(CN) – Bankruptcy laws don’t protect corporations from making settlement payments to shareholders of privately traded securities, the 6th Circuit ruled in an issue of first impression.
Quality Stores merged with Central Tractor Farm and Country in a $208 million leveraged buyout in 1999. The merger placed financial strain on Quality, which had trouble adjusting to the costs of integration and aggressive expansion. It filed for Chapter 11 protection in November 2001.
Quality and QSI Holdings sued shareholders, claiming the stock-for-cash arrangement had left the company with too little capital, causing it to rack up debt. They sought to avoid further payouts and to recover previous payments, calling them fraudulent transactions.
Shareholders insisted that Quality was still on the hook for the buyout payments, because bankruptcy law exempts from protection “settlement payments” made by a financial institution. The company argued that this exemption applies to publicly traded securities only.
The Cincinnati-based federal appeals court held that nothing in the exemption’s text limits it to publicly held securities. And because the transactions were made through HSBC Bank, they satisfied the “financial institution” requirement.
The 6th Circuit affirmed the lower court’s ruling that the exemption applies to privately traded securities, and that Quality and QSI can’t avoid the payouts.