Supreme Court to Look at Bankruptcy Safe Harbor Protections

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By Diane Davis

The U.S. Supreme Court agreed May 1 to examine whether bankruptcy safe harbor protections include transfers made via a financial institution when it acts solely as a conduit ( Merit Mgmt. Grp., LP, v. FTI Consulting, Inc., U.S., No. 16-784, review granted 5/1/17 ).

The question “is of great practical importance, since many potentially voidable transfers are made for the economic benefit of a party through a financial institution,” 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 BNA May 1.

Federal appeals courts have been sharply divided. The Seventh Circuit, the lower court in this case, has sided with the Eleventh and rejected the approach of the Second, Third, Sixth, Eighth and Tenth Circuits. Those courts apply the safe harbor when a financial institution is nothing more than a pass-through.

Here, the payment was made by one financial institution to another, but the benefit and detriment of the transfer affected companies that weren’t financial institutions, according to petitioner Merit Management Group, LP.

Disregards Plain Language

The Seventh Circuit’s decision is wrong, Merit Management argued in its petition.

The Seventh Circuit’s decision “disregards the plain language of the safe harbor; it mistakes breadth for ambiguity; and it substitutes the court’s understanding of Congress’ principal goals for the language that Congress chose to implement its goals,” Merit Management said.

Bankruptcy Code Section 546(e) prohibits a trustee from avoiding a transfer that, among other things, is made “by or to (or for the benefit of)” a financial institution. The statute protects several types of entities, including financial institutions, arising from transactions such a settlement payments and securities contracts.

The original version of the safe harbor was added to the Bankruptcy Code in 1982 and was limited to margin payments and settlement payments among commodity brokers, forward contract merchants, stockbrokers, and securities clearing agencies. In 2006, the safe harbor was broadened to include securities contracts, commodity contracts, and forward contracts.

Substance Over Form

“The Seventh Circuit concluded that the language of Section 546(e) was ambiguous and that the congressional purpose in enacting the safe harbor of 546(e) was concerned with the economic substance of the transaction, not with the form,” Tabb said.

“The question is how to apply the ‘made by or to’ language when in form a payment is made to a qualifying institution, but that institution is acting as a mere conduit,” Tabb said.

“Under the majority view in the circuits, ‘made to’ is satisfied even in the mere conduit situation,” he said.

“But the Seventh Circuit found that reading to exalt form over substance, and that it did not further the congressional purpose,” Tabb said.

Possible Reversal?

“If the court reverses the Seventh Circuit, the breadth of the 546(e) safe harbor would be disturbingly staggering, and would apply far beyond the apparent congressional purpose,” Tabb said.

“Given the current configuration of the court, one would predict a likelihood that the court will reverse and stand on the ‘plain meaning’ of the statutory language,” Tabb said.

With the “current configuration of the Congress and the views of our president, a reversal by legislation would appear extremely unlikely,” Tabb added.

Follow Plain Meaning

Bankruptcy Prof. Bruce A. Markell, Northwestern Pritzker School of Law, Chicago, predicts that the court will “reverse the Seventh Circuit’s decision based on the statute’s plain meaning.”

“Congress has the ability to rewrite the statute,” Markell said.

From his own perspective, however, the case should be “affirmed,” Markell told Bloomberg BNA May 1.

“The statute was designed to protect public securities clearing the market and they clearly aren’t threatened by private treatment when the securities aren’t in the market,” Markell said.

“This could be another case where the outcome depends on whether a majority of the court is swayed by the plain language of the exception, regardless of the result, or whether the justices conclude that these types of privately-held stock sales, which use banks as payment conduits, do not fall within the ambit of the transactions Congress sought to protect,’’ Andrew Muller, a bankruptcy partner at law firm Stinson Leonard Street LLP, said in a May 1 interview with Bloomberg News.

Related Case

Courts are also split on whether Section 546(e) is available to a state law constructive fraudulent transfer defendant post-bankruptcy,” Markell said.

Markell noted that in In re Tribune Co. Fraudulent Conveyance Litig., the Second Circuit recently held that Section 546(e) should continue to provide post-bankruptcy protection.

That case, Deutsche Bank Trust Co. Americas v. Robert R. McCormick Foundation, is currently pending before the Supreme Court to see if it will grant certiorari. The issue is whether Section 546(e) preempted state-law fraudulent transfer claims brought by the creditors of a bankrupt company.

The court will probably agree to hear this case as well, Markell said. If it is granted certiorari, it is possible the court could hear the cases together, although Markell thinks that is unlikely.

Waiting on a Tie-Breaker

The court was “most likely” waiting on Justice Neil M. Gorsuch to get enough votes to agree to hear the matter, Tabb and Markell said.

G. Ray Warner, professor of bankruptcy law at St. John’s University School of Law, Jamaica, N.Y., disagreed.

Warner told Bloomberg BNA May 1 that “this cert. grant coming at this time reflects the recently developed important circuit split that is now a robust one.”

“I doubt it has anything to do with the Gorsuch appointment or a four to four split among the more senior Justices,” Warner said.

The case will be heard in the court’s next term, which will most likely be in the fall.

Brian C. Walsh, Bryan Cave LLP, St. Louis, Mo., and Jason J. DeJonker, Bryan Cave LLP, Chicago, Ill., represent Merit Management Group; Barbara Whiten Balliette, Reid Collins & Tsai LLP, Austin, Texas, represents FTI Consulting Inc.

Dawn McCarty also contributed to this story.

To contact the reporter on this story: Diane Davis in Washington at

To contact the editor responsible for this story: Jay Horowitz at

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