A Safe Harbor For Trustees And Bondholders: Using Section 546(E) To Protect Trustees And Bondholders From Avoidance Actions

Section 546(e) of the Bankruptcy Code offers a strong defense for holders of bonds, notes and other securities to preference and fraudulent transfer actions brought in bankruptcy proceedings. Essentially, any payment made to settle or complete a securities transaction, including repurchases and redemptions of bonds, notes and debentures, is protected from avoidance under the Bankruptcy Code. For many years, however, this powerful defense was rarely used. When the defense was raised, it was usually in the context of protecting payments made in leveraged buy-outs. Bankruptcy courts were often hostile to the defense and narrowly interpreted the application of the defense to limit its use. Over the last several years, however, the use of the section 546 safe harbors has come to the forefront, as debtors and liquidating trustees have attempted to avoid commercial paper transactions and note redemptions, leveraged buyouts, and transfers made to customers from large brokerage and securities firms that have fallen into bankruptcy. The recent surge in the use of section 546 as a defense against these avoidance actions has allowed for appellate review and interpretation of the use of the defense. These courts have greatly expanded the use and application of the safe harbor defense and have found that the plain language of the statute protects a much wider range of securities transactions and securities contracts than bankruptcy courts had previously found. Most recently, the Second Circuit Court of Appeals in In re Quebecor Worldwide (USA), Inc., affirming bankruptcy court and district court decisions, found that section 546(e) protected the holders of notes and their indenture trustee from being required to give back millions of dollars in payments they had received from Quebecor Worldwide to repurchase their notes in the weeks leading up to its bankruptcy filing. This ruling, along with several other recent rulings, give trustees and bond holders a road map to protect payments received in connection with redemptions, repurchases and other restructurings of bonds, notes, debentures and other securities, from avoidance as a preference and from fraudulent transfer claims in the issuers' bankruptcies.

What does Section 546(e) Say?

Section 546(e) of the Bankruptcy Code Provides:

Notwithstanding sections 544, 545, 547, 548(a)(1) (B), and 548(b) of this title, the 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, or that is a transfer made by or to (or for the benefit of) [any of those parties], in connection with a securities contract... commodity contract, ... or forward contract, that is made before the commencement of the case, except under section 548(a)(1)(A) of this title. 11 U.S.C. § 546(e). Note that the section 546(e) safe harbors do not apply to the recovery of fraudulent transfers under section 548(a)(1)(A) of the Bankruptcy Code that are found to be actually fraudulent, i.e., made with actual intent to hinder, delay or defraud creditors. However, it does protect against the recovery of any preference claim and against any other type of fraudulent transfer claim, including constructive fraudulent transfer claims and any fraudulent transfer claim brought under state law, even if such state law or other non-bankruptcy law fraudulent transfer claim is an actual fraudulent transfer claim.

Moreover, the term "settlement payment" has a very broad definition under the Bankruptcy Code.

Specifically, a "settlement payment" is defined in Section 741 of the Bankruptcy Code 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. Also, the term "securities contract" is given a broad and general definition under the Bankruptcy Code. Specifically, Section 741 of the Bankruptcy Code defines "securities contract" to mean "a contract for the purchase, sale, or loan of a security, ... including any repurchase ... transaction on any such security." It should also be noted that the definition of the term "security" includes, among other things, notes, bonds, debentures and collateral trust certificates. 11 U.S.C. §101(49...