On February 27, 2018, the Supreme Court issued a significant decision that will increase the exposure of debt and equity investors that receive payments from all kinds of highly leveraged transactions, including leveraged buy-outs and dividend recapitalizations. The unanimous opinion in Merit Management Group, LP v. FTI Consulting, Inc. affirmed the Seventh Circuit’s holding that section 546(e) of the Bankruptcy Code does not operate to shield a recipient of an alleged fraudulent transfer when the recipient is not a covered financial institution, notwithstanding the fact that the transfer at issue may have flowed through such a financial institution.[1] Overturning decisions by other circuit courts of appeal, the Court examined the statutory structure and context of the Bankruptcy Code’s “safe harbor” to distinguish transfers made by, to, or for the benefit of financial intermediaries, with those that merely pass through such intermediaries.
A. Facts
Valley View Downs, LP (“Valley View”) and Bedford Downs Management Corporation (“Bedford”) were competitors for the last harness-racing license in Pennsylvania.[2] Rather than continuing to fight over the license, the parties decided to join forces.[3] Specifically, they entered into an agreement whereby Bedford would withdraw its bid for the license (clearing the path for Valley View) and, after it obtained the license, Valley View would purchase Bedford.[4] Valley View would then procure additional licensing and open a “racino” — a race track with slot machines.
After Valley View obtained the license, it arranged for a loan from a syndicate of offshore banks (collectively the “Lending Bank”) to finance the purchase of Bedford’s outstanding stock from its shareholders.[5] The loan proceeds were transferred from Valley View’s lender to a Pennsylvania bank that acted as the escrow agent for the transaction (the “Escrow Bank”). Following the closing, Valley View obtained Bedford’s stock certificates and the Escrow Bank disbursed $55 million to Bedford’s shareholders.[6] At the time, Merit Management Group, LP (“Merit”) owned 30% of Bedford and therefore received $16.5 million in exchange for its shares.[7]
Despite winning the harness-racing license, Valley View ultimately failed to obtain additional licensing and its plans to open a racetrack casino fell through. Valley View filed for bankruptcy and FTI Consulting, Inc. was subsequently appointed to serve as the trustee of a litigation trust established under the confirmed chapter 11 plan (the “Litigation Trustee”).[8]
The Litigation Trustee filed suit against Merit seeking to avoid the $16.5 million in payments from Valley View on the grounds that the payments were constructively fraudulent transfers under section 548 of the Bankruptcy Code. Section 548(a)(1)(B) allows a trustee to avoid any transfer of “an interest of the debtor in property” if debtor “received less than a reasonably equivalent value in exchange for such transfer . . . and . . . was insolvent on the date that such transfer was made . . . .”[9] The Litigation Trustee alleged that Valley View was insolvent when it purchased the Bedford shares and that Valley View “significantly overpaid” for the stock.[10]
B. The District Court Decision and Section 546(e) “Safe Harbor”
At the district court, Merit argued that under section 546(e) of the Bankruptcy Code the payments it received from the sale of Bedford stock were insulated from attack.[11] Specifically, section 546(e) prevents a trustee from avoiding a constructive fraudulent transfer that constitutes (1) “a settlement payment . . . made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency” or (2) “a transfer made by or to (or for the benefit of)...
