The U.S. Solicitor General told the Supreme Court that the Second Circuit “erred in finding that creditors’ state-law avoidance actions are preempted by [the safe harbor in] Section 546(e).”
On March 12, the government’s advocate in the Supreme Court also said that the Second Circuit’s ruling in In re Tribune Co. Fraudulent Transfer Litigation, 946 F.3d 66 (2d Cir. Dec. 19, 2019), “would render [Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883 (Feb. 27, 2018)] a virtual nullity.”
Nonetheless, the Solicitor General recommended that the justices not grant certiorari to correct the errors in Tribune, largely because there is no circuit split as yet. To read ABI’s reports on Tribune and Merit Management, click here and here.
Merit Management
The Supreme Court held in Merit Management 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).
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.
The Second Circuit’s Tribune Decisions
The Second Circuit’s opinions 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, holding that Section 546(e) impliedly preempted a lawsuit by creditors under state fraudulent transfer law. The appeals court held that having a financial institution somewhere in the chain of payments was sufficient to invoke the safe harbor.
The Second Circuit believed that allowing creditors’ fraudulent transfer suits under state law 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).
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 after Merit Management, the Second Circuit withdrew the mandate in May 2018 to revisit the issues.
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. 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 also held that the safe harbor was applicable because a bank was acting as Tribune’s depositary. The newspaper publisher was therefore a “financial institution” as defined in Section 101(22)(A).
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.” In 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.
In July 2020, 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. In October, the Supreme Court invited the Solicitor General to file a brief expressing the views of the government.
SG Says the New Tribune Decision Is Wrong
The Solicitor General didn’t beat around the bush. In the first sentence of the “Discussion” in the its amicus brief, the government said that the Second Circuit “erred in finding that creditors’ state-law avoidance actions are preempted by [the safe harbor in] Section 546(e).” To read the government’s brief, click here.
“The text of Section 546(e),” the government said, “does not express an intent to preempt state-law avoidance claims brought by creditors.” The Solicitor General said that “nothing in the statutory text indicates that Congress intended permanently to divest creditors of their own state-law causes of action.”
According to the Solicitor General, the Second Circuit “also erred” in holding that suits by creditors under state law would create an “irreconcilable conflict” with the purposes of the safe harbor.
The Supreme Court “in Merit Management rejected a similar effort to override Section 546(e)’s text based on assumptions about congressional purpose. 138 S. Ct. at 897,” the Solicitor General said. The government went on to say that “that Congress did not intend to preclude every avoidance action that might introduce uncertainty into securities markets.”
Similarly, the Solicitor General concluded that the Second Circuit erred in calling Tribune a “financial institution” just because a bank acted as its depositary in the leveraged buyout transaction. In the government’s opinion, that “understanding of Section 101(22)(A) would render Merit Management a virtual nullity.”
The Solicitor General went on to say that the Second Circuit’s interpretation will make “the safe harbor . . . apply to virtually every transfer made in connection with a securities contract, since some party to almost every such transfer will” have a financial institution embedded somewhere in the chain of payments.
The Solicitor General criticized the Second Circuit for failing to consider whether the financial institution was acting as an “agent for significant aspects of the overall transaction” or was only providing “ministerial assistance.”
No Split — No ‘Cert’ Grant
Despite having found several errors by the Second Circuit, the Solicitor General concluded that the Supreme Court’s “review is not warranted at this time [in the] absence of a circuit conflict” on the issue of federal preemption. The government believes that the Supreme Court’s “eventual review . . . would benefit from further analysis by other courts of appeals.”
On the question of whether a whether a minor role by a financial institution is sufficient to invoke the safe harbor, the Solicitor General again said there is no circuit split. The government believes that the high court “would likely benefit from prior consideration of the issues by additional courts of appeals.”
The U.S. Solicitor General told the Supreme Court that the Second Circuit “erred in finding that creditors’ state-law avoidance actions are preempted by [the safe harbor in] Section 546(e).”
On March 12, the government’s advocate in the Supreme Court also said that the Second Circuit’s ruling in In re Tribune Co. Fraudulent Transfer Litigation, 946 F.3d 66 (2d Cir. Dec. 19, 2019), “would render [Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883 (Feb. 27, 2018)] a virtual nullity.”
Nonetheless, the Solicitor General recommended that the justices not grant certiorari to correct the errors in Tribune, largely because there is no circuit split as yet. To read ABI’s reports on Tribune and Merit Management, click here and here.
Merit Management
The Supreme Court held in Merit Management 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).
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.