Litigation Coverage: Court Rejects Covidien’s Novel Indenture-Based Safe Harbor Defense to Mallinckrodt Opioid Trust’s $1.6B Spinoff Avoidance Claims

Relevant Document:
Opinion

Judge Brendan L. Shannon today issued an opinion largely denying Covidien’s motion for summary judgment on the Mallinckrodt opioid master disbursement trust II’s $1.6 billion spinoff suit against Mallinckrodt’s former parent. Judge Shannon specifically rejects Covidien’s novel argument that the standard repurchase and redemption provisions in its public notes indentures render the issuer and guarantors “financial participants” for the section 546(e) “safe harbor” avoidance defense.

If Judge Shannon had agreed with Covidien, then any company with more than $1 billion in outstanding notes governed by an indenture with standard redemption and repurchase provisions would qualify as a “financial participant” for safe harbor purposes, which would dramatically expand the scope of transactions that cannot be clawed back by debtors and trustees.

Judge Shannon also denies Covidien’s request for summary judgment on the trust’s claims to recover payments made by Mallinckrodt under tax and indemnity agreements executed as part of Mallinckrodt’s 2013 spinoff from Covidien and on the trust’s alter ego claims to hold Covidien liable for Mallinckrodt’s opioid liabilities.

To qualify for the safe harbor defense under section 546(e) of the Bankruptcy Code, a transfer must be made to a “financial participant” in connection with a “securities transaction.” “Financial participants” are usually investment funds or market makers with billions of dollars in securities purchase and sale contracts, derivatives or options (such as the fund defendants in the trust’s $1.6 billion share repurchase clawback action) – not medical device manufacturers such as Covidien.

Judge Shannon agrees with Covidien that transfers of assets and payments made by Mallinckrodt in connection with the spinoff qualify as transfers in connection with a “securities contract,” namely the spinoff separation agreement. The separation agreement governed the distribution of Mallinckrodt shares to Covidien shareholders, which was clearly a “securities transaction,” and governed the transfers of assets undertaken in the spinoff, the judge finds.

The fact that the “vast majority” of spinoff asset transfers were themselves not transfers of or on account of securities does not take them out of the broad scope of transfers made in connection with “securities transactions” under section 546(e), Judge Shannon explains.

However, Judge Shannon also finds that defendants Covidien International Finance SA, Covidien Ltd. and Covidien Group Holdings Ltd. do not qualify as “financial participants” eligible for “safe harbor” protection under section 546(e) because they are not parties to a securities contract, commodity contract, swap agreement, repurchase agreement or forward contract for transactions of at least $1 billion, as required by section 101(22A)(A) of the Bankruptcy Code.

Covidien argued that these defendants qualify as “financial participants” because they are issuers or guarantors under indentures for more than $5 billion in notes that contain standard redemption and “change of control” repurchase provisions, but the judge disagrees.

“The Indentures put forth by Covidien here refer to the purchase and sale of securities, but they are not themselves contracts ‘for the purchase, sale, or loan of a security’ or even an option to enter into such a contract,” Judge Shannon points out.

Instead, the judge explains, the indentures are “documents that govern the underlying securities contracts, such as the note purchase agreements.” Unlike the documents in the cases cited by Covidien, the indentures “are not evidence of specific securities transactions,” Judge Shannon observes.

Judge Shannon does agree with Covidien that one defendant, Covidien Group Sarl, qualifies as a “financial participant” because it had currency forward and swap contracts with an aggregate notional principal amount exceeding $2.5 billion and securities contracts for the purchase, or option to purchase, shares of other companies that exceeded the alternative $100 million mark-to-market positions test.

The judge rejects the trust’s argument that Covidien Group Sarl’s contracts do exceed the $1 billion threshold because they are “FX forwards” that “do not involve the exchange of interest payments” and thus do not have a “notional principal amount.” “Section 101(22A) expressly includes ‘forward contracts’ among the type of agreements” that can qualify a defendant as a “financial participant,” Judge Shannon says.

Turning to the tax and indemnity transfers, Judge Shannon finds that summary judgment is inappropriate because the trust “lacks the necessary facts” from discovery to respond to Covidien’s argument that the tax and indemnity transfers were made in connection with a “securities contract.”

“The Court recognizes that because the Tax and Indemnity Obligations were incurred by Mallinckrodt in the Separation Agreement any payments made on account of those Obligations are likely to be transfers made ‘in connection with’ a ‘securities contract,’” the judge says, but “it is not possible to conclusively determine that issue” on the current record.

Finally, Judge Shannon rejects Covidien’s argument that the trust’s alter ego claims are indirectly barred by the safe harbor because the defense “precludes the Trust from avoiding the release provided by Mallinckrodt in the Separation Agreement.” According to the judge, the safe harbor applies only to avoidance claims under the Bankruptcy Code and does not apply to the trust’s state law alter ego claims.

“While Covidien may be free to argue later that the release operates as a complete defense to this claim, that issue is not properly before the Court” at this point, Judge Shannon writes.