Supreme Court Limits Scope of Avoidance Action Safe Harbor for Securities Transactions

Firm Thought Leadership

A bankruptcy trustee or a debtor in possession has powers under the Bankruptcy Code to avoid certain transfers the debtor may have made prior to the petition date, including preferential and fraudulent transfers.

Section 546(e) of the Bankruptcy Code, however, limits such avoiding powers for certain transfers made as part of a securities settlement. It states:
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 idea behind this so-called “safe harbor” is to preserve market certainty and to prevent trouble at one financial institution from spreading to others, “minimize[ing] the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries”, H.R. Rep. No. 97-420, at 1 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583, 1982 WL 25042.
On February 27, 2018, the Supreme Court in Merit Management Group, LP v. FTI Consulting, Inc. resolved a Circuit split regarding whether the section 546(e) safe harbor was available to protect transfers merely because the funds passed through a financial institution prior to reaching the recipient. The case involved an attempt by Merit Management Group, LP (“Merit”) to invoke the 546(e) safe harbor in defending against a fraudulent transfer claim asserted by FTI Consulting, Inc. (“FTI”), acting as litigation trustee in the bankruptcy case of Valley View Downs, L.P. (“Valley View”).

Factual Background

In the transaction at issue, Valley View agreed to purchase all of the stock of Bedford Downs Management Corporation (“Bedford Downs”) for a payment of $55 million to Bedford Downs’s stock holders, one of which was Merit. Valley View funded the purchase of Bedford Downs stock through financing obtained from a Cayman branch of Credit Suisse. The borrowed funds were sent directly from Credit Suisse to Citizens Bank of Pennsylvania (“Citizens”), which acted as a third-party escrow agent for the stock purchase. Citizens distributed all those funds to the shareholders in October 2007, except for $7.5 million, which Citizens, by agreement, kept in escrow as an indemnification holdback until it was later distributed to shareholders in October 2010.

In its defense against FTI’s fraudulent transfer claims to avoid the payment it received from Valley View, Merit argued that, because the payment from Valley View came into its possession from a financial intermediary, it constituted a transfer “by or to (or for the benefit of)” a financial institution, bringing it within the protection of section 546(e). The District Court for the Northern District of Illinois agreed that section 546(e) safe harbor applied and dismissed FTI’s fraudulent transfer claims. The Seventh Circuit Court of Appeals reversed, holding that the incidental involvement of a financial institution in transferring funds to purchase stock should not shield a transfer of funds that flows from one private party to another private party. By that ruling, the Seventh Circuit (agreeing with the Eleventh Circuit) departed from the prior decisions of the Second, Third, Sixth and Eighth Circuits, which all have held that the involvement of a financial institution as a conduit for payment is sufficient for the 546(e) safe harbor to apply.

The Court’s Decision

The Court, analyzing the wording and history of section 546(e) and the broader structure of the Bankruptcy Code’s chapter 5 avoidance provisions, held that the relevant transfer to test against the criteria for protection under 546(e) is the ultimate transfer the trustee seeks to avoid, and not a particular component of the transfer. When a trustee seeks to avoid a transfer that has a number of steps, the Supreme Court held that the 546(e) safe harbor “applies to the overarching transfer that the trustee seeks to avoid, not any component part of that transfer.” FTI at 12.

Thus, in determining whether the transfer to Merit was protected by section 546(e), the Court focused on the transfer from Valley View to Merit. Because neither Valley View nor Merit was a financial institution or any other entity listed in section 546(e), the Court held that the safe harbor does not apply. The fact that the transfer was effected through Credit Suisse and Citizens was irrelevant under the Supreme Court’s view of the transaction. The true transfer that FTI sought to avoid was the transfer of cash from Valley View to Merit, irrespective of what form that transfer took.


The Supreme Court’s conclusion significantly reduces the scope of the protection afforded by the 546(e) safe harbor. In doing so, it resets market expectations with respect to what sorts of transactions fall within the 546(e) safe harbor. The majority of prior Circuit court and lower court decisions had concluded that the mere transfer of funds to a financial institution as part of a larger transaction was sufficient to protect the transfer under the 546(e) safe harbor. See, notably, In re Quebecor World (USA) Inc., 719, F.3d 94, 99-100 (2d Cir. 2013) (applying safe harbor where a financial institution was the disbursing agent for noteholders who were the ultimate recipients of payment from the debtor). The Supreme Court’s decision in FTI rejects that approach, stating that a transaction covered by the exception was a “transfer that is a securities transaction” rather than “a transfer that involves” or “comprises” a securities transaction. FTI at 13. Under the Supreme Court’s decision, transfers cannot be insulated from avoidance risk merely by passing funds or property through a financial intermediary.

The full implications of the Supreme Court’s decision will need to be sorted out by Bankruptcy Courts over time. The transfer involved in the FTI case was relatively straightforward and the two financial institutions acting as a lender and an escrow agent undoubtedly were acting as conduits for a transfer of funds from Valley View to Merit. More complex transaction structures in which financial institutions take a more substantial ownership role of the funds may not so easily fit into the Supreme Court’s approach.


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