Type: Law Bulletins
Date: 03/12/2018

Supreme Court Resolves Circuit Split Regarding Breadth of "Securities Safe Harbor" Applied to Multi-step Transfers Involving Financial Institutions as Mere Conduit Intermediaries

Safe Harbor Protection Generally

In general, a trustee or debtor-in-possession in a bankruptcy has the power to avoid certain prepetition transfers made by a Debtor. The most common of these are fraudulent transfers and preference payments. But this avoiding power is not unlimited. It is subject to a number of codified exceptions and defenses. And one such exception that has been used to shield an increasing number of transactions is the securities “safe harbor” provision found in section 546(e) of the Bankruptcy Code.

The 546(e) safe harbor was intended by Congress to ensure the public’s confidence in and the stability of the commodities and securities markets by preventing the avoidance of certain transfers made by, to or for the benefit of certain enumerated financial market participants. The section provides that a trustee may not avoid a transfer that is a margin payment or settlement payment made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency made before a bankruptcy case is filed, unless it is an intentionally fraudulent transfer under section 548(a)(1)(A).

Over the years, courts began to apply this safe harbor protection broadly and in increasingly complex transactions, such as LBOs, that involve many component parts. Given the efficacy of this market-oriented shelter, it did not take long before transactions were deliberately structured to involve financial institution intermediaries in order to obtain the protections of section 546(e). And, as such creativity abounded, courts began to disagree whether the mere presence of a “financial institution” in a multi-step transfer was sufficient to invoke the safe harbor if the financial institution was a mere conduit and did not have an interest in the transferred property, such as when it acted as an escrow agent. Eventually, a circuit split developed between the broader interpretation of the Second, Third, Sixth, Eighth, and Tenth Circuits, and the narrower interpretation of the Seventh and Eleventh Circuits, regarding the proper application of the section 546(e) safe harbor provision. Enter the Supreme Court.

Supreme Court Weighs In

Only days ago, in Merit Management Group, LP v. FTI Consulting, Inc., 583 U.S. ____ (February 27, 2018) (Merit), the Supreme Court resolved the circuit split, siding with the minority. In Merit, petitioner Merit Management Group, LP (“MMG”) was a shareholder of Bedford Downs Management Corporation (“Bedford”). Bedford entered into an agreement with Valley View Downs, LP (“Valley View”) by which Valley View was to purchase all of Bedford’s stock for $55 million after certain other events took place. As part of the corporate acquisition, Valley View had Credit Suisse finance the transaction and wire $55 million to Citizens Bank of Pennsylvania as the third-party escrow agent for the transaction. Citizens Bank in turn disbursed the funds pursuant to the parties’ agreement, and MMG received approximately $16.5 million from the sale of its Bedford stock to Valley View. Valley View and its parent company subsequently filed for Chapter 11 bankruptcy.

Ultimately, the Bankruptcy Court appointed FTI Consulting, Inc. (“FTI”) as trustee of a litigation trust under the Debtor’s confirmed reorganization plan. FTI filed suit against MMG in the Northern District of Illinois to avoid the $16.5 million transfer from Valley View to MMG as a constructively fraudulent transfer, i.e., one for less than reasonably equivalent value. MMG moved for judgment on the pleadings, asserting that the safe harbor provision applied because the transfer involved Credit Suisse and Citizens Bank. The District Court granted the motion. But the Seventh Circuit Court of Appeals reversed, holding that the safe harbor provision “did not protect transfers in which financial institutions served as mere conduits.”

The Supreme Court, in resolving the circuit split, affirmed the Seventh Circuit’s decision and remanded for further proceedings. It determined that courts “must look to the overarching transfer from [Debtor] to [Creditor] to evaluate whether it meets the safe-harbor criteria” when the overarching transfer is the “same transfer that the trustee seeks to avoid pursuant to its substantive avoiding powers.” The Court held that the “relevant transfer for purposes of the § 546(e) safe harbor is the same transfer that the trustee seeks to avoid pursuant to its substantive avoiding powers.” The Court reasoned that the text of section 546(e) works as an exception to the trustee’s avoiding powers and that the focus of its application is the transfer sought to be avoided. Since it was never argued that either Valley View (the transferor) or MMG (the transferee) was a covered entity under section 546(e), and since that was relevant transfer, FTI could proceed with its avoidance action.


While the practical implications of the decision are still being fully assessed, there are a few aspects that may potentially limit its reach:

See if transferor/transferee is “customer” of financial institution. Definitions mean everything when it comes to the Bankruptcy Code’s market-oriented safe harbors. No party in Merit argued that either Valley View or MMG was a “customer” of Credit Suisse or Citizens Bank. By definition under section 101(22) of the Bankruptcy Code, a defendant’s status as a “customer” of a financial institution means that that defendant is itself a “financial institution” and should enjoy section 546(e) safe harbor protection. In fact, in a footnote, the Court even noted that its decision did not address “what impact, if any, [the definition of “customer”] would have in the application of the §546(e) safe harbor.” See Merit at 5 n.2. And in oral argument the Court actually seemed upset that the issue was not raised below and would therefore limit its decision.

Still must have avoidable relevant transfer. A defendant in an action to set aside a transfer may still argue that the trustee failed to “properly identify an avoidable transfer under the Code” and include arguments regarding the component parts of the transfer. As 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) (emphasis added). Not a transfer that involves. Not a transfer that comprises. But a transfer that is a securities transaction covered under §546(e).

However, if the trustee has properly identified an avoidable transfer, the court is under no obligation to review the component parts of the transaction when considering the limit to the avoiding power. The focus remains on the overarching transaction, rather than the means to achieve the ultimate transfer. And it is doubtful that any financial intermediary would want to be viewed as anything other than a mere conduit.

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