In a 2018 decision, the Supreme Court of the United States settled a difference of opinion among federal circuit courts of appeal about interpretation of § 546(e) in the U.S. Bankruptcy Code. That section includes a safe harbor provision relating to trustee clawback of transfers involving securities and financial institutions. The ruling had significant implications for debtors involved in bankruptcy proceedings, as well as more generally for structuring business transactions.
The federal Bankruptcy Code authorizes a bankruptcy trustee to avoid certain preferential or fraudulent transfers of a debtor and thereby take property back into the bankruptcy estate. Trustee avoidance powers are referred to as the clawback provisions in the Code. Exercise of the power results in avoidable preference litigation in the bankruptcy case when disputes about the clawback occur.
Section 546 of the Bankruptcy Code contains specific limitations on a bankruptcy trustee’s clawback authority. Specifically, § 546(e) includes a safe harbor provision for certain transfers of securities involving financial institutions. The language of the section is complex. Prior to the Supreme Court decision, federal circuit courts of appeal across the country rendered inconsistent decisions on the interpretation of the safe harbor provision as it relates to financial institutions.
The Eighth Circuit Court of Appeals, which includes Minnesota, was among a group of circuits that interpreted the safe harbor protection as extending to a transfer in which a financial institution acts as an intermediary or conduit for transferring funds from the debtor to the ultimate recipient. Another group of circuits ruled that a financial institution acting solely as a conduit for a transfer did not qualify for the exception. The latter group of circuits favored an interpretation that required the financial institution to be either the transferor or transferee in the overall transfer for the safe harbor to apply.
In the case of Merit Management Group, LP v. FTI Consulting, Inc., 583 U. S. ___ , 138 S.Ct. 883 (2018), the United States Supreme Court resolved the split among the circuit courts of appeals concerning the interpretation of § 546(e). The Court’s decision was unanimous.
The Merit Management case arose during the bankruptcy proceedings of Valley View Downs, LP, a racetrack company, and Centaur, LLC, the parent company of Valley View. During the bankruptcy proceedings, a dispute occurred concerning clawback of a $16.5 million securities transfer by Valley View to Merit that took place prior to the bankruptcy.
FTI Consulting, as the trustee of the Centaur litigation trust, sought to avoid the transfer to Merit on the basis of constructive fraud and clawback the funds into the bankruptcy estate. Merit countered, arguing that the transfer was qualified as an exception to the clawback rules under Bankruptcy Code § 546(e), because of the involvement of Credit Suisse and Citizens Bank in the transfer process.
In the bankruptcy litigation, the Bankruptcy Court and District Court agreed with Merit that the transfer qualified under the safe harbor provision. The Seventh Circuit reversed, holding that the safe harbor provision does not protect a transfer in which financial institutions served solely as an intermediary in a transaction. Merit appealed to the Supreme Court.
The Supreme Court reviewed the language and Congressional history of the Bankruptcy Code section and concluded that the § 546(e) safe harbor provision applies to the overarching transaction, not the component parts of the transfer. As a result, since the financial institutions in the Merit transfer served only as conduits in the transfer, the exception did not apply.
The Merit Management decision of the Supreme Court limits application of the financial institution safe harbor provision in § 546(e), which is also referred to as the securities safe harbor provision, to transfers in which a financial institution is part of the overarching transaction. Merely routing a transfer through a financial institution will not protect a bankrupt debtor from clawback liability. The Court’s decision effectively narrowed the application of the safe harbor provision.
The case illustrates the complexity of bankruptcy laws and the types of statutory issues that arise during a bankruptcy case. In any situation where bankruptcy litigation arises, it is essential for each party to be represented by an attorney experienced specifically in adversary proceedings that occur during a bankruptcy case. While some bankruptcy lawyers who assist clients with bankruptcy petitions do handle adversary proceedings, many do not.
Bankruptcy litigation requires a specialized set of skills and knowledge. An in-depth understanding of the process of adversary proceedings during a bankruptcy case is critical, since adversary proceedings must meet very specific requirements under the U.S. Bankruptcy Code, Federal Rules of Bankruptcy Procedure, and local rules.
At the Dave Burns Law Office, I represent creditors and debtors in all types of adversary proceedings in the United States Bankruptcy Courts in Minneapolis and St. Paul. Bankruptcy litigation is a primary focus of my practice.
If you face or are considering filing any type of adversary proceeding or litigation in a bankruptcy case, I welcome you to contact me at (612) 677-8351 or by sending an email to me at firstname.lastname@example.org. I am available to meet with clients in both Minneapolis and St. Paul and welcome inquiries from clients and referring attorneys throughout the State of Minnesota.
The Dave Burns Law Office hopes you find this article helpful. But please do not rely on it as legal advice. The law changes regularly and the outcome of any legal matter depends on its unique circumstances. View full disclaimer