On Feb. 27, 2018, the Supreme Court handed down its decision in Merit Management Group LP v FTI Consulting Inc.[1] The Supreme Court unanimously ruled that if a transferee is seeking the protection of the § 546(e) securities safe harbor, a court must look to the overarching transfer the trustee seeks to avoid under one of the substantive avoidance statutes, and not the component parts that together make up the transfer. The decision resolved a conflict among the circuit courts regarding the proper application of the § 546(e) safe harbor.
While the opinion answers some questions, footnote 2 points the way to another § 546(e) battlefield: whether a transferee claiming protection under § 546(e) qualifies as a “financial institution” by virtue of the transferee’s status as a “customer” under § 101(22)(A). This issue was discussed in an earlier article by Gregory Schwegmann and Joshua Bruckerhoff (Reid Collins & Tsai LLP; Austin, Texas), originally published in the January 2018 edition of the Commercial Fraud Committee Newsletter.[2]
Justice Sotomayor’s opinion framed the issue in Merit as follows:
[T]his Court is asked to determine how the safe harbor operates in the context of a transfer that was executed via one or more transactions, e.g., a transfer from A ® D that was executed via B and C as intermediaries, such that the component parts of the transfer include A ® B ® C ® D. If a trustee seeks to avoid the A ® D transfer, and the § 546(e) safe harbor is invoked as a defense, the question becomes: When determining whether the § 546(e) securities safe harbor saves the transfer from avoidance, should courts look to the transfer that the trustee seeks to avoid (i.e., A ® D) to determine whether that transfer meets the safe-harbor criteria, or should courts look also to any component parts of the overarching transfer (i.e., A ® B ® C ® D)?
As relevant here, Valley View was to purchase the stock of Bedford Downs for $55 million. Valley View arranged for the Cayman Islands branch of Credit Suisse to finance the $55 million purchase price as part of a larger $850 million transaction. Credit Suisse wired the $55 million to Citizens Bank of Pennsylvania, which had agreed to serve as the third-party escrow agent for Valley View’s purchase of the Bedford Downs stock. The Bedford Downs shareholders, one of which was Merit Management Group, LP, also deposited their stock certificates into escrow.
At closing, Valley View received the Bedford Downs stock certificates, and Citizens Bank ultimately disbursed all $55 million to the Bedford Downs shareholders. Merit received approximately $16.5 million from the sale of its Bedford Downs stock to Valley View. The closing statement for the transaction reflected Valley View as the “Buyer,” the Bedford Downs shareholders as the “Sellers,” and $55 million as the “Purchase Price.”
When Valley View and its parent company, Centaur LLC, later filed for chapter 11 bankruptcy, the bankruptcy court confirmed a reorganization plan and appointed FTI Consulting, Inc., to serve as trustee of the Centaur litigation trust. FTI filed suit against Merit seeking to avoid the $16.5 million transfer from Valley View to Merit for the sale of Bedford Downs’ stock. The complaint alleged that the transfer was constructively fraudulent under § 548(a)(1)(B) of the Code because Valley View was insolvent when it purchased Bedford Downs and “significantly overpaid” for the Bedford Downs stock. Merit contended that the § 546(e) safe harbor barred FTI from avoiding the Valley View-to-Merit transfer. According to Merit, the safe harbor applied because the transfer was a “settlement payment ... made by or to (or for the benefit of)” a covered “financial institution” — here, Credit Suisse and Citizens Bank.
The Supreme Court disagreed, concluding the relevant transfer for purposes of the § 546(e) safe harbor is the transfer the trustee seeks to avoid, here the $16.5 million transfer from Valley View to Merit. The trustee was not trying to avoid the “component” or “conduit” transactions by which Valley View transferred money to Merit, so those transactions were not analyzed. Section II.B. of the opinion discusses when the component parts of a transfer may be considered and when the component parts are irrelevant, stating that “[i]f a trustee properly identifies an avoidable transfer … the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power, where that limit is defined by reference to an otherwise avoidable transfer,…”
While the Court states at one point that “we need not deviate from the plain meaning of the language used in § 546(e)” and refers elsewhere to the “plain language of the safe harbor,” the opinion dissects § 546(e) at great length. The opinion focuses to some degree on the words “that is,” which appear three times in § 546(e), and the words “made by or to (or for the benefit of),” which appear twice. The Court stated:
The transfer that the “the trustee may not avoid” is specified to be “a transfer that is” either a “settlement payment” or made “in connection with a securities contract.” § 546(e)…. Not a transfer that involves. Not a transfer that comprises. But a transfer that is a securities transaction covered under § 546(e).
Further, “[t]he safe harbor saves from avoidance certain securities transactions “made by or to (or for the benefit of)” covered entities.[3] Transfers “through” a covered entity, conversely, appear nowhere in the statute.”
Merit resolves a circuit split based on a plain-language reading of § 546(e). There is little, if any, discussion of the circuit court decisions, the Supreme Court going so far as to state:
The parties and the lower courts dedicate much of their attention to the definition of the words “by or to (or for the benefit of)” as used in § 546(e), and to the question whether there is a requirement that the “financial institution” or other covered entity have a beneficial interest in or dominion and control over the transferred property in order to qualify for safe harbor protection. In our view, those inquiries put the proverbial cart before the horse. Before a court can determine whether a transfer was made by or to or for the benefit of a covered entity, the court must first identify the relevant transfer to test in that inquiry.
Trustees and the lower courts will have to keep that admonition in mind.
[1] 583 U.S. (2018).
[2] “The Definition of ‘Financial Institution’: The Next Battleground in the Fight over § 546(e) of the Bankruptcy Code?” The full article can be found here.
[3] See § 546(e).