The safe harbor provision in 11 U.S.C. § 546(e) provides, in relevant part, that a trustee may not avoid a transfer “made by or to (or for the benefit of) a ... financial institution ... in connection with a securities contract” unless the trustee is asserting an intentional fraudulent conveyance claim.[1] The rule was designed to provide stability to financial markets by protecting certain transfers from avoidance proceedings in bankruptcy.[2] Recently, the Second Circuit issued an amended opinion in Deutsche Bank Trust Co. Ams. v. Large Private Ben. Owners (In re Tribune Co. Fraudulent Conveyance Litig.) (“Tribune”),[3] reaffirming that § 546(e) barred state law constructive fraudulent conveyance claims seeking to avoid payments made by Tribune Company to shareholders as part of an LBO.[4] The court reasoned that Tribune, a multimedia corporation, qualified as a “financial institution” under § 546(e) because Tribune was a customer of a financial institution acting as Tribune’s agent for the LBO.[5]

Section 546(e) has been heavily litigated the last several years.[6] In 2018, the Supreme Court seemed to narrow the applicability of § 546(e) when it abrogated the so called “conduit” defense in Merit Mgmt. Group LP v. FTI Consulting Inc.[7] Nevertheless, Tribune illustrates that § 546(e)’s safe harbor can still be a potent defense in avoidance actions.

Some background is necessary to understand the significance of Tribune. In 2007, Tribune Company made payments to shareholders as part of an LBO.[8] To facilitate the transaction, Tribune transferred the payments to intermediaries.[9] The intermediaries then paid the shareholders in exchange for their stock, which was returned to Tribune.[10] Tribune filed for chapter 11 protection in 2008.[11] In 2011, certain unsecured creditors filed state law constructive fraudulent conveyance claims, seeking to claw back payments made by Tribune to shareholders as part of the LBO.[12] The Second Circuit held that § 546(e) preempted the creditors’ claims.[13] At the time of the decision, it was the law in the Second Circuit that § 546(e) protects transfers even when financial institutions do not have a beneficial interest in the transferred funds (i.e., even when the financial institutions serve as mere conduits for the transfer).[14] The Tribune creditors petitioned the Supreme Court for certiorari. As their petition was pending, the Supreme Court decided Merit.[15]

In Merit, Valley View Downs, LP and Bedford Downs Management Corp. were both competing to obtain the last “harness-racing” license from the Pennsylvania State Harness Racing Commission.[16] Bedford Downs agreed to withdraw from the competition to obtain the license. In exchange, Valley View agreed to purchase Bedford Downs’ stock for $55 million.[17] To effectuate the purchase, Valley View arranged for Credit Suisse to wire the $55 million to a third-party escrow agent.[18] The Bedford Downs shareholders also deposited their stock certificates into escrow.[19] At closing, Valley View received the Bedford Downs stock and the escrow agent disbursed the funds to the shareholders.[20] Merit Management Group LP, one of the shareholders, received $16.5 million from the sale.[21] Valley View subsequently filed a chapter 11 petition.[22] The litigation trustee sought to avoid the transfer from Valley View to Merit under § 548(a)(1)(B).[23] The lower court granted Merit’s motion for judgment on the pleadings and ruled that the safe harbor provision applied.[24] But the Seventh Circuit reversed, explaining that the safe harbor provision does not protect transfers when financial institutions serve as “mere conduits.”[25]

A unanimous Supreme Court affirmed the Seventh Circuit.[26] Relying on the text of § 546(e), the Court explained that “the relevant transfer for purposes of the § 546(e) safe-harbor inquiry is the overarching transfer that the trustee seeks to avoid under one of the substantive avoidance provisions.”[27] In other words, § 546(e) does not protect transfers in which financial institutions serve as “mere conduits.”[28] In Merit, the relevant transfer was the Valley View-to-Merit transfer.[29] And because the parties did not contend that either Merit or Valley View were “financial institutions,” the transfer fell outside of § 546(e).[30]

After Merit, the creditors in Tribune moved the Second Circuit to recall its mandate. The court agreed and issued an amended opinion. In the amended opinion, the court explained that under Merit, the payments from Tribune would only be protected if Tribune or the shareholders were considered a “covered entity” — such as a “financial institution” — under § 546(e).[31] Section 101(22A) provides that a “financial institution” includes, among other things, a “customer” of an entity that is a commercial or savings bank or trust company acting as an “agent” for such customer.[32] Tribune hired Computershare to act as its “Depositary” for the LBO.[33] Computershare is considered a “financial institution” under § 546(e) because it is a trust company and a bank.[34] As part of the LBO, Computershare held and received Tribune’s deposit for the purchase of the shares, received the shares on Tribune’s behalf, and paid the shareholders.[35] Thus, Tribune was Computershare’s “customer,” and Computershare was acting as Tribune’s “agent.”[36] Tribune was therefore a “financial institution” under § 546(e).[37]

Tribune demonstrates that § 546(e)’s safe harbor is alive and well, despite Merit’s nullification of the conduit defense.[38] The decision also highlights an important issue the Supreme Court explicitly did not address in Merit — that is, whether a debtor can qualify as a financial institution under § 546(e) by virtue of its relationship with an intermediary.[39] In Merit, the parties did not contend that either Valley View or Merit were financial institutions.[40] If they had, perhaps the outcome would have been different.[41]