CLIENT PUBLICATION
FINANCIAL RESTRUCTURING & INSOLVENCY | August 9, 2016
Not So Safe After All?
United States Bankruptcy Court for the District of Delaware Holds That
Litigation Trustee May Pursue State Law Fraudulent Conveyance Claims,
Notwithstanding Bankruptcy Code Safe Harbors
On June 20, 2016, the United States Bankruptcy Court for the District of Delaware (the
“Bankruptcy Court”) denied in part a motion to dismiss and allowed state law constructive
fraudulent transfer claims to proceed, despite the fact that such claims likely would have been
precluded by the Bankruptcy Code’s safe harbors if brought pursuant to federal law. This
decision is notable in that it is at odds with a recent decision by the Second Circuit Court of
Appeals in Tribune,1 which held that state law constructive fraudulent conveyance claims
brought by creditors are barred by the Bankruptcy Code’s safe harbors.
Background
In 2007, private equity fund Water Street Healthcare Partners, L.P. (“Water Street”) acquired Physiotherapy
Holdings, Inc. (the “Debtor”) for roughly $150 million. Shortly after the transaction closed, Water Street entered into
an agreement to merge the Debtor with Benchmark Medical, Inc. Water Street owned 45% of the common stock of
the surviving entity, while private equity fund Wind Point Partners IV, L.P. (together with Water Street, the
“Defendants”) held a 35% ownership stake. Throughout the next five years, the Defendants increased their
ownership to approximately 90% of the Debtor’s common shares.
The litigation trustee (the “Trustee”)2 alleges that during this time, the Defendants engaged in various forms of
accounting fraud in order to overstate the Debtor’s financial health and reap a substantial profit from the sale of
their shares. By 2009, the Debtor’s financial condition had deteriorated significantly, and, according to the Trustee,
the Defendants began implementing new strategies to sell the company and maximize the potential sale
consideration, including pressuring the Debtor’s senior management into manipulating net revenue and patient visit
counts to make the Debtor seem more profitable.3
1 Deutsche Bank Trust Co. Ams. v. Large Private Beneficial Owners (In re Tribune Co. Fraudulent Conveyance Litig.), 818 F.3d 98 (2d Cir. 2016).
2 The Debtor established the PAH Litigation Trust through its plan of reorganization. Because the Secured Noteholders (defined below) assigned
their individual claims to the Trustee, the Litigation Trust has standing to assert claims in the capacity of both an estate representative and an
assignee.
3 Because the Defendants’ representatives sat on the board, the Trustee asserted that Defendants were well aware of these accounting
manipulations.
