This Client Alert relates to the Supreme Court’s decision in Merit Management Group, LP v. FTI Consulting, Inc., No. 16-784, issued on February 27, 2018. The Bankruptcy Code allows the trustee or a debtor-in-possession to avoid and recover certain pre-bankruptcy transfers made by the debtor for the benefit of the bankruptcy estate. One limitation to these avoiding powers is a safe harbor provided by 11 U.S.C. § 546(e).
As originally enacted, the § 546(e) safe harbor was intended to protect certain margin and settlement payments related to securities, commodities and the securities markets. Over the years, however, Congress expanded the language of the § 546(e) safe harbor, such that it now provides, in relevant part, that “the trustee may not avoid a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a . . . financial institution . . . or that is a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract.” The expansion of the safe harbor resulted in it being routinely raised as a defense to avoidance actions where financial institutions were conduits to the transfers at issue.
Under the facts of the Merit case, Valley View Downs, LP and Bedford Downs Management Corp. resolved a dispute in the process of securing the last available harness-racing license in Pennsylvania. The settlement involved Bedford Downs withdrawing its name from consideration and Valley View purchasing all of Bedford Downs’ stock for $55 million after it obtained the license. Valley View was granted the license and arranged for a holding company to wire $55 million to the third-party escrow agent bank of Pennsylvania. In response, the Bedford Downs shareholders, including Merit Management Group, LP, deposited their Bedford Downs stock into escrow. The third-party bank then disbursed $16.5 million to Merit in exchange for its portion of the Bedford Downs stock.
Valley View ultimately filed for Chapter 11 bankruptcy and, via the trustee of its litigation trust, FTI Consulting, Inc., brought an action to avoid the transfer from Valley View to Merit. FTI argued that the transfer was constructively fraudulent transfer because Valley View was insolvent at the time of the payment and overpaid for the Bedford Downs stock. Merit contended that such transfer involved a “settlement payment . . . made by or to (or for the benefit of) a . . . financial institution” and, therefore, was protected by the § 546(e) safe harbor.
The Supreme Court held that, when applying the § 546(e) safe harbor, a court must first identify the relevant transfer sought to be avoided and then determine whether the § 546(e) safe harbor applies to such transfer. Under the facts, such transfer was the transfer of Valley View’s $16.5 million in exchange for Merit’s stock in Bedford Downs. Because that transfer was not made by or to (or for the benefit of) a financial institution, the Court concluded that it was not protected by the § 546(e) safe harbor. The Court found the involvement of financial institutions in the transfer process irrelevant to the § 546(e) safe harbor defense.
The Court rejected Merit’s argument that the court must also consider the component parts of such transfer, i.e., the transfers to and from the financial institutions. The Court explained that, when a transfer is executed via multiple transactions, such transactions are not relevant for purposes of the § 546(e) safe harbor if the trustee is not seeking to avoid them. For example, if a transfer from A → D is executed via B and C as intermediaries, the component parts of the transfer include A → B → C → D. If the trustee seeks only to avoid A → D, the transactions to and from A → B, B → C, and C → D can and should be ignored for purposes of applying the § 546(e) safe harbor. Thus, the relevant transfer for purposes of the § 546(e) safe harbor inquiry is only the overarching transfer from A → D.
As a result of the Court’s holding, it is clear that the use of a financial institution as a conduit in a transaction will not insulate the ultimate transfer from avoidance actions. Accordingly, the § 546(e) safe harbor appears to have been returned to its origins where it will continue to protect only certain margin and settlement payments related to securities.
Client Alert 2018-059
