Another New York District Court Widens the Bankruptcy Code's Securities Contract Safe Harbor

In 2019, the U.S. Court of Appeals for the Second Circuit made headlines when it ruled 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, commodity, or forward contract payments set forth in section 546(e) of the Bankruptcy Code. In that ruling, In re Tribune Co. Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019), cert. denied, 209 L. Ed. 2d 568 (U.S. Apr. 19, 2021) ("Tribune 2"), the Second Circuit also concluded that a debtor may itself qualify as a "financial institution" covered by the safe harbor, and thus avoid the implications of the U.S. Supreme Court's decision in Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018), by retaining a bank or trust company as an agent to handle LBO payments, redemptions, and cancellations.

In 2020 and 2021, a handful of bankruptcy and district courts in the Second Circuit picked up where the Second Circuit left off in Tribune 2, ruling that prebankruptcy recapitalization or LBO transactions were safe-harbored from avoidance as fraudulent transfers because they were effected through a bank or other qualifying financial institution. However, the Tribune 2 "workaround" to Merit has not been universally embraced.

The latest court to jump on the Tribune 2 bandwagon is the U.S. District Court for the Southern District of New York. In Holliday, Liquidating Trustee of the BosGen Liq. Trust v. Credit Suisse Secs. (USA) LLC, 2021 WL 4150523 (S.D.N.Y. Sept. 13, 2021) ("Boston Generating"), appeal filed, No. 21-2543 (2d Cir. Oct. 8, 2021). District Judge George B. Daniels affirmed a bankruptcy court ruling that: (i) section 546(e) preempts intentional fraudulent transfer claims under state law because the intentional fraud exception expressly included in section 546(e) provision applies only to intentional fraudulent transfer claims under federal law; and (ii) payments made to the members of limited liability company debtors as part of a prebankruptcy recapitalization transaction were protected from avoidance under section 546(e) because for that section's purposes the debtors were "financial institutions," as customers of banks that acted as their depositories and agents in connection with the transaction.

Further developments on this issue are likely. Even though the U.S. Supreme Court declined to review Tribune 2, both Boston Generating and an earlier ruling on this issue by the U.S. District Court for the Southern District of New York—In re Nine West LBO Sec. Litig., 482 F. Supp. 3d 187 (S.D.N.Y. 2020), appeal filed, No. 20-3290 (2d Cir. Sept. 25, 2020)—have been appealed to the Second Circuit. 

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 prebankruptcy 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, "except under section 548(a)(1)(A) of the [Bankruptcy Code]." 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 under section 548(a)(1)(A), as distinguished from being constructively fraudulent under section 548(A)(1)(B) 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) of the Bankruptcy Code defines the term "financial institution" to include, in relevant part:

[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). "Customer" and "securities contract" are defined broadly in sections 741(2) and 741(7) of the Bankruptcy Code, respectively. Section 741(8) defines "settlement payment" 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." A similar definition of settlement payment is set forth in section 101(51A).

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.

In 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"), the U.S. Court of Appeals for the Second Circuit affirmed lower court decisions dismissing creditors' state law constructive fraudulent transfer claims arising from the 2007 LBO of Tribune. 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 lead to the conclusion that the safe harbor was intended to preempt constructive fraudulent transfer claims asserted by creditors under state law.

Prior to the Supreme Court's ruling in Merit, there was a split among the circuit courts concerning whether the section 546(e) safe harbor barred state law constructive fraud claims 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. For its part, 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

In Merit, a unanimous Supreme 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 overall is itself a financial institution. Because the selling shareholder in the LBO transaction that was challenged in Merit 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 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 selling shareholder's status on the scope of the safe harbor.

In April 2018, the Supreme Court issued an order that, in light of its ruling in Merit, the Court would defer consideration of a petition seeking review of Tribune 1. The Second Circuit later suspended the effectiveness of Tribune 1 "in anticipation of further panel review." In a revised opinion issued in December 2019—Tribune 2—the Second Circuit reaffirmed the court's previous decision that the creditors' state law constructive fraudulent transfer claims in that case were preempted by the section 546(e) safe harbor.

In Tribune 2, the Second Circuit 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, the court again concluded that section 546(e) barred the creditors' state law avoidance claims, but for a different reason. 

The Second Circuit explained that, under Merit, the payments to Tribune's shareholders were 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) of the Bankruptcy Code, and "therefore a covered entity."

According to the Second Circuit, the entity Tribune retained to act as depository in connection with the LBO was a "financial institution" for purposes of section 546(e) because it was a trust company and a bank. Therefore, the court reasoned, Tribune was likewise a financial institution because, under the ordinary meaning of the term as defined by section 101(22), Tribune was the bank's "customer" with respect to the LBO payments, and the bank 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." Tribune 2, 946 F.3d at 91.

Some Notable Post-Tribune 2 Court Rulings

In Nine West, Judge Jed S. Rakoff of the U.S. District Court for the Southern District of New York dismissed $1.1 billion in fraudulent transfer and unjust enrichment claims brought by a chapter 11 plan litigation trustee and an indenture trustee against shareholders, officers, and directors seeking to avoid payments made to the defendants as part of a 2014 LBO of women's clothing retailer Nine West Holding Inc. ("Nine West"). Citing Tribune 2, the district court ruled that the payments were protected by the section 546(e) safe harbor because they were made by a bank acting as Nine West's agent. According to the court, "When, as here, a bank is acting as an agent in connection with a securities contract, the customer qualifies as a financial institution with respect to that contract, and all payments in connection with that contract are therefore safe harbored under Section 546(e)." Id. at 206.

Also in accordance with Tribune 2, the district court ruled that the safe harbor preempted both trustees' state law fraudulent transfer claims against the defendants. In addition, the court held that section 546(e) preempted the litigation trustee's unjust enrichment claims against director and officer defendants because such claims, however denominated, sought recovery of the same payments that were protected from avoidance under the safe harbor. 

In SunEdison Litigation Trust v. Seller Note, LLC (In re SunEdison, Inc.), 620 B.R. 505 (Bankr. S.D.N.Y. 2020), Judge Stuart M. Bernstein of the U.S. Bankruptcy Court for the Southern District of New York invoked section 546(e) to dismiss a chapter 11 plan litigation trustee's complaint seeking to avoid and recover alleged constructive fraudulent transfers made in 2015 by SunEdison Holdings, a subsidiary of renewable-energy development company SunEdison, Inc., in connection with a the acquisition of a wind and solar power generation project involving two separate sequential transfers, only one of which was effected through a "financial institution."

Under Merit, the Sun Edison court explained, the "relevant transfer" in this case was "the overarching transfer" even though only one step of the transaction involved a financial institution. According to the court, "[t]his was an integrated transaction," and because one step of the transaction was effected through a qualified financial institution, section 546(e) shielded the "component steps" from avoidance as a constructive fraudulent transfer. Id. at 515. 

At least one court outside of the Second Circuit has criticized the Tribune 2 "workaround" approach. In In re Greektown Holdings, LLC, 621 B.R. 797 (Bankr. E.D. Mich. 2020), reh'g denied, 2020 WL 6701347 (Bankr. E.D. Mich. Nov. 13, 2020), Judge Maria L. Oxholm of the U.S. Bankruptcy Court for the Eastern District of Michigan denied a motion for summary judgment filed in avoidance litigation by the recipients of payments made as part of a prebankruptcy recapitalization transaction that involved the issuance of unsecured notes underwritten by a financial institution and payment of a portion of the proceeds to the defendants. Citing Merit, the defendants argued that the transfer was safe-harbored because the transaction was undertaken "for the benefit of" the underwriter, which acted as the debtor-transferor's agent, thereby making the transferor a financial institution as the underwriter's customer.

The court rejected this argument, ruling that the transaction fell outside the section 546(e) safe harbor because: (i) neither the transferor nor the transferees were financial institutions in their own right; (ii) the defendants failed to establish that the transaction was "for the benefit of" the underwriter financial institution by showing that it "received a direct, ascertainable, and quantifiable benefit corresponding in value to the payments"; and (iii) the evidence did not show that the underwriter was acting as either the transferor's agent or custodian in connection with the transaction, such that the transferor itself could be deemed a financial institution. Notably, the court was "not persuaded by the agency analysis in [Tribune 2] as it does not distinguish between mere intermediaries contracted for the purpose of effectuating a transaction and agents who are authorized to act on behalf of their customers in such transactions." Id. at 827. Under Tribune 2, the court wrote, "any intermediary hired to effectuate a transaction would qualify as its customer's agent [, which] … would result in a complete workaround of [Merit]." Id.

Boston Generating

Boston Generating LLC ("BosGen"), its holding company EBG Holdings LLC ("EBG"), and their subsidiaries (collectively, "debtors") owned and operated electric power generating facilities near Boston. In November 2006, BosGen and EBG launched a leveraged recapitalization transaction whereby they borrowed approximately $2.1 billion from lenders, in part to fund a $925 million tender offer for EBG's member units and warrants, and the distribution of $35 million in dividends to EBG's members. The Bank of New York ("BNY") acted as the depository and agent for both BosGen and EBG in connection with the tender offer. 

The $2.1 billion cash infusion from the credit facilities was deposited into BosGen and EBG bank accounts at U.S. Bank National Association ("US Bank"). US Bank then transferred ("BofA transfer") approximately $708 million to EBG's Bank of America ("BofA") account to fund the unit buyback, warrant redemption, and dividend distribution and approximately $50 million to pay fees and expenses incurred in connection with the closing of the credit facilities. Thereafter, EBG caused the funds to be transferred to its accounts at BNY ("BNY transfer" and, together with the BofA transfer, "BosGen transfer"). In December 2006, EBG directed BNY to pay the BosGen transfer funds as part of the $925 million unit and warrant redemption payment and the $35 million dividend payment ("dividend transfer") to EBG's members.

The debtors filed for chapter 11 protection in the Southern District of New York in August 2010. After authorizing the sale of substantially all of the debtors' assets, the bankruptcy court confirmed a liquidating chapter 11 plan for the debtors in August 2011. The plan created a liquidating trust to pursue claims on behalf of the debtors' general unsecured creditors. The liquidating trustee commenced an adversary proceeding seeking, among other things, to avoid and recover the BofA transfer and the dividend transfer as intentional and constructive fraudulent transfers under the New York Debtor & Creditor Law. The defendants moved to dismiss, arguing that the transfers were safe-harbored under section 546(e).

The bankruptcy court granted the motion to dismiss the liquidating trustee's fraudulent transfer claims. The court ruled that: (i) section 546(e) preempted the claims; and (ii) the payments were protected by the section 546(e) safe harbor because BosGen and EBG were "financial institutions," as customers of US Bank and/or BNY. See Holliday v. K Road Power Management, LLC (In re Boston Generating LLC), 617 B.R. 442 (Bankr. S.D.N.Y. 2020), aff'd, 2021 WL 4150523 (S.D.N.Y. Sept. 13, 2021). 

Initially, the court acknowledged that neither Tribune 1 nor Tribune 2 addressed whether section 546(e) preempts intentional (as distinguished from constructive) fraudulent transfer claims under state law. Nonetheless, the court saw "no reason why Tribune's reasoning does not extend to intentional state law fraudulent transfer claims." Examining the plain language of section 546(e), the court declined to extend section 546(e)'s exception for federal intentional fraudulent transfer claims under section 548(a)(1)(A) to include state law intentional fraudulent transfer claims.

According to the bankruptcy court:

Congress may have specifically excluded state law intentional fraudulent transfer claims from section 546(e)'s exception having determined the need for stability in the securities markets overrode the potential danger of creditors escaping claims for intentional fraud based on a fear that inconsistent application of fifty (50) states' fraudulent transfer statutes would result in instability in the securities markets.

Holliday, 617 B.R. at 480. Looking at the BosGen transfer as an "integrated transaction," the bankruptcy court determined that the transfer satisfied the requirements for the safe harbor because: (i) "a transfer of cash to a financial institution made to repurchase and cancel securities—in other words, to complete a securities transaction—qualifies for the safe harbor as a settlement payment"; (ii) the LLC member units and warrants qualified as "securities" under the Bankruptcy Code's broad definition; (iii) the payments were made "in connection with a securities contract"—the tender offer; (iv) BosGen qualified as a "financial institution" by virtue of its relationship with US Bank, which acted as the agent of its customers BosGen and EBG in connection with the tender offer; and (v) additionally, or in the alternative, both BosGen and EBG qualified as "financial institutions" as customers of BNY, which acted as their agent in connection with the tender offers.

Finally, the court also ruled that section 546(e) preempted the liquidating trustee's constructive fraudulent transfer claims under state law—an issue that was conceded by the trustee.

The liquidating trustee appealed the decision.

The District Court's Ruling

The district court affirmed the ruling below.

On appeal, the liquidating trustee argued that the BofA transfer was the "relevant transfer" for the purposes of his avoidance complaint and, misapplying Merit, the bankruptcy court concluded that the relevant transfer also included the BNY transfer. The avoidance defendants countered that the "'overarching transfer' was the payment by the Debtors of nearly $1 billion … to their shareholders in satisfaction of their equity interests."

District Judge George B. Daniels explained that, in accordance with Merit, the relevant transfer is defined by the governing substantive avoiding power—here, the N.Y. Debtor & Creditor Law—which requires that, "where a transfer is only a step in a general plan, the plan must be viewed as a whole with all its composite applications." Boston Generating, 2021 WL 4150523, at *3 (citation and internal quotation marks omitted). Thus, Judge Daniels concluded, the liquidating trustee improperly sought to avoid only one component—the BofA transfer—of the "overarching" BosGen transfer, which was "an integral transfer" in the leveraged recapitalization transaction. Analyzing the BofA transfer in a vacuum, Judge Daniels wrote, "would permit the trustee to circumvent the safe harbor by carving up an integrated securities transaction consisting of multiple component parts … [, which] would unnecessarily restrict the safe harbor and 'seriously undermine … markets in which certainty, speed, finality, and stability are necessary to attract capital.'" Id. (quoting Tribune 2, 946 F.3d at 90).

The district court found no fault with the bankruptcy court's finding that the BosGen transfer was a settlement payment made in connection with a securities contract, as required by section 546(e). According to Judge Daniels, the bankruptcy court also properly found that BosGen was covered by the safe harbor because, as the customer of a bank or trust company—US Bank—that acted as its agent in connection with a securities contract, it was a "financial institution."

Judge Daniels rejected the liquidating trustee's argument that a customer is a financial institution only when a bank makes or receives the relevant transfer on behalf of the customer. According to him, even if the court were to adopt this approach, BosGen would satisfy it, when the transaction was viewed as a whole, rather than piecemeal, as urged by the liquidating trustee. In addition, Judge Daniels rejected the liquidating trustee's contention that a financial institution must be specifically identified as such in a securities contract to serve as a customer's agent.

The district court also held that the bankruptcy court did not err in ruling that the $35 million dividend payment was safe harbored because it was a settlement payment made in connection with the tender offer.

Finally, the district court held that the bankruptcy court properly concluded, in accordance with Tribune 2, that the liquidating trustee's state law fraudulent transfer claims (both intentional and constructive) were preempted by section 546(e). 


By the Boston Generating ruling, another lower court in the Second Circuit has now ruled that the results of Merit might be avoided by structuring transactions so that the target or recapitalized entity is a "customer" of the financial intermediaries involved. Whether this approach holds up to further appellate scrutiny remains to be seen. Appeals in both Boston Generating and Nine West are pending before the Second Circuit. It may take a circuit split on the issue to induce the Supreme Court to address the question.

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