Post-Merit, the Second Circuit Reaffirms Its Ruling That State Law Avoidance Claims Are Preempted by the Section 546(e) Safe Harbor

In In re Tribune Co. Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019), the U.S. Court of Appeals for the Second Circuit reaffirmed, notwithstanding the U.S. Supreme Court's ruling in Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883, 200 L. Ed. 2d 183 (2018), its 2016 decision that creditors' state law fraudulent transfer claims arising from the 2007 leveraged buyout ("LBO") of Tribune Co. ("Tribune") were preempted by the safe harbor for certain securities, commodities, or forward contract payments set forth in section 546(e) of the Bankruptcy Code. The Second Circuit concluded that a debtor may itself qualify as a "financial institution" covered by the safe harbor, and thus avoid the implications of Merit, by retaining a bank or trust company as an agent to handle LBO payments, redemptions, and cancellations.

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. Thus, the section 546(e) "safe harbor" bars avoidance claims challenging a qualifying transfer unless the transfer was made with actual intent to hinder, delay, or defraud creditors, as distinguished from being constructively fraudulent because the debtor was insolvent at the time of the transfer (or became insolvent as a consequence) and received less than reasonably equivalent value in exchange.

Section 101(22)(A) 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)(A) (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, there was a split among the circuit courts of appeals concerning whether the section 546(e) safe harbor barred constructive fraud claims seeking to avoid transactions in which the financial institution involved was merely a "conduit" for the transfer of funds from the debtor to the ultimate transferee. The Second Circuit ruled that the safe harbor applied under those circumstances in In re Quebecor World (USA) Inc., 719 F.3d 94 (2d Cir. 2013). The Supreme Court resolved the circuit split in Merit.

The Supreme Court's Ruling in Merit

In Merit, a 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 in Merit 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 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 financial institutions 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 Second Circuit 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 automatic stay to permit the Creditors' prosecution of lawsuits asserting such state law claims in state and federal courts. Beginning in December 2011, 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 federal 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 in the consolidated avoidance litigation granted a motion to dismiss the Creditors' state law constructive 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 fraudulent 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) ("Tribune 1"). 

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 Tribune 1. 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 … 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 Co. Ams. v. Robert R. McCormick Foundation, 138 S. Ct. 1162, 2018 WL 1600841 (U.S. Apr. 3, 2018).

In May 2018, the Second Circuit issued an order suspending the effectiveness of Tribune 1 "in anticipation of further panel review." The order neither vacated the underlying decision nor established a schedule for further review.

The Second Circuit's Revised Ruling

In a revised opinion issued on December 19, 2019 ("Tribune 2"), two of the three judges on the panel that issued Tribune 1 reaffirmed the court's previous decision that the Creditors' state law constructive fraudulent transfer claims were preempted by the section 546(e) safe harbor.

The Second Circuit panel acknowledged that one of the holdings in Tribune 1 (as well as its previous ruling in Quebecor) was abrogated by Merit's pronouncement that the section 546(e) safe harbor does not apply if a financial institution is a mere conduit. However, with certain significant exceptions, the Second Circuit otherwise restated verbatim much of its 2016 opinion concerning the safe harbor, including its determinations that the LBO payments were made "in connection with a securities contract" and that section 546(e) barred the Creditors' state law avoidance claims. The Second Circuit reached the same conclusion concerning the scope of section 546(e), but for a different reason.

The Second Circuit explained that, under Merit, the payments to Tribune's shareholders are shielded from avoidance under section 546(e) only if either Tribune, which made the payments, or the shareholders who received them were "covered entities." It then concluded that Tribune was a "financial institution," as defined by section 101(22)(A) of the Bankruptcy Code, and "therefore a covered entity."

According to the Second Circuit, CTC, which Tribune retained to act as depositary in connection with the LBO, is a "financial institution" for purposes of section 546(e) because it is a trust company and a bank. Therefore, the court explained, Tribune was likewise a financial institution because, under the ordinary meaning of the term, Tribune was CTC's "customer" with respect to the LBO payments, and CTC was Tribune's agent according to the common-law definition of "agency." "Section 546(e)'s language is broad enough under certain circumstances," the Second Circuit wrote, "to cover a bankrupt firm's LBO payments even where, as here, that firm's business was primarily commercial in nature."

Finally, the Second Circuit panel limited Merit to its facts, noting that the case did not address preemption but, instead, discussed whether the relevant transfer for purposes of section 546(e) "was the overarching transfer or any of its component transfers." Moreover, the Second Circuit found nothing in Merit's reasoning to contradict its assessment of Congress's preemptive intent. It was unpersuaded by the Creditors' argument that the Supreme Court in Merit rejected "a primary premise" of the Second Circuit's ruling—namely, "that section 546(e) was intended to promote finality in the securities markets" (internal quotation marks omitted). According to the Second Circuit, in Merit, the Court "merely concluded that, to the extent the policies animating Section 546(e) were relevant for determining the safe harbor's scope, those policies did not supply a basis for 'deviat[ing] from the plain meaning of the language used in § 546(e)'" (citing Merit, 138 S. Ct. at 897, 888). In addition, the Second Circuit explained, Merit does not contradict its findings that the Creditors' legal theory: (i) has no support in the language of the Bankruptcy Code; (ii) leads to "substantial anomalies and conflicts" with the Bankruptcy Code's procedures; and (iii) "requires reading Section 546(e)'s reference to a trustee et al. avoidance claim to mean that creditors could bring their own claims—a reading that is less than plain."


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.

In handing down its ruling in Tribune 2, the Second Circuit employed substantially the same reasoning articulated by the U.S. District Court of the Southern District of New York in denying a litigation trustee's motion in a related lawsuit 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). See In re Tribune Co. Fraudulent Conveyance Litig., 2019 WL 1771786 (S.D.N.Y. Apr. 23, 2019). The decisions of both the district court and the Second Circuit in Tribune 2 suggest that the results of Merit might be avoided by structuring transactions such that the LBO target is a "customer" of the financial intermediaries involved.

The Creditors filed a petition for rehearing en banc of Tribune 2 on January 2, 2020. The Creditors have challenged, among other things, the Second Circuit's conclusion that CTC was an agent for Tribune. The court denied the petition on February 6. 

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