Second Circuit Settles The Meaning Of Settlement Payments Under Section 546(E) Of The Bankruptcy Code

The powers and protections granted to a bankruptcy trustee or chapter 11 debtor in possession under the Bankruptcy Code are numerous and far-reaching. From the automatic stay of creditor collection actions afforded by section 362 of the Bankruptcy Code to the unilateral power to assume or reject contracts under section 365 to the avoidance powers of chapter 5, the filing of a petition for relief under the Bankruptcy Code shifts the balance of power in many respects to the debtor.

Concerned by the potential for systemic risk to financial markets, however, Congress enacted a number of curbs on these key bankruptcy powers to the extent they might otherwise affect transactions involving certain financial instruments and securities. One of these "safe harbors" relating to (among other things) certain settlement payments under securities contracts can be found in section 546(e) of the Bankruptcy Code. The scope of protection afforded by section 546(e) has been the subject of considerable discussion and debate in the courts. In particular, some courts have attempted to reconcile a conflict between the apparently plain meaning of section 546(e) and Congress's stated intent in enacting it, yielding divergent results. Implicitly overruling a recent New York bankruptcy court's decision in In re MacMenamin's Grill Ltd., 450 B.R. 414 (Bankr. S.D.N.Y. 2011), the Second Circuit Court of Appeals in In re Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011), ruled that section 546(e) does, in fact, mean what it says.

THE SAFE HARBOR OF SECTION 546(e) OF THE BANKRUPTCY CODE

Section 546 of the Bankruptcy Code imposes several limitations on a trustee's avoidance powers. Several subsections of section 546, including section 546(e), provide safe-harbor protections against avoidance of transfers related to securities transactions that are complementary to the safe-harbor provisions found elsewhere in the Bankruptcy Code. Section 546(e) provides in part that:

the trustee may not avoid a transfer that is a . . . settlement payment as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a . . . financial institution . . . or that is a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract, as defined in section 741(7), . . . that is made before the commencement of the case, except under section 548(a)(1)(A) of this title.

Thus, under section 546(e), the trustee may not avoid, among other things, transfers to or by financial institutions, if such transfers are settlement payments made in connection with a securities contract, unless the transfer was made with actual fraudulent intent to hinder, delay, or defraud creditors under section 548(a)(1)(A) of the Bankruptcy Code.

The term "settlement payment" is defined in both sections 101 and 741 of the Bankruptcy Code, with only minor variations between the definitions. A "settlement payment" is defined in section 741(8), somewhat circularly, 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." The definition of the term in section 101(51A) varies slightly by adding the phrase "net settlement payment" and substituting "forward contract trade" for "securities trade." Section 741(7) of the Bankruptcy Code defines a "securities contract" as, among other things, "a contract for the purchase, sale, or loan of a security," and section 101(49) defines "security" to include "stock."

Although the plain language of section 546(e) and its defined terms do not clearly restrict application of the safe harbor to publicly...