Business Restructuring Review

Tribune District Court Rules That LBO Payments May Not Be Avoided Because Debtor Was "Customer" of "Financial Institution"

In In re Tribune Co. Fraudulent Conveyance Litig., 2019 WL 1771786 (S.D.N.Y. Apr. 23, 2019), the U.S. District Court for the Southern District of New York denied a litigation trustee’s motion to amend a complaint seeking to avoid alleged fraudulent transfers made to selling shareholders as part of a 2007 leveraged buyout ("LBO") of the Tribune Co. ("Tribune"), ruling that the safe harbor in section 546(e) of the Bankruptcy Code continues to bar such claims notwithstanding the U.S. Supreme Court’s February 2018 decision in Merit Management Group v. FTI Consulting. According to the district court’s ruling, payments made to shareholders as part of the LBO transaction were insulated from avoidance as constructive fraudulent transfers because Tribune hired a commercial bank to serve as exchange agent for the transfers. As a "customer" of a "financial institution," the court reasoned, Tribune itself became a "financial institution," thereby triggering application of the safe harbor and avoiding the strictures of Merit.

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 pre-bankruptcy 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, unless the transfer was made with the actual intent to hinder, delay, or defraud creditors.

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

[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) (emphasis added).

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). 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.

Prior to the Supreme Court’s ruling in Merit, five circuit courts of appeals ruled that the section 546(e) safe harbor extends to transactions even where the financial institution involved is merely a "conduit" for the transfer of funds from the debtor to the ultimate transferee. See In re Quebecor World (USA) Inc., 719 F.3d 94 (2d Cir. 2013) (the safe harbor is applicable where the financial institution was a trustee, and the actual exchange was between two private entities); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009) (section 546(e) is not limited to public securities transactions and protects from avoidance a debtor’s payments deposited in a national bank in exchange for the shareholders’ privately held stock during an LBO); In re QSI Holdings, Inc., 571 F.3d 545 (6th Cir. 2009) (the safe harbor applied even though the financial institution involved in the LBO was only the exchange agent); In re Resorts Int’l, Inc., 181 F.3d 505, 516 (3d Cir. 1999) (noting that "the requirement that the ‘commodity brokers, forward contract merchants, stockbrokers, financial institutions, and securities clearing agencies’ obtain a ‘beneficial interest’ in the funds they handle . . . is not explicit in section 546"); In re Kaiser Steel Corp., 952 F.2d 1230, 1240 (10th Cir. 1991) (rejecting the argument that "even if the payments were settlement payments, § 546(e) does not protect a settlement payment ‘by’ a stockbroker, financial institution, or clearing agency, unless that payment is to another participant in the clearance and settlement system and not to an equity security holder").

The Eleventh Circuit ruled to the contrary in In re Munford, Inc., 98 F.3d 604 (11th Cir. 1996). In Munford, the court held that section 546(e) did not shield from avoidance payments made by the debtor to shareholders in an LBO because the "financial institution" involved was only a conduit for the transfer of funds and securities—the bank never had a "beneficial interest" sufficient to qualify as a "transferee" in the LBO. The Seventh Circuit widened the circuit split on the issue when it agreed with the rationale of Munford in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016), aff’d, 138 S.Ct. 883 (2018). The Supreme Court granted a petition to review the Seventh Circuit’s ruling to resolve the circuit split.

The Supreme Court’s Ruling in Merit

In Merit, the unanimous Court held that section 546(e) does not protect transfers made through a "financial institution" to a third party, regardless of whether the financial institution had a beneficial interest in the transferred property. Instead, the relevant inquiry is whether the transferor or the transferee in the transaction sought to be avoided is itself a financial institution. Because the selling shareholder in the LBO transaction that was challenged as a constructive fraudulent transfer was not a financial institution (even though the conduit banks through which the payments were made met that definition), the Court ruled that the payments fell outside of the safe harbor.

In a footnote, the Court acknowledged that the Bankruptcy Code defines "financial institution" broadly to include not only entities traditionally viewed as financial institutions, but also the "customers" of those entities, when they act as agents or custodians in connection with a securities contract. The selling shareholder in Merit was a customer of one of the conduit banks, yet never raised the argument that it therefore also qualified as a financial institution for purposes of section 546(e). For this reason, the Court did not address the possible impact of the shareholder transferee’s customer status on the scope of the safe harbor. The district court considered this question in Tribune.


In 2007, Tribune was the target of an LBO that paid its shareholders more than $8 billion in exchange for their shares in the company. There were two separate parts to the transaction. First, Tribune transmitted the cash necessary to purchase its shares in connection with a tender offer to a depositary, Computershare Trust Company, N.A. ("CTC"). CTC then accepted and held tendered shares on Tribune’s behalf and paid selling shareholders $34 per share. Second, with CTC acting in the same capacity, Tribune purchased its remaining shares and borrowed an additional $3.7 billion in a go-private merger with a newly-formed Tribune entity.

Shortly after the LBO was completed in December 2007, Tribune experienced financial difficulties due to declining advertising revenues and its failure to meet projections. The company filed for chapter 11 protection in December 2008 in the District of Delaware.

In 2010, Tribune’s unsecured creditors’ committee (the "Committee") sued Tribune’s former shareholders and certain other defendants in the bankruptcy court to, among other things, avoid and recover the LBO payments as fraudulent transfers under sections 548(a) and 550 of the Bankruptcy Code. In 2011, finding that Tribune’s various creditors (collectively, the "Creditors") regained the right to pursue state law constructive fraudulent transfer claims against the selling shareholders because such claims had not been asserted on behalf of Tribune’s estate prior to expiration of the statute of limitations under section 546(a), the bankruptcy court modified the stay to permit the Creditors’ prosecution of lawsuits asserting such claims in state and federal courts. In December 2011 and March 2012, approximately 40 state and federal cases involving more than 5,000 defendants, including the litigation commenced by the Committee, were consolidated in the U.S. District Court for the Southern District of New York.

The bankruptcy court confirmed Tribune’s chapter 11 plan in July 2012. The plan assigned the  avoidance claims asserted by the Committee to a litigation trust. Thus, the litigation trustee became the successor plaintiff in that litigation. The plan did not assign the Creditors’ state law constructive fraudulent transfer claims to the litigation trust.

In September 2013, the district court granted a motion to dismiss the Creditors’ state law fraudulent transfer claims, finding that the automatic stay deprived individual creditors of standing to challenge the same transactions that the litigation trustee was simultaneously seeking to avoid. The Second Circuit affirmed on appeal, but on different grounds, holding that such claims were preempted by the section 546(e) safe harbor. According to the Second Circuit, even though section 546(e) expressly provides that "the trustee" may not avoid certain payments under securities contracts unless such payments were made with the actual intent to defraud, section 546(e)’s language, its history, its purposes, and the policies embedded in the securities laws and elsewhere led to the conclusion that the safe harbor was intended to preempt constructive fraud transfer claims asserted by creditors. See Deutsche Bank Trust Co. Ams. v. Large Private Beneficial Owners (In re Tribune Co. Fraudulent Conveyance Litig.), 818 F.3d 98 (2d Cir. 2016).

On September 9, 2016, the Creditors filed a petition for a writ of certiorari with the U.S. Supreme Court.

In January 2017, the district court dismissed the litigation trustee’s intentional fraudulent transfer claims against the selling shareholders, ruling, among other things, that any fraudulent intent of Tribune’s officers in connection with the LBO could not be imputed to Tribune.

The Supreme Court issued its ruling in Merit on February 27, 2018. Shortly afterward, the Tribune litigation trustee sought court permission to amend his complaint to add federal constructive fraudulent transfer claims against the selling shareholders.

On April 3, 2018, the Supreme Court issued an order that, in light of its recent ruling in Merit, the Court would defer consideration of the Creditors’ petition seeking review of the Second Circuit’s 2016 preemption decision. According to the Supreme Court, deferring consideration of whether the Court should review the merits of the Second Circuit’s decision "will allow the Court of Appeals or the District Court to consider whether to recall the mandate, entertain a Federal Rule of Civil Procedure 60(b) motion to vacate the earlier judgment, or provide any other available relief in light of this Court’s decision in [Merit]." See Deutsche Bank Trust Company Americas v. Robert R. McCormick Foundation, 138 S. Ct. 1162, 2018 WL 1600841, No. 16-317 (U.S. Apr. 3, 2018).

On May 15, 2018, the Second Circuit issued an order suspending the effectiveness of its Tribune safe-harbor decision "in anticipation of further panel review." The order neither vacated the underlying decision nor established a schedule for further review. In June 2018, the district court stayed the litigation trustee’s request to amend his complaint pending further action by the Second Circuit in the Creditors’ litigation, noting that the Second Circuit was likely to rule on the applicability of section 546(e) to the LBO in that litigation.

On April 4, 2019, the litigation trustee renewed his motion seeking permission to file an amended complaint asserting constructive fraudulent transfer claims against the selling shareholders, relying entirely on Merit. The shareholder defendants opposed the motion, arguing, among other things, that Merit was not dispositive because Tribune was itself a "financial institution" in the LBO as a "customer" of CTC.

The District Court’s Ruling

The district court denied the litigation trustee’s motion to amend the complaint, ruling that the proposed amendment would be futile because the federal constructive fraudulent transfer claims were barred by section 546(e) and amendment would result in undue prejudice to the shareholder defendants.

Initially, the court noted that the only issue disputed by the parties was whether Tribune was a "financial institution" or a "financial participant" covered by the safe harbor. Although Tribune did not satisfy section 101(22A)(A)’s definition of "financial participant," the district court concluded that the company qualified as a "financial institution" under section 101(22) because: (i) it was undisputed that, as both a "bank" and a "trust company," CTC was a financial institution; (ii) Tribune was a "customer" of CTC; (iii) CTC acted as Tribune’s "agent or custodian" in connection with the LBO; and (iv) CTC acted "in connection with a securities contract" when it acted as depositary.

The district court noted that section 101(22) (defining "financial institution") does not define the term "customer," and the provision expressly states that the term is not limited to the definition of "customer" in the definitions contained in sections 741(2) and 761(9), which apply to stockbroker and commodity broker liquidations. Therefore, the court looked to the ordinary meaning of the term, which includes purchasers of goods or services, consumers, patrons and bank account holders. Because Tribune was a purchaser of CTC’s services, the district court held that Tribune was CTC’s customer. In addition, CTC acted as Tribunes "agent" because Tribune entrusted CTC with billions of dollars in cash as well as the task of making payments on Tribune’s behalf to the selling shareholders, "a paradigmatic principal agent relationship." Also, the court found that Tribune’s use of CTC to purchase Tribune stock from the selling shareholders was sufficient to establish that CTC’s involvement in the LBO was "in connection with a securities contract."

The district court found that Merit was distinguishable. It wrote that "[t]he tension suggested by the [litigation trustee] between the [selling shareholders’] successful invocation of Section 546(e)’s safe harbor and [Merit] does not exist" because the Supreme Court specifically declined to address the scope of the definition of "financial institution" and acknowledged the possibility that an entity qualifying as a "customer" could satisfy that definition.

The court noted that its conclusion comports with section 546(e)’s goals of promoting stability and finality in securities markets and protecting investors. In doing so, it rejected the litigation trustee’s argument that Tribune was not a "systemically important" institution that should benefit from the safe harbor:

[A]t the time of the LBO, Tribune was a publicly traded, Fortune 500 company. The [litigation trustee] sued over 5,000 [selling shareholders] of Tribune—whose only involvement in this transaction was receiving payment for their shares—to unwind securities transactions. This is precisely the sort of risk that Section 546(e) was intended to minimize.

Finally, the court held that, even if the safe harbor did not apply, the court would deny the motion for leave to amend because amendment would unduly prejudice the shareholder defendants. The court explained that permitting amendment of the complaint to add new federal constructive fraudulent transfer claims in such a complex case after years of litigation would require significant additional discovery and trial preparation and would significantly delay resolution of the case.


Merit potentially opened the door for constructive fraudulent transfer claims against selling shareholders in many LBOs. Such payments typically pass through financial intermediaries that would be considered "financial institutions" and were previously considered to be protected from avoidance by the safe harbor in many circuits. Tribune, however, suggests that the results of Merit might be avoided by structuring transactions so that the LBO target is a "customer" of the financial intermediaries involved.

However, it remains to be seen whether the district court’s ruling in Tribune will withstand scrutiny on appeal or whether the Second Circuit will weigh in on the issue in the still-pending Creditors’ litigation.

Tribune is not the only recent case addressing the ramifications of Merit and the section 546(e) safe harbor. For example, in In re Greektown Holdings, LLC, 2019 WL 1770323 (6th Cir. Apr. 22, 2019), the Sixth Circuit noted that "[Merit] squarely addresses the dispositive issue in this case and abrogated the Sixth Circuit precedent on which both the bankruptcy court and district court relied." The court accordingly vacated and remanded lower court rulings invoking the section 546(e) safe harbor to dismiss a litigation trustee’s complaint seeking to avoid under state fraudulent transfer laws redemption payments made under a note purchase agreement through a "financial institution" to members of a limited liability company.

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