Another New York District Court Widens The Bankruptcy Code's Securities Contract Safe Harbor

• Published date: 01 February 2022
• Subject Matter: Corporate/Commercial Law, Criminal Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy, Contracts and Commercial Law, Securities, White Collar Crime, Anti-Corruption & Fraud, Shareholders
• Law Firm: Jones Day
• Author: Mr Charles Oellermann and Mark Douglas

In 2019, the U.S. Court of Appeals for the Second Circuit made headlines when it ruled that creditors' state law fraudulent transfer claims arising from the 2007 leveraged buyout ("LBO") of Tribune Co. ("Tribune") were preempted by the safe harbor for certain securities, commodity, or forward contract payments set forth in section 546(e) of the Bankruptcy Code. In that ruling, In re Tribune Co. Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019), cert. denied, 209 L. Ed. 2d 568 (U.S. Apr. 19, 2021) ("Tribune 2"), the Second Circuit also concluded that a debtor may itself qualify as a "financial institution" covered by the safe harbor, and thus avoid the implications of the U.S. Supreme Court's decision in Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018), by retaining a bank or trust company as an agent to handle LBO payments, redemptions, and cancellations.

In 2020 and 2021, a handful of bankruptcy and district courts in the Second Circuit picked up where the Second Circuit left off in Tribune 2, ruling that prebankruptcy recapitalization or LBO transactions were safe-harbored from avoidance as fraudulent transfers because they were effected through a bank or other qualifying financial institution. However, the Tribune 2 "workaround" to Merit has not been universally embraced.

The latest court to jump on the Tribune 2 bandwagon is the U.S. District Court for the Southern District of New York. In Holliday, Liquidating Trustee of the BosGen Liq. Trust v. Credit Suisse Secs. (USA) LLC, 2021 WL 4150523 (S.D.N.Y. Sept. 13, 2021) ("Boston Generating"), appeal filed, No. 21-2543 (2d Cir. Oct. 8, 2021). District Judge George B. Daniels affirmed a bankruptcy court ruling that: (i) section 546(e) preempts intentional fraudulent transfer claims under state law because the intentional fraud exception expressly included in section 546(e) provision applies only to intentional fraudulent transfer claims under federal law; and (ii) payments made to the members of limited liability company debtors as part of a prebankruptcy recapitalization transaction were protected from avoidance under section 546(e) because for that section's purposes the debtors were "financial institutions," as customers of banks that acted as their depositories and agents in connection with the transaction.

Further developments on this issue are likely. Even though the U.S. Supreme Court declined to review Tribune 2, both Boston Generating and an earlier ruling on this issue by the U.S. District Court for the Southern District of New York-In re Nine West LBO Sec. Litig., 482 F. Supp. 3d 187 (S.D.N.Y. 2020), appeal filed, No. 20-3290 (2d Cir. Sept. 25, 2020)-have been appealed to the Second Circuit.

The Section 546(e) Safe Harbor

Section 546 of the Bankruptcy Code imposes a number of limitations on a bankruptcy trustee's avoidance powers, which include the power to avoid certain preferential and fraudulent transfers. Section 546(e) provides that the trustee may not avoid, among other things, a prebankruptcy transfer that is a settlement payment "made by or to (or for the benefit of) a . financial institution [or a] financial participant ., or that is a transfer made by or to (or for the benefit of)" any such entity in connection with a securities contract, "except under section 548(a)(1)(A) of the [Bankruptcy Code]." Thus, the section 546(e) "safe harbor" bars avoidance claims challenging a qualifying transfer unless the transfer was made with actual intent to hinder, delay, or defraud creditors under section 548(a)(1)(A), as distinguished from being constructively fraudulent under section 548(A)(1)(B) because the debtor was insolvent at the time of the transfer (or became insolvent as a consequence) and received less than reasonably equivalent value in exchange.

Section 101(22) of the Bankruptcy Code defines the term "financial institution" to include, in relevant part:

[A] Federal reserve bank, or an entity that is a commercial or savings bank, industrial savings bank, savings and loan association, trust company, federally-insured credit union, or receiver, liquidating agent, or conservator for such entity and, when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer (whether or not a "customer", as defined in section 741) in connection with a securities contract (as defined in section 741) such customer ..

11 U.S.C. ' 101(22). "Customer" and "securities contract" are defined broadly in sections 741(2) and 741(7) of the Bankruptcy Code, respectively. Section 741(8) defines "settlement payment" as "a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade." A similar definition of settlement payment is set forth in section 101(51A).

The purpose of section 546(e) is to prevent "the...