The Second Circuit’s per curiam affirmance of the bankruptcy and district courts means that a leveraged transaction cannot be set aside in the Second Circuit as a fraudulent transfer if the professionals properly structure the transaction to invoke the so-called safe harbor in Section 546(e).

The nonprecedential opinion from the Second Circuit on September 19 permits a company to structure a leveraged transaction to avoid the consequences of Merit Management Group LP v. FTI Consulting Inc., 583 U.S. 366 (Sup. Ct. Feb. 27, 2018). In Merit Management, the Supreme Court held that the presence of a financial institution as a conduit in the chain of payments in a leveraged buyout will not invoke the safe harbor in Section 546(e). That section provides that a trustee may not avoid a “settlement payment . . . made by or to (or for the benefit of) . . . a financial institution.”

Merit Management held that Section 546(e) only applies to “the transfer that the trustee seeks to avoid.” For the unanimous Court, Justice Sonia Sotomayor said that “the relevant transfer for purposes of the Section 546(e) safe-harbor inquiry is the overarching transfer that the trustee seeks to avoid.” Id. at 378.

The Leveraged Recapitalization

The complex leveraged recapitalization amounted to this:

The operating company borrowed some $1 billion from a new credit facility secured by its assets. The operating company transferred the loan proceeds to a bank account of its parent holding company. The holding company had no assets other than ownership of the operating company.

The holding company then transferred the loan proceeds to a second bank, which distributed the funds to equity holders in redemption of their warrants and equity interests and to pay a dividend.

More than three years later, the operating company ended up in chapter 11. The plan paid only the first-lien lender. Owed hundreds of millions of dollars, subordinate lenders received nothing more than the right to distributions from whatever the liquidating trustee might recover in lawsuits.

The liquidating trustee filed a fraudulent transfer suit under state law, alleging that the operating company was insolvent at the time of the leveraged restructuring. Bankruptcy Judge Robert E. Grossman of Central Islip, N.Y., granted the defendants’ motion for summary judgment. Holliday v. K Road Power Management LLC (In re Boston Generating LLC), 617 B.R. 442 (Bankr. S.D.N.Y. June 18, 2020). To read ABI’s report, click here. Judge Grossman was affirmed by District Judge George B. Daniels. Holliday v. Credit Suisse Sec. (USA) LLC, 20-5404 (GBD), 2021 WL 4150523 (S.D.N.Y. Sept. 13, 2021). To read ABI’s report, click here.

The trustee appealed to the circuit, without success.

The Relevant Transaction

Although the appeal was sub judice for almost one year, the panel, composed of Circuit Judges Susan L. Carney, Joseph F. Bianco and Allison J. Nathan, made short shrift of the appeal in about five pages, not including the caption.

“[F]or substantially the same reasons stated by the district court in its thorough and well reasoned decision,” the panel “conclude[d] that the bankruptcy court did not err in finding that the . . . Transfer was executed in connection with a securities contract.”

The appeals court said that the two lower courts “correctly determined” that the loan agreement demonstrated how the loan proceeds were to be used to fund the dividend and the redemption of the equity interests.

Even if Section 547(e) required the debtor to be a party to the securities contract, the panel said that the “plain text” of the tender offer documents showed that the debtor was a party to the contract as a subsidiary of the holding company.

Furthermore, the panel said that the bankruptcy court properly found that the debtor and its parent were “financial institutions” under Section 101(22)(A). Citing Second Circuit precedent, the panel said,

“[T]he Bankruptcy Code defines a ‘financial institution’ to include a ‘customer’ of a bank or other such entity ‘when’ the bank or other such entity ‘is acting as agent’ for the customer ‘in connection with a securities contract.’”

In re Nine W. LBO Sec. Litig., 87 F.4th 130, 145 (2d Cir. 2023).

In the case on appeal, the panel said that the debtor and its parent both had retained the bank to act as their agent depository.

Affirming the district court, the panel summed up the holding as follows:

[B]ecause the . . . Transfer constitutes a “transfer made . . . in connection with a securities contract” by a qualifying financial institution, it is entitled as a matter of law to the protection of Section 546(e)’s safe harbor, which pre-empts the Trustee’s state-law fraudulent conveyance claims. Nine West, 87 F.4th at 150 (holding that state law claims that conflict with Section 546(e)’s purpose are pre-empted).