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December 12, 2022

A Bankruptcy Giant’s Swan Song: Judge Drain Expands the Lookback Period to Bring Avoidance Actions & Calls on Congress to Curtail the Safe Harbor Exception


In the final written opinion of his illustrious career, Judge Robert D. Drain of the U.S. Bankruptcy Court for the Southern District of New York issued a decision in Halperin v. Morgan Stanley Investment Management, Inc. (In re Tops Holding II Corporation)1 that imposes greater risk on targets of fraudulent transfer claims. This article analyzes the Tops Holding decision and its go-forward impact.


The Bankruptcy Code provides mechanisms for trustees to avoid and recover certain transfers made by debtors before bankruptcy. These avoidance powers are subject to certain limitations. One limitation is the statutory lookback period during which purportedly fraudulent transfers can be avoided. Generally, the lookback period is two years for fraudulent transfer avoidance actions brought under Bankruptcy Code section 548, and four or six years if the trustee employs state law through Bankruptcy Code section 544. Following a recent trend among some bankruptcy courts, Judge Drain applied a ten-year lookback period, relying on the IRS’s applicable statute of limitations, thereby allowing a fraudulent transfer claim to be asserted in respect of a transaction ten years before the petition date.

Another limitation on a trustee’s avoidance powers is the safe harbor contained in Bankruptcy Code section 546(e) (the Safe Harbor Provision), which precludes the avoidance of: (i) a “settlement payment” or a transfer “in connection with a securities contract; (ii) made by or to (or for the benefit of) a “financial institution.” Because qualifying transactions are shielded from avoidance, the questions of: (i) what qualifies as a transfer made “in connection with a securities contract” or as a “settlement payment;” and (ii) who meets the statutory definition of a “financial institution” have been the subject of much litigation in recent years, resulting in a safe harbor that some critics say is now so broad that it swallows a trustee’s general avoidance powers Indeed, in Tops Holding, not only did Judge Drain hold that the dividend payments at issue were not safe-harbored, he directly called for Congress to narrow the Safe Harbor Provision’s applicability.

Tops’ and Tops Holding’s Background

Notwithstanding its continually increasing liabilities and lackluster operating revenues, Tops II Holding Corporation (Tops) paid dividends to a group of private investors (the Investor Group) in 2009, 2010, 2012 and 2013 totaling $375 million (the Dividend Payments). On February 21, 2018, Tops and its affiliated debtors filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. On November 9, 2018, the Court confirmed Tops’ Chapter 11 plan. The trustee for the litigation trust established under the plan (the Litigation Trustee) subsequently sued the former equity investors to avoid the Dividend Payments as actual and constructive fraudulent transfers under New York Debtor and Creditor Law (the DCL) and Bankruptcy Code section 544(b). The Investor Group moved to dismiss the fraudulent transfer claims, asserting, among other defenses, that the Litigation Trustee’s claims with respect to the 2009 and 2010 Dividend Payments were time-barred and that the Dividend Payments were safe harbored. Neither defense prevailed.

Extending the Lookback Period to Ten Years to Bring Avoidance Actions

Bankruptcy Code section 544(b) allows a trustee to step into the shoes of any creditor holding an allowed unsecured claim to avoid a prepetition transfer made by the debtor, provided the transfer is voidable under applicable law. Voidable “under applicable law” generally means state law, which generally provides that avoidance actions are time-barred unless brought within four or six years of the time the transfer was made.

In contrast, the federal government is generally not limited by state statutes of limitations, including those in state fraudulent transfer laws, based on the doctrine nullum tempus occurrit regi (“no time runs against the king”).2 Indeed, the Internal Revenue Code (IRC) provides that the IRS may collect a tax assessment within ten years of the assessment in question.3 In recent years, parties seeking to avoid purportedly fraudulent transfers made outside the typical four or six year lookback period generally provided for under state law have argued that “applicable law,” as used in Bankruptcy Code section 544(b), incorporates the IRC and estate representatives are therefore entitled to utilize the ten-year lookback period in the IRC.

In Tops Holding, the Litigation Trustee’s fraudulent transfer claims were timely with respect to the Dividend Payments made in 2012 and 2013: i.e., Dividend Payments in those years were within the applicable six-year lookback period, but untimely with respect to the Dividend Payments made in 2009 and 2010. To defeat the statute of limitations defenses, the Litigation Trustee asserted in the complaint that “[u]nder Section 544(b) of the Bankruptcy Code, the Trustee may avoid any transfer . . . that is voidable under applicable non-bankruptcy law by any creditor holding an unsecured, allowable claim [and that] [c]reditors of Tops exist who could avoid the 2009 [and 2010] Dividend[s] under applicable law, including the Internal Revenue Service.”

Judge Drain held that the estate is afforded the ten-year lookback period when bringing fraudulent transfer claims under the DCL through Bankruptcy Code section 544(b) where the IRS is an unsecured creditor of the debtor’s estate and was a creditor at the time of the targeted transaction. In such instances, the creditor’s claim held at the time of the bankruptcy filing need not be identical to the one held at the time of the purportedly fraudulent transfer.4 Since the IRS is typically a creditor of many corporate entities, this ruling has broad ramifications. Even when the IRS is not a creditor, Tops Holding’s reasoning paves the way for estate representatives to utilize the lookback period afforded to other federal governmental departments that may be creditors of a debtor.5 However, in order to proceed on a constructive fraudulent transfer claim, the plaintiff will need to show that the debtor was insolvent at the time of the relevant transaction, which will presumably be a more difficult burden the longer that time has passed since the transaction. Yet the Litigation Trustee in Tops Holding was able to overcome this burden.6

As noted, Judge Drain’s decision follows the recent trend of bankruptcy courts, which have applied the IRS ten-year statute of limitations to fraudulent transfer claims.7 Some courts, however, have reached the contrary result and held that trustees are not afforded the ability to step into the IRS’s shoes to benefit from the ten-year lookback period.8

Judge Drain Calls for Congress to Curtail the Safe Harbor Provision’s Applicability

In Tops Holding, the investors defendants also argued that the Dividend Payments were exempt from avoidance under the Safe Harbor Provision because (a) they were transfers made in connection with a securities contract, i.e., there were private notes offerings that were “securities contracts,” and the Dividend Payments, funded by the proceeds from the notes offerings, were transfers “in connection with” those notes offerings and (b) the Dividend Payments were transfers by a “financial institution” because they were made by Tops through its bank to the investors’ banks, which were acting as either Tops’ or the investors’ agents or custodians and were therefore the parties’ “financial institutions.”9

In analyzing whether the Dividend Payments were transfers “in connection with a securities contract,” the Court rejected the notion that it should analyze the notes offerings and the Dividend Payments together as an “integrated transaction.” Instead, the Court held that, even though the notes offerings were “securities contracts,” it should not look beyond the specific transfer sought to be avoided by the Litigation Trustee in deciding whether such transfer was safe harbored.10 Accordingly, the Court looked at the Dividend Payments in isolation and held that, since such payments were not payments to settle a “securities contract,” they were not safe harbored transfers.

Judge Drain’s ruling on this issue is significant in two respects. First, the rejection of the “integrated transaction” analysis in determining whether a transfer is “in connection with a securities contract” is arguably at odds with other decisions issued from within the Southern District of New York concerning the Safe Harbor Provision.11 Second, albeit implicitly, the decision may be read by some to alter the statutory language of the Safe Harbor Provision, changing the requirement that a transfer be “in connection with a securities contract” to say that the transfer must be “in completion of [or to finalize or to settle] a securities contract.”

Moreover, the Court utilized a restrictive approach to interpret whether an entity qualifies as a “financial institution” as a result of being a “financial institution’s” customer. The Court held that the investor defendants had not identified an agency or custody agreement between (a) a “financial institution” and (b) either Tops or the Investor Group. In arguing the presence of a custodial relationship, the investors produced flow of funds memoranda showing the flow of funds from one of the book-running managers into Tops’ bank account and thereafter from Tops to one of the investor’s bank accounts. The Court held, however, that this was insufficient and the flow of funds memoranda were merely evidence of a creditor-debtor relationship, rather than agent-principal.

Perhaps most significantly, and recognizing the differing interpretations of the Safe Harbor Provision, Judge Drain called on Congress to curtail the Safe Harbor Provision’s application:

As this is my last opinion before retiring from the bench, perhaps I can be indulged in asking, why Congress has put the courts to all this parsing and hair splitting over . . . [what qualifies as a safe harbored transaction]. After all, at issue here is a transaction whereby, after encumbering a privately held company’s assets with privately issued debt, a handful of sophisticated private equity investors took massive dividends that, as asserted by the Complaint, left the pension plans of thousands of workers and hundreds of creditors holding the bag. Only the veracity of that last assertion – that is, whether Tops was insolvent or rendered insolvent by the dividends – not whether the dividends are safe-harbored, should be at issue. The avoidance of these dividends and the loans that funded them would have no effect on the public securities markets, the ostensible purpose for section 546(e). On the other hand, . . . [g]iven the importance of fraudulent transfer law in bankruptcy cases, Congress should act to restrict to public transactions its currently overly broad free pass in section 546(e) that has informed the playbook of private loan and equity participants to loot privately held companies to the detriment of their non-insider creditors with effective impunity.12

* * * * *

The defendants have appealed Tops Holding to the district court, so there will likely be further notable developments on these issues.

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

  1. Case No. 18-22279 (RDD), Adv. Pro. No. 20-08950, 2022 WL 6827457 (Bankr. S.D.N.Y. Oct. 12, 2022) (Tops Holding).

  2. This doctrine was justified in modern times by the policy that revenues should not be forfeited due to the negligence of public officials.

  3. See 28 U.S.C. § 6502(a).

  4. See Silverman v. Sound Around, Inc. (In re Allou Distribs.), 392 B.R. 24, 34 (Bankr. E.D.N.Y. 2008) (holding that to satisfy the standing requirements of Bankruptcy Code section 544(b), “a triggering creditor must be the same creditor on both the Transfer Date and the Petition Date, but need not hold the same claim at these two essential points in time.”).

  5. For example, the Securities and Exchange Commission is entitled to a six-year lookback period under 28 U.S.C. §§ 2415(a) and 2416.

  6. The Court noted that the fact that a business actually survived for a considerable period of time after a challenged transfer is a factor that a court may consider in deciding whether the business was insolvent or had unreasonably low capital at the time of the transfer. However, the Court further noted, it is only one of many factors that may be relevant, it is not necessarily controlling, and courts should also consider the company’s debt to equity ratio, its historical capital cushion, the need for working capital in the specific industry at issue, and all reasonably anticipated sources of operating funds, which may include new equity infusions, cash from operations, or cash from secured or unsecured loans over the relevant time period. The Court concluded that “unreasonably small capital” for purposes of analyzing whether a constructively fraudulent transfer occurred “is not limited to a train wreck that is imminent because the engineer has fallen asleep; it can also be found where a key support for a trestle has rotted, no one is performing maintenance, and eventually the bridge will collapse.” Tops Holding, 2022 WL 6827457, at *18.

  7. See, e.g., Maxus Liquidating Trust v. YPF S.A. (In re Maxus Energy Corp.), 641 B.R. 467, 545–546 (Bankr. D. Del. 2022); Williamson v. Smith (In re Smith), Adv. Pro. No. 22-07002, 2022 WL 1814415, at *4–7 (Bankr. D. Kan. June 2, 2022); In re Webster, 629 B.R. 654 (Bankr. N.D. Ga. 2021).

  8. See, e.g., In re Mirant Corp., 675 F.3d 530 (5th Cir. 2012) (declining to afford the trustee use of the six-year lookback period provided for in the Fair Debt Collection Practice Act); In re Vaughan, 498 B.R. 297 (Bankr. D.N.M. 2013) (declining to afford the trustee use of the IRS ten-year lookback period).

  9. See 11 U.S.C. § 101(22)(A) (defining a “financial institution” as banks and the customers of such banks when the banks are acting as the customers’ agents or custodians).

  10. See Merit Mgmt. Group, LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018) (Merit). Merit directed lower courts to examine the “overarching transfer that the trustee seeks to avoid.”

  11. See In re Boston Generating LLC, 617 B.R. 442 (Bankr. S.D.N.Y. 2020), aff’d sub nom. Holliday v. Credit Suisse Sec. (USA) LLC, No. 20 Civ. 5404, 2021 WL 4150523 (S.D.N.Y. Sep. 13, 2021); SunEdison Litig. Trust v. Seller Note, LLC, 620 B.R. 505 (Bankr. S.D.N.Y. 2020); In re Nine West LBO Sec. Litig., 482 F. Supp.3d 187 (S.D.N.Y. 2020).

  12. Tops Holding, 2022 WL 6827457, at *30 (internal citations and quotations omitted) (emphasis in original).