May 9, 2019

Fraudulent Transfers: SDNY Revives 546(e) Bankruptcy Safe Harbor

Last year, the SCOTUS created significant uncertainty concerning the application of a commonly used mechanism to protect former shareholders in an LBO from fraudulent conveyance claims.  In Merit Management Group, LP v. FTI Consulting, Inc., the Court held that Section 546(e) of the Bankruptcy Code’s safe harbor for transactions made through a financial institution did not apply to transactions in which financial institutions were mere “conduits.”

Prior to the Court’s decision, the safe harbor was widely viewed as protecting public shareholders because the payments that they received in a deal were ordinarily disbursed through a financial institution “paying agent,” and several federal circuits had interpreted this payment procedure as sufficient to invoke the protection of Section 546(e).

The Merit Management decision raised concerns about the continuing viability of this safe harbor, but a recent decision from the SDNY appears to have breathed new life into it.  As this Ropes & Gray memo explains, it did so not by focusing on the level of a financial institution’s involvement in the transaction, but by focusing on what parties might properly be characterized as “financial institutions.” Here’s an excerpt:

In In re Tribune Company Fraudulent Conveyance Litigation, No. 11md2296 (S.D.N.Y. Apr. 23, 2019), U.S. District Court Judge Cote ruled that payments in a leveraged buyout to thousands of shareholders are protected because having a traditional financial institution (e.g., a commercial bank or trust company) as an intermediary in the transaction can qualify the company making the payments (in this case, Tribune) as itself a “financial institution” within the meaning of Bankruptcy Code section 546(e).

Specifically, Judge Cote held that the safe harbor’s statutory definition of “financial institution” included Tribune, as the transferor, because Tribune was a “customer” of Computershare Trust Company (the depositary for the LBO), and CTC acted as Tribune’s agent in the transaction. Judge Cote held that the payments were made “by . . . a financial institution” and were “in connection with a securities contract” (a term that courts define very broadly), thus qualifying for the safe harbor, notwithstanding Merit Management.

The memo also says that the Tribune Company decision  “provides a road map” to secure the safe harbor defenses for payments made in LBOs, leveraged recaps & similar transactions. But it also cautions that Judge Cote’s opinion – though persuasive in its reasoning – is likely to be far from the last word on the issue. 

John Jenkins