Detroit Judge Criticizes the Second Circuit’s Tribune Decision on the Safe Harbor

This month, the Supreme Court sought the views of the U.S. Solicitor General regarding the grant or denial of a petition for certiorari challenging the Second Circuit’s decision in the Tribune fraudulent transfer litigation. Despite the restrictive reading the Supreme Court gave to the safe harbor in Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883 (Feb. 27, 2018), the Second Circuit persisted in immunizing a fraudulent transfer when a bank was involved in the chain of payments.

Deciding this week that the safe harbor was not applicable in a case similar to Tribune, Bankruptcy Judge Maria L. Oxholm of Detroit disagreed with the Second Circuit, made important pronouncements about the interpretation of Section 546(e) and provided reason for granting certiorari to review Tribune.

Judge Oxholm said that the Second Circuit had created a “complete workaround of Merit Management.”

The Detroit Litigation

Judge Oxholm’s decision arose from the bankruptcy of the Greektown casino in Detroit. The trustee of a litigation trust created under a chapter 11 plan brought claims alleging there was about $145 million in fraudulent transfers resulting from a leveraged buyout that occurred less than three years before the chapter 11 filing.

As usual, there were several banks and brokers playing various roles in the transaction. Of significance to Judge Oxholm’s decision, a broker sold notes and distributed the proceeds to those who ended up as defendants in the fraudulent transfer suit.

Now retired, the bankruptcy judge then assigned to the case followed Sixth Circuit authority and granted the defendants’ motion for summary judgment in 2015. He dismissed, ruling that the suit was precluded by the safe harbor in Section 546(e). The district court affirmed.

While the appeal was pending in the Sixth Circuit, the Supreme Court handed down Merit Management, impliedly overruling the Sixth Circuit decision on which the bankruptcy judge had dismissed the suit. The Sixth Circuit vacated and remanded the Greektown decision for further consideration in view of Merit Management.

Judge Oxholm’s 61-page opinion on October 19 was the culmination of the remand. Before we analyze her opinion, let’s look at Merit Management and Tribune.

Merit Management

Merit Management raised the question of whether the presence of a financial institution as a conduit in the chain of payments in a leveraged buyout is sufficient to invoke Section 546(e).

Section 546(e) 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 was 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.

The Supreme Court held that the safe harbor is for “financial institutions,” not for transactions. More specifically, the Court ruled that Section 546(e) only applies to “the transfer that the trustee seeks to avoid.” Merit Management, id., at 888. In other words, sticking a bank or broker in the middle of a chain of payments from the transferor to the defendant does not invoke the safe harbor. To read ABI’s report on Merit Management, click here.

Tribune

The Second Circuit’s opinion arose from the chapter 11 reorganization of newspaper publisher Tribune Co.

Two years before Merit Management, the Second Circuit reversed the district court and dismissed the fraudulent transfer suit. The appeals court held that Section 546(e) impliedly preempted state fraudulent transfer law, under which the creditors were suing. It was sufficient to invoke the safe harbor, in the opinion of the appeals court, if a bank or financial institution was somewhere in the chain of payments.

The appeals court said that allowing fraudulent transfer suits to unwind “settled securities transactions” would “seriously undermine” the markets. In re Tribune Co. Fraudulent Transfer Litigation, 818 F.3d 98, 119 (2d Cir. 2016). To read ABI’s report on the first Tribune opinion, click here.

The creditors in Tribune had filed a petition for certiorari before the Supreme Court handed down Merit Management. At the suggestion of a pair of justices on the Supreme Court, the Second Circuit withdrew the mandate in Tribune in May 2018 to revisit the issue.

Merit Management had overruled one of the grounds for the Second Circuit’s belief that having a bank in the chain of payments is enough to invoke the safe harbor.

The Second Circuit handed down its new decision in December 2019. In re Tribune Co. Fraudulent Transfer Litigation, 946 F.3d 66 (2d Cir. Dec. 19, 2019). The result was the same: dismissal. The Second Circuit found a loophole in Merit Management.

The appeals court adhered to its original holding that the safe harbor in the Bankruptcy Code preempts state law. Upholding dismissal a second time, the panel concluded that the newspaper publisher was a “financial institution” as defined in Section 101(22)(A), thus making the safe harbor applicable.

How’s that possible?

A “financial institution” in Section 101(22)(A) is defined to be a bank or “trust company, . . . and when any such . . . entity is acting as agent or a custodian for a customer . . . in connection with a securities contract . . . such customer.” Translated into plain English, a customer of a financial institution itself becomes a “financial institution” if the financial institution is acting as the customer’s agent or custodian.

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.

Thus, Tribune fell within the definition of a “financial institution,” making the safe harbor applicable and compelling dismissal of the suit. To read ABI’s report on the second Tribune opinion, click here.

In July, the creditors filed a second petition for certiorari. Deutsche Bank Trust Co. v. Robert R. McCormick Foundation, 20-8 (Sup. Ct.). Several amicus briefs were filed. On October 5, the Supreme Court invited the Solicitor General to file a brief expressing the views of the government.

That leads us to the opinion by Judge Oxholm.

Identify the Transfer

The defendants in the Detroit litigation filed a motion for summary judgment, contending they were protected by the Section 546(e) safe harbor.

Judge Oxholm interpreted Merit Management to mean that she must identify the “‘overarching transfer that the trustee seeks to avoid . . . .’” Merit Management, id., at 892-93. She concluded that the relevant transfer was from the transferor to the defendants. The trustee was not attacking any transfer to the broker.

Even if the transfer was not to the broker, the safe harbor would still apply under Section 546(e) if the transfer was “for the benefit of” the broker. In deciding whether the transaction was for the benefit of the broker, Judge Oxholm noted that the broker was paid several million dollars in fees for various services.

Citing circuit court authority, Judge Oxholm said that the transaction would be for the benefit of the broker if the broker “received a direct, ascertainable, and quantifiable benefit corresponding in value to the payments to Defendants.”

Judge Oxholm held that the broker’s fees were “insufficient” to make the transaction for the benefit of the broker. She said that the fees were “incidental” to the transaction and “do not correspond in value to the . . . transfers to the Defendants.”

The Criticism of Tribune

Next, Judge Oxholm addressed the definition of “financial institution” in Section 101(22)(A). Recall that someone is a “financial institution” if a broker serves as their agent or custodian.

Without much analysis, the Second Circuit had held in the second Tribune opinion that a financial institution was acting as an agent for a party in the challenged transfer.

Judge Oxholm therefore analyzed whether the broker was anyone’s agent. She said that both Michigan and federal law follow the Restatement (Third) of Agency to decide whether an agency was created. She said that an agent acts on behalf of a principal but must have authority to negotiate for the principal.

Judge Oxholm said she was “not persuaded by the agency analysis in In re Tribune Co. as it does not distinguish between mere intermediaries contracted for the purpose of effectuating a transaction and agents who are authorized to act on behalf of their customers in such transactions.” Under Tribune, she said, “any intermediary hired to effectuate a transaction would qualify as its customer’s agent . . . . This would result in a complete workaround of Merit Management.”

Judge Oxholm continued, saying that “there must be a finding that a principal authorized the agent to act on its behalf. Otherwise, any service provider would qualify as an agent.”

On the question of agency, Judge Oxholm made her ruling as a matter of law, because there was a written contract. The documents said that the broker was not an agent but was serving in other roles, such as financial advisor or independent contractor.

Judge Oxholm therefore held that the defendants “failed to establish an agency relationship” because they presented no evidence to “support the crucial elements of an agency relationship.” The broker, she said, was only performing “contractual services.”

Custodian

The defendants had another argument: The broker was their “custodian” as defined in Section 101(11). If a broker was acting as a custodian for the defendants, Section 101(22)(A) would transform the defendants into financial institutions protected by the safe harbor.

The defendants cited securities regulations to show that the broker was serving as a custodian. Judge Oxholm ruled that the definition of a custodian in Section 101(11) controlled, not the definition of a custodian elsewhere in federal law. She said it was “inappropriate to adopt and interpret a completely different definition.”

Under Section 101(11)(C), a custodian is a “trustee, receiver, or agent . . . that is appointed or authorized to take charge of property of the debtor for the purpose of enforcing a lien against such property, or for the purpose of general administration of such property for the benefit of the debtor’s creditors.”

Applying the Section 101(11)(C) definition, Judge Oxholm said that the broker did not have a lien and was not administering the property “for the benefit of all” creditors. [Emphasis in original.] She therefore held that the broker was not serving as a custodian in a fashion that would invoke the safe harbor.

In short, Judge Oxholm denied the defendants’ motion for summary judgment and held that the safe harbor did not apply because the transfer was not to or for the benefit of a financial institution.