Grede V. FCStone, LLC: A Confirmation Of The Broad Scope Of The Section 546(E) Safe Harbor

Avoidance actions are an important source of recovery for the creditors of a bankruptcy estate. Although estate representatives are given significant avoidance powers under the Bankruptcy Code, section 546(e)'s safe harbor prevents the unwinding of certain transactions that, if undone, could cause disruption to the securities and commodities markets. Recently, in Grede v. FCStone, LLC, 746 F.3d 244 (7th Cir. 2014), the U.S. Court of Appeals for the Seventh Circuit confirmed courts' view of the expansiveness of the 546(e) safe harbor when it overruled a district court's "equitable" approach to creditor distributions. The Seventh Circuit held that, among other things, a trustee could not avoid a prepetition transfer to a favored customer (an investor in one of the debtor's securities investment portfolios) as a constructively fraudulent transfer because the transferred funds came from the debtor's sale of securities. The court reasoned that the distribution to the customer from its investment account, like the payment made by the purchaser to the debtor for securities whose proceeds were deposited into the account, qualified as a "settlement payment" and was made "in connection with a securities contract."

The 546(e) Safe Harbor

In 1982, Congress broadened a limited safe harbor for securities transactions then set forth in section 764(c) of the Bankruptcy Code, which applied only in commodity-broker liquidation cases under chapter 7, by replacing the provision with section 546(e) (then designated as section 546(d), until renumbering in 1984).

Section 546 of the Bankruptcy Code imposes a number of limitations on a bankruptcy trustee's avoidance powers, including the power to avoid certain preferential and/or fraudulent transfers. Section 546(e) provides:

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of [the Bankruptcy Code], the trustee may not avoid a transfer that is a margin payment, as defined in section 101, 741, or 761 of [the Bankruptcy Code], or settlement payment as defined in section 101 or 741 of [the Bankruptcy Code], 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) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract, as defined in section 741(7) [of the Bankruptcy Code], commodity contract, as defined in section 761(4) [of the Bankruptcy Code], or forward contract, that is made before the commencement of the case, except under section 548(a)(1)(A) of [the Bankruptcy Code].

The purpose of section 546(e) is to prevent "the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market." H.R. Rep. No. 97-420, at 1 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583, 1982 WL 25042. The provision was "intended to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries." Id.

If a transaction falls within the scope of section 546(e), it may not be avoided unless the transfer is avoidable under section 548(a)(1)(A) of the...