In In re Tribune Co. Fraudulent Conveyance Litig., 2019 WL 1771786 (S.D.N.Y. Apr. 23, 2019), the U.S. District Court for the Southern District of New York denied a litigation trustee’s motion to amend a complaint seeking to avoid alleged fraudulent transfers made to selling shareholders as part of a 2007 leveraged buyout ("LBO") of the Tribune Co. ("Tribune"), ruling that the safe harbor in section 546(e) of the Bankruptcy Code continues to bar such claims notwithstanding the U.S. Supreme Court’s February 2018 decision in Merit Management Group v. FTI Consulting. According to the district court’s ruling, payments made to shareholders as part of the LBO transaction were insulated from avoidance as constructive fraudulent transfers because Tribune hired a commercial bank to serve as exchange agent for the transfers. As a "customer" of a "financial institution," the court reasoned, Tribune itself became a "financial institution," thereby triggering application of the safe harbor and avoiding the strictures of Merit.
The Section 546(e) Safe Harbor
Section 546 of the Bankruptcy Code imposes a number of limitations on a bankruptcy trustee’s avoidance powers, which include the power to avoid certain preferential and fraudulent transfers. Section 546(e) provides that the trustee may not avoid, among other things, a pre-bankruptcy transfer that is a settlement payment "made by or to (or for the benefit of) a . . . financial institution [or a] financial participant . . . , or that is a transfer made by or to (or for the benefit of)" any such entity in connection with a securities contract, unless the transfer was made with the actual intent to hinder, delay, or defraud creditors.
Section 101(22) of the Bankruptcy Code defines the term "financial institution" to include:
[A] Federal reserve bank, or an entity that is a commercial or savings bank, industrial savings bank, savings and loan association, trust company, federally-insured credit union, or receiver, liquidating agent, or conservator for such entity and, when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer (whether or not a "customer", as defined in section 741) in connection with a securities contract (as defined in section 741) such customer . . . .
11 U.S.C. § 101(22) (emphasis added).
The purpose of section 546(e) is to prevent "the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market." H.R. Rep. No. 97-420, at 1 (1982). The provision was "intended to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries." Id.
Prior to the Supreme Court’s ruling in Merit, five circuit courts of appeals ruled that the section 546(e) safe harbor extends to transactions even where the financial institution involved is merely a "conduit" for the transfer of funds from the debtor to the ultimate transferee. See In re Quebecor World (USA) Inc., 719 F.3d 94 (2d Cir. 2013) (the safe harbor is applicable where the financial institution was a trustee, and the actual exchange was between two private entities); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009) (section 546(e) is not limited to public securities transactions and protects from avoidance a debtor’s payments deposited in a national bank in exchange for the shareholders’ privately held stock during an LBO); In re QSI Holdings, Inc., 571 F.3d 545 (6th Cir. 2009) (the safe harbor applied even though the financial institution involved in the LBO was only the exchange agent); In re Resorts Int’l, Inc., 181 F.3d 505, 516 (3d Cir. 1999) (noting that "the requirement that the ‘commodity brokers, forward contract merchants, stockbrokers, financial institutions, and securities clearing agencies’ obtain a ‘beneficial interest’ in the funds they handle . . . is not explicit in section 546"); In re Kaiser Steel Corp., 952 F.2d 1230, 1240 (10th Cir. 1991) (rejecting the argument that "even if the payments were settlement payments, § 546(e) does not protect a settlement payment ‘by’ a stockbroker, financial institution, or clearing agency, unless that payment is to another participant in the clearance and settlement system and not to an equity security holder").
The Eleventh Circuit ruled to the contrary in In re Munford, Inc., 98 F.3d 604 (11th Cir. 1996). In Munford, the court held that section 546(e) did not shield from avoidance payments made by the debtor to shareholders in an LBO because the "financial institution" involved was only a conduit for the transfer of funds and securities—the bank never had a "beneficial interest" sufficient to qualify as a "transferee" in the LBO. The Seventh Circuit widened the circuit split on the issue when it agreed with the rationale of Munford in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016), aff’d, 138 S.Ct. 883 (2018). The Supreme Court granted a petition to review the Seventh Circuit’s ruling to resolve the circuit split.
The Supreme Court’s Ruling in Merit
In Merit, the unanimous Court held that section 546(e) does not protect transfers made through a "financial institution" to a third party, regardless of whether the financial institution had a beneficial interest in the transferred property. Instead, the relevant inquiry is whether the transferor or the transferee in the transaction sought to be avoided is itself a financial institution. Because the selling shareholder in the LBO transaction that was challenged as a constructive fraudulent transfer was not a financial institution (even though the conduit banks through which the payments were made met that definition), the Court ruled that the payments fell outside of the safe harbor.
In a footnote, the Court acknowledged that the Bankruptcy Code defines "financial institution" broadly to include not only entities...
