The Supreme Court ruled in February 2018 that the so-called safe harbor under Section 546(e) only applies to “the transfer that the trustee seeks to avoid.” Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883, 200 L. Ed. 2d 183, 86 U.S.L.W. 4088 (Sup. Ct. Feb. 27, 2018).
The high court opinion had the effect of abrogating one of the Second Circuit’s principal holdings in Note Holders v. Large Private Beneficial Owners (In re Tribune Co. Fraudulent Conveyance Litigation), 818 F.3d 98 (2d Cir. 2016).
Tribune included two rulings by the Second Circuit that precluded creditors of a bankrupt company from bringing suit on their own behalf based on state fraudulent transfer law. First, the circuit court ruled that the safe harbor in Section 546(e) applies even if a bank only serves as a conduit for money paid to selling shareholders in a leveraged buyout that turns out to be a fraudulent transfer. The appeals court said that the safe harbor protects transactions, not just financial institutions.
Second, the appeals court held that the Section 546(e) safe harbor impliedly preempts state law on fraudulent transfers anytime there is a bankruptcy of a company that was the subject of a leveraged buyout. As a consequence of preemption, the Second Circuit said that individual creditors cannot mount a fraudulent transfer suit on their own behalf. In the opinion of the Second Circuit, the safe harbor blocked lawsuits not only by trustees and debtors but also by creditors asserting claims of their own in a non-bankruptcy court.
The creditors in Tribune had filed a petition for certiorari before the Supreme Court handed down Merit Management. With the Supreme Court authority in hand, the creditors prevailed on the Second Circuit in May 2018 to withdraw the mandate in Tribune and revisit the issue.
Without further briefing on the merits, the Second Circuit issued a revised Tribune opinion on December 19, reaching the same result by dismissing the creditors’ constructive fraudulent transfer claims. In substance, the Second Circuit found a loophole in Merit Management.
By employing a “financial institution” as its “agent,” an entity that is not otherwise covered by the Section 546(e) safe harbor can immunize a transaction from attack as a constructive fraudulent transfer under Section 548(a)(1)(B), the Second Circuit held in the opinion, which will likely be called Tribune II.
The First Tribune Opinion
The case arose in the chapter 11 reorganization of newspaper publisher Tribune Co. and focused on Section 546(e), which provides that “the trustee may not” sue for recovery of a “settlement payment” that was made “by or to (or for the benefit of) a . . . financial institution” unless the suit is brought under Section 548(a)(1)(A) for recovery of a fraudulent transfer within two years of bankruptcy made with actual intent to hinder, delay or defraud creditors.
Tribune’s official creditors’ committee was authorized to sue selling shareholders for allegedly receiving fraudulent transfers with “actual intent.” When the two-year statute of limitations was about to expire, Tribune’s bankruptcy judge modified the automatic stay by allowing company retirees, along with pre-LBO unsecured bondholders, to sue selling shareholders using constructive fraudulent transfer theories. The individual creditors’ suit ended up in district court in Manhattan, where the selling shareholders moved to dismiss.
Granting the motion to dismiss, the district court held that individual creditors lacked standing because the creditors’ trust was simultaneously suing on fraudulent transfer grounds, albeit on a different theory. The judge also held that the safe harbor only bars suits by a trustee and does not preclude creditors from suing under state law.
Writing for the three-judge panel in March 2016, Circuit Judge Ralph K Winter, Jr. reversed the district court on both scores, with dismissal still the result. First, he ruled that the creditors had standing.
Judge Winter nonetheless ruled that Section 546(e) impliedly preempted state fraudulent transfer law, under which the creditors were suing.
Following existing Second Circuit precedent, he ruled that the involvement of a financial institution as a mere conduit did not obviate the applicability of the Section 546(e) safe harbor. In the context of a leveraged buyout, he said that allowing fraudulent transfer suits to unwind “settled securities transactions” would “seriously undermine” the markets. For reasons Judge Winter developed at length about the congressional policy shown in the safe harbor, the appeals court held that state law constructive fraudulent transfer claims are preempted.
To read ABI’s report on the first Tribune opinion, click here.
Merit Management and the Withdrawal of the Mandate
Already pending in the Supreme Court, Merit Management raised the question of whether the presence of a financial institution as a mere conduit in the chain of payments in a leveraged buyout was sufficient to invoke Section 546(e). Before the decision from the high court came down, the Tribune creditors filed a petition for certiorari.
Merit Management abrogated one of the grounds on which the Second Circuit had dismissed the creditors’ lawsuit in Tribune. Where the Second Circuit said that the safe harbor protects transactions, the Supreme Court held that the protection is for “financial institutions.”
Evidently, several justices of the Supreme Court were recused from considering the Tribune certiorari petition. So, Justices Anthony M. Kennedy and Clarence Thomas issued a “Statement” on April 3, 2018, saying that the Second Circuit could recall the Tribune mandate and “decide whether relief from judgment is appropriate given the possibility that there might not be a quorum in this Court. See U.S.C. § 2109.” On May 15, 2018, the Second Circuit recalled the mandate to reconsider the Tribune decision in light of Merit Management. To read ABI’s report, click here.
The New Tribune Opinion
The Second Circuit did not hold oral argument anew, nor did the court call for additional briefing on the merits. Rather, Circuit Judges Winter and Christopher F. Droney filed a revised opinion on December 19 based on papers filed in connection with withdrawal of the mandate. (Judge Droney retired this month. District Judge Alvin K. Hellerstein sat on the original panel by designation. His name does not appear on the revised opinion from December 19.)
For the most part, the new opinion is a verbatim restatement of the original opinion, with significant additions. The appeals court acknowledged the Supreme Court’s holding that the safe harbor does not apply if a financial institution is a mere conduit, therefore abrogating one of the holdings in the original Tribune opinion.
The revised opinion added a new section explaining why the Section 546(e) safe harbor still applies, although the new theory was not argued or decided in the original opinion.
The appeals court adhered to its original holding that the safe harbor in the Bankruptcy Code preempts state law. To uphold dismissal once again, the two circuit judges on the panel were tasked with deciding whether the safe harbor still applied. The judges framed the question as whether Tribune was subsumed within the definition of a “financial institution” as defined in Section 101(22)(A).
A “financial institution” in Section 201(22)(A) is defined to be a bank or “trust company, . . . and when any such . . . entity is acting as agent . . . for a customer . . . in connection with a securities contract . . . such customer.” In other words, a customer of a financial institution itself becomes a “financial institution” if the financial institution is acting as the customer’s agent.
Relying on information that was arguably not in the record on the motion to dismiss in district court, the appeals court ruled that a depositary used for making payments to selling shareholders in the leveraged buyout was an agent for Tribune.
In essence, Tribune fell within the definition of a “financial institution,” thus making the safe harbor applicable and compelling dismissal of the suit.
In that regard, the Second Circuit held that “Section 546(e)’s language is broad enough under certain circumstances to cover a bankrupt firm’s LBO payments even where, as here, that firm’s business was primarily commercial in nature.”
The panel ended its new opinion by distinguishing and limiting Merit Management’s holding to the facts and issues before the Supreme Court.
The panel said the Supreme Court was “was not tasked with assessing Section 546(e)’s preemptive force, and it did not address preemption.” Therefore, the circuit court said that Merit Management did not “control our disposition of the preemption issue.” Furthermore, the circuit judges found nothing “in Merit Management’s reasoning that contradicts our assessment of Congress’s preemptive intent.”
Observations
When structuring a transaction that might later be attacked as a constructive fraudulent transfer, it still seems possible in the Second Circuit to sanitize the transaction by using a financial institution in the role of agent.
The creditors have filed a petition for rehearing en banc. Principally, the creditors are attacking the appeals court’s conclusion that the depositary was an agent for Tribune.
The Supreme Court ruled in February 2018 that the so-called safe harbor under Section 546(e) only applies to “the transfer that the trustee seeks to avoid.” Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883, 200 L. Ed. 2d 183, 86 U.S.L.W. 4088 (Sup. Ct. Feb. 27, 2018).
The high court opinion had the effect of abrogating one of the Second Circuit’s principal holdings in Note Holders v. Large Private Beneficial Owners (In re Tribune Co. Fraudulent Conveyance Litigation), 818 F.3d 98 (2d Cir. 2016).
Tribune included two rulings by the Second Circuit that precluded creditors of a bankrupt company from bringing suit on their own behalf based on state fraudulent transfer law. First, the circuit court ruled that the safe harbor in Section 546(e) applies even if a bank only serves as a conduit for money paid to selling shareholders in a leveraged buyout that turns out to be a fraudulent transfer. The appeals court said that the safe harbor protects transactions, not just financial institutions.
Second, the appeals court held that the Section 546(e) safe harbor impliedly preempts state law on fraudulent transfers anytime there is a bankruptcy of a company that was the subject of a leveraged buyout. As a consequence of preemption, the Second Circuit said that individual creditors cannot mount a fraudulent transfer suit on their own behalf. In the opinion of the Second Circuit, the safe harbor blocked lawsuits not only by trustees and debtors but also by creditors asserting claims of their own in a non-bankruptcy court.
The creditors in Tribune had filed a petition for certiorari before the Supreme Court handed down Merit Management. With the Supreme Court authority in hand, the creditors prevailed on the Second Circuit in May 2018 to withdraw the mandate in Tribune and revisit the issue.
Without further briefing on the merits, the Second Circuit issued a revised Tribune opinion on December 19, reaching the same result by dismissing the creditors’ constructive fraudulent transfer claims. In substance, the Second Circuit found a loophole in Merit Management.
By employing a “financial institution” as its “agent,” an entity that is not otherwise covered by the Section 546(e) safe harbor can immunize a transaction from attack as a constructive fraudulent transfer under Section 548(a)(1)(B), the Second Circuit held in the opinion, which will likely be called Tribune II.