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By Daniel Gill
The ability of some leveraged buyouts to withstand attacks by bankruptcy trustees took center stage during oral arguments at the U.S. Supreme Court Nov. 6.Specifically, the court examined whether the “safe harbor” defense to fraudulent transfer actions created by Section 546(e) of the Bankruptcy Code applies when a financial institution was merely a conduit to the transaction ( Merit Mgmt. Grp., LP v FTI Consulting, Inc. , U.S., 16-784, oral argument 11/6/17 ). This section provides that a trustee can’t pursue certain lawsuits to undo a transfer that was made “by or to (or for the benefit of)" certain financial institutions.
The Seventh Circuit below ruled that the safe harbor defense doesn’t apply if the financial institutions protected by the statute acted only as a pass-through or conduit of the transaction. The petitioner, Merit Management Group LP, argued that the plain language of the statute means that so long as the transaction passed through one or more financial institutions, the safe harbor defense comes into play.
The questions asked by the Court suggest that it may be open to affirming the Seventh Circuit’s decision.
The justices appeared concerned about the expansive effect that Merit wants to apply to the safe harbor rule. “I’m concerned about the scope of the rationale that we would adopt,” Chief Justice John G. Roberts Jr. said.
The justices focused on what transfer was sought to be avoided, and against whom.
“So why should it matter whether the transfer was through the banks rather than handed over by Valley View to Merit?” Justice Ruth Bader Ginsburg asked, referring to the two end participants of the transaction.
Justice Samuel A. Alito Jr. followed with a similar query: “Why shouldn’t the exemption provision be applied to the transfer that the trustee is seeking to avoid,” instead of to the banks through which the transfer passed?
Roberts pointed out that Merit’s theory would have the exemption “cover the simple use of a check to convey a straight-forward purchase and sale if the purchaser pays with a check.”
There was less discussion of the plain language of the statute than some scholars had predicted.
Perhaps Justice Anthony M. Kennedy tipped which way he was leaning when he asked respondent’s counsel a question about how the court should write an opinion on the matter: “Well, if we’re writing the opinion to accept your proposition, how do we qualify it?” he asked.
At one point in the proceedings, Justice Elena Kagan asked Paul D. Clement, representing respondent FTI Consulting Inc., why the Solicitor General didn’t submit a brief on behalf of the United States. He replied if the United States were concerned that the Seventh Circuit’s interpretation of the safe harbor put the markets at any kind of risk—as insinuated by Merit—the Solicitor General would have been before the court “waving at least a yellow flag.”
He also said that who didn’t file an amicus brief was telling in itself.
For example, he said, no financial institutions submitted a brief in the case. “And the fact that they’re not here, I think, underscores that the entities that Congress was trying to protect are fully protected by our view, and they’re fully protected by the Petitioner’s view.”
They didn’t have an interest at stake in the case, he suggested.
FTI was the trustee of a litigating trust created by the Chapter 11 bankruptcy plan of Valley View Downs LP. Before filing bankruptcy, Valley View bought the shares of a competitor, including those held by Merit Managment Group.
The litigation trust sued Merit to claw back the purchase price of Merit’s shares of the competitor bought by Valley View. That suit alleged that Valley View paid Merit more than the shares were worth, asserting a constructive fraud claim.
The Seventh Circuit split from five other circuits, including the Second and Third, when it ruled that the safe harbor doesn’t apply when the financial institutions are mere pass-throughs of the transfer.
“The case is very important for bankruptcy practitioners, as it raises the larger question of whether securities buyouts can ever be avoided,” Charles J. Tabb, of counsel, Foley & Lardner LLP and Mildred Van Voorhis Jones Chair in Law at the University of Illinois, Champaign, Ill., told Bloomberg Law.
The National Association of Bankruptcy Trustees emphasized the significance of the ruling for creditors in an amicus brief.
“A trustee’s ability to recover a constructively fraudulent transfer is often the creditors’ only hope for a meaningful recovery, and the Court’s decision will have a dramatic effect on the ability of amicus’ members to achieve that central objective of the Bankruptcy Code,” the association wrote in its brief.
The issue is prominent in leveraged buyout cases, where the purchase of a company is basically financed by the assets of the purchased company.
Reversal by the justices “would prevent a trustee from attempting to unwind a failed leveraged buyout, even when it is a purely private transaction, as most are,” the trustees association said.
“An affirmance of the Seventh Circuit by the Supreme Court certainly will cause a stir with the New York and Delaware bankruptcy bars,” where most large commercial cases are heard, Prashant M. Rai told Bloomberg Law. Rai is a restructuring attorney at Weil, Gotshal & Manges LLP, New York. He’s written a Bloomberg Law Insights article on the issue.
Brian C. Walsh, of Bryan Cave LLP, St. Louis, argued for Merit Management. FTI Consulting was represented at argument by Paul D. Clement, of Kirkland & Ellis LLP, Washington.
To contact the reporter on this story: Daniel Gill in Washington at email@example.com
To contact the editor responsible for this story: Jay Horowitz at JHorowitz@bna.com
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