claims; and 3) on appeal, Judge Denise L. Cote reversed Judge Gerber's 2015 opinion concluding that the Trustee adequately pleaded an intentional fraudulent transfer claim.

The U.S. Court of Appeals for the Second Circuit has a demanding standard for showing fraudulent intent. Against that backdrop, the court first analyzed whether there was fraudulent intent on the part of CEO Smith and Blavatnik to hinder, delay or defraud creditors. Regarding Smith, the Trustee relied upon: 1) the CEO's public warning to Lyondell creditors that they would face harm as a result of the merger; and 2) the CEO's request to his subordinate to take a second look at company projections, as evidence of his fraudulent intent.

The court dismissed these assertions, finding first that “there were external events driving the preparation of the Refreshed Projections that do not require ascribing a malevolent motive to Smith,” and second that “there is nothing fraudulent about asking an employee to take a second look at projections in the face of a merger.” The Trustee argued further that the entire process of preparing the Refreshed Projections —€ i.e., that Smith “commanded” his employee to reach projections that would reach a higher value — was indicative of fraud, but the court rejected this assertion as well.

The court noted that: 1) it was entirely plausible that Smith, as an experienced CEO, simply believed, based upon his knowledge of the company and industry, that EBITDA in the higher range was likely to be achieved; 2) there's nothing wrong with a CEO expressing his opinion, and Smith's employee testified that he was not directed to reach a particular result; and 3) although the process by which the Refreshed Projections were prepared was “hardly flawless … the mere fact that the Trustee can show that the projections could have been more accurate … does not mean that the methods used … rise to the level of actual fraud.”

Because the Trustee failed to establish that the Refreshed Projections were not used to defraud Lyondell's creditors, the court concluded that the Trustee could not prove Smith's fraudulent intent by a preponderance of the evidence. The court also rejected the Trustee's accusation that Blavatnik had the requisite fraudulent intent to support a finding that the toehold payments were actual fraudulent transfers, in light of: 1) Blavatnik's testimony that Lyondell's projections “did not drive the decision by Access and Basell to proceed with the merger”; and 2) the testimony presented at trial, by Blavatnik and others at Access, which established that Blavatnik had a “keen interest” in seeing LBI succeed, and arguably lost more than anyone as a result of the bankruptcy.

The court next focused on whether the Trustee established actual fraudulent intent by proving badges of fraud and concluded that he was unable to do so for the following reasons: 1) the toehold payments were negotiated between two sophisticated parties as a result of arms-length dealing; 2) even if Toehold Payment 1 was made to an insider, it was not a transfer of essential assets, there were no pending lawsuits at the time of the transfer and the transfer was not for substantially all of the debtor's assets; 3) Toehold Payment 2 was not made to an insider; and 4) the Trustee failed to show that Lyondell was insolvent at the time the toehold payments were made.

Having earlier concluded that CEO Smith lacked the requisite intent, the court then analyzed whether, assuming Smith did intend to hinder, delay or defraud creditors, Smith's intent could be imputed horizontally to Basell as the acquiring entity under the “collapsing doctrine.” The court noted that it was uncontroversial that the collapsing doctrine could be applied where form must give way to substance, and the doctrine has been used to combine multiple transactions and impute the intent of a corporation's officer to the corporation of which he is an officer. In other words, a vertical application of the collapsing doctrine. The Trustee, however, sought to expand the doctrine horizontally — to impute the intent of company officer A to corporation B — but was unable to provide any support for such authority. And the court was unable to locate any case allowing what it described as “an unprecedented expansion of the collapsing doctrine.”

The court was further troubled with the Trustee's novel theory because it flew in the face of a long line of case law holding that the intent of the transferor, not the transferee, is the relevant inquiry for section 548 of the Bankruptcy Code. In other words, the transferee's good faith or lack thereof is irrelevant. The court therefore held that the Trustee's novel application of the collapsing doctrine failed. The court concluded its analysis of the Trustee's intentional fraudulent claims by holding that: 1) Smith was not an agent of Basell, and therefore, no agency relationship existed; and 2) such claims independently failed because Lyondell did not possess a property interest in either toehold payment, was not the borrower or physical transferor of either toehold payment, and the Trustee failed to establish that Lyondell had any control over the funds used to make the toehold payments.

The Preference Action

The Trustee sought to recover the $300 million October Repayment as a preferential transfer made within 90 days of the petition date. The Trustee needed only to prove insolvency on the date of the October Repayment and, although he was entitled to a rebuttable presumption of insolvency under section 547(f) of the Bankruptcy Code, the court found that the defendants had successfully rebutted that presumption, thereby shifting the burden back to the Trustee. Ultimately, the Trustee was unable to make the proper showing of insolvency.

The court first concluded that Lyondell, not LBI, was the relevant party for ascertaining whether the Trustee could avoid the $300 million transfer to Access under section 547(b) of the Bankruptcy Code. And therefore the analysis of the section 547(b) insolvency requirement was limited to Lyondell only. That posed a problem for the Trustee, whose only insolvency expert for October 2008 testified about LBI on a consolidated basis and the court was not willing to extrapolate Lyondell's stand-alone insolvency based upon that testimony. The court did not accept the Trustee's eleventh-hour attempt to argue that Lyondell, not LBI, was the relevant entity. The court also did not accept the Trustee's argument that several internal LBI emails referenced the possibility of bankruptcy and were therefore evidence of balance-sheet insolvency. Thus, the court found that the Trustee did not satisfy his burden to prove the October Repayments were an avoidable preference.

The Successful Breach of Contract Claim

To prevail on a breach of contract claim under New York law, a plaintiff must prove: 1) a contract; 2) performance of the contract by one party; 3) breach by the other party; and 4) damages. Terwilliger v. Terwilliger, 206 F.3d 240, 245-46 (2d Cir. 2000). There was no dispute at trial that a contract existed between the parties or that AI International refused to fund the requested draft in December 2008. The issue was whether LBI's impending Chapter 11 filing constituted a material adverse change excusing AI International's performance under the ARCA. Whereas the ARCA did include a solvency requirement at the time of closing, it did not include a solvency requirement at the time of draw, and the court was unwilling to infer one where the parties drafted none.

As such, the court concluded that AI International breached its obligation to LBI and Lyondell to fund the December 2008 draw request and, as a result, the Trustee was entitled to restitutionary damages. As the purpose of restitution “aims to restore the non-breaching party to as good a position as the one she occupied before the contract was made,” 360 Networks Corp. v. Geltzer (In re Asia Glob. Crossing, Ltd.), 404 B.R. 335, 341 (S.D.N.Y. 2009), the court decided to calculate such damages by estimating the benefits paid for but not received by LBI. Accordingly, the court concluded that the Trustee was entitled to recover the amount of the $12 million commitment fee minus 40%, or $7.2 million, representing the value unjustly retained by Access.

Breach of Fiduciary Duties Under Luxembourg Law

The Trustee asserted several liability claims under Luxembourg law, including: 1) a tort liability claim against Blavatnik and Access arising under the Luxembourg Civil Code, the foundation of which was the allegation that they acted as de-facto managers of Basell and LBI, and that they engaged in misconduct that caused harm to both companies; 2) a similar tort liability claim against Blavatnik under the Luxembourg Companies Act; 3) a tort liability claim on behalf of LBI against Kassin for abdications of duty in the conduct of his formal roles under both the Companies Act and the Luxembourg Civil Code; and 4) claims against Blavatnik, Kassin and Benet as members of the LBI Supervisory Board for failing to exercise alleged veto rights post-merger to prevent the upsizing of the ABL Facilities or entrance into the Access Revolver.

In order to have prevailed on his breach of fiduciary duties claims against Blavatnik or Access, the Trustee needed to prove that: 1) Blavatnik or Access acted as de-facto directors of Basell and LBI; 2) their actions in that capacity constituted a “fault” or “misconduct” under Luxembourg law; and 3) such misconduct caused harm to Basell and LBI. The Trustee satisfied the first prong of the analysis at trial because the evidence established that Blavatnik and Access took affirmative and independent acts of management of Basell and LBI in the context of the merger, on long-term and on a repeated basis, and in lieu of the managers of the GP. But the Trustee also needed to, but could not, prove that their actions constituted a fault or misconduct, which then caused harm to Basell and LBI.

The Trustee argued that Blavatnik: 1) placed his own personal interests above those of Basell by extracting over a billion dollars in capital from Basell prior to the merger, 2) set detrimental parameters for funding the merger, and 3) imposed an unreasonably short diligence time to complete the merger. The court found, however, that the Trustee was unable to prove any of these allegations because he could not prove Basell was insolvent on the merger date. Therefore, the court found that Blavatnik had not committed actionable fault or misconduct. But even had the Trustee proven actionable fault or misconduct, the court found that the Trustee did not prove the proximate causal relationship between Blavatnik's alleged misconducts and the alleged harm to the combined entity. Accordingly, the court rejected the Trustee's tort claims under Luxembourg law against Blavatnik and Access.

The court also rejected the Trustee's claim that Kassin should be held liable for violating either the Companies Act, GP's articles of association or Articles 1382 and 1383 of the Luxembourg Civil Code for abdicating his responsibility as a manager of the GP and following the direction of Blavatnik in taking steps to cause the merger to occur.

Finally, the Trustee asserted a claim against Blavatnik, Kassin and Benet as members of the LBI Supervisory Board for failing to exercise their veto rights under LBI's Articles of Association to prevent the upsize of the ABL Facilities and the Access Revolver, or failing to exercise their mandates as members of the Supervisory Board. But this claim also failed because, when read and understood as a whole, the provisions of the LBI Articles of Association did not provide the Supervisory Board members with true veto rights. Rather, they had certain “authorization” rights with respect to certain activities including, of relevance, the entry into the ABL Facilities and the Access Revolver, unless such facilities were previously approved in a business or financing plan.

Since the plan to enter into the Access Revolver and upsize the ABL Facility were both contemplated in the merger financing documents that had already been approved in the context of the merger, the court concluded that the Trustee could not prove at trial that LBI's Supervisory Board failed to exercise its veto right with respect to those facilities. The Trustee's aiding and abetting claims against AIH and AI Chemical fell along with the underlying Luxembourg claims.

Conclusion

Questions of solvency and capital adequacy were a central focus of the Lyondell trial, and the cornerstone of the Trustee's case was the assertion that the Refreshed Projections were fraudulently prepared. The expert testimony offered by the Trustee, however, was found to be unreliable and, without this testimony, the Trustee could not establish that Lyondell was insolvent on any relevant date. In support of his intentional fraudulent transfer claims, the Trustee argued that CEO Smith had the requisite fraudulent intent, which he didn't, and then attempted to impute that intent horizontally to Blavatnik. A novel application of the collapsing doctrine to be sure, but Judge Glenn rejected that theory, commenting that “no amount of mental gymnastics can substantiate a recovery on an intentional fraudulent transfer claim brought against … the person who himself lost billions on LBI's failure.”

So what's the takeaway? This lengthy opinion is a must-read for creditor committees, post-confirmation trusts, distressed investors and any other party seeking to advance estate litigation in order to maximize estate value. At first blush, the opinion may discourage some from the pursuit of litigation stemming from leveraged transactions. But that would be the wrong reaction. As Judge Glenn noted, the results in this case were very fact-dependent. It was the unforeseen events that plagued LBI in 2008 that drove the outcome of this case more so than the allegations of fraud. Under the right set of circumstances, and with the right mindset — €” understanding that bankruptcy judges are evaluating challenged leveraged transactions which occurred in real time –€” LBO litigation can and should be pursued to maximize estate value.

***** Steven B. Smith is a Senior Consultant at JND Corporate Restructuring (www.JNDLA.com) and a member of this newsletter's Board of Editors. Prior to accepting his current position, he was bankruptcy counsel in the New York office of Blank Rome LLP.