A bankruptcy judge in Buffalo, N.Y., decided that Second Circuit authority did not require him to invoke the safe harbor in Section 546(e) just because a company used a bank account to repurchase its own stock.
Years before bankruptcy, a privately held company agreed to repurchase stock owned by an individual who held about one-third of the shares. After the company’s chapter 11 case was converted to chapter 7, the trustee sued to recover payments made within a year of bankruptcy. The shareholder filed a motion to dismiss, raising the safe harbor in defense. Bankruptcy Judge Michael J. Kaplan denied the motion in an opinion on Dec. 1.
Section 546(e) proscribes the avoidance of “a transfer made by or to (or for the benefit of)” a “financial institution” that was made “in connection with a securities contract.”
The shareholder argued that the safe harbor applied, and required dismissal of the complaint, because the payments were made by a bank “in connection with a securities contract.” Judge Kaplan disagreed. He said the safe harbor did not apply because the “debtor’s checking account was a substitute for cash.”
Most prone among the courts of appeals to invoke the safe harbor, the Second Circuit has made three major pronouncements on Section 546(e). Judge Kaplan distinguished the Second Circuit’s Tribune decision from March because the case in his court did not involve a leveraged buyout or the company’s incurrence of debt.
His case was unlike the 2011 Enron decision, Judge Kaplan said, because the company did not draw a line of credit to redeem publicly traded securities.
Judge Kaplan said his case was also unlike the 2013 case of Quebecor World, where the debtor made a payment to an indenture trustee in payment of commercial paper issued by the debtor’s affiliate.
Interpreting Second Circuit authority, Judge Kaplan said he was bound by one proposition: The bank “need not have taken a ‘beneficial interest’ in a security.” On the other hand, he said there was no Second Circuit case compelling him to ignore the Eleventh Circuit’s 1996 decision in Mumford, where the bank only acted as an intermediary or conduit.
Similar to the Eleventh Circuit, Judge Kaplan interpreted Section 546(e) to mean that the safe harbor applies if the payment was made to or for the benefit of a financial institution. He denied the motion to dismiss because the payments to the shareholder “were not made ‘by or to (or for the benefit of)’ a financial institution.”
The debtor’s checking account, he said “was a substitute for cash.”
Judge Kaplan also might have cited the Seventh Circuit’s July decision in FTI Consulting Inc. v. Merit Management Group LP, holding that a transfer through a financial institution as a conduit does not by itself invoke the safe harbor. In laying out an existing split of circuits, FTI said that the Second Circuit makes the safe harbor applicable if the bank is only a conduit. To read ABI’s discussion of FTI, click here.
When the bank’s only role is honoring a depositor’s check, it could be said that the bank is not even acting as a conduit, thus making Judge Kaplan’s case even more remote from the safe harbor than FTI or Mumford.
To read ABI’s discussion of Tribune, click here.