We have noodled on the impact that the Supreme Court’s decision in Merit Management Group, LP v. FTI Consulting, Inc.,[1] which held that the safe harbor provided in Section 546(e) of the Bankruptcy Code does not apply when the financial institutions[2] involved in a transaction are mere conduits or intermediaries, might have on “[t]he long-running litigation spawned by the leveraged buyout of Tribune Company . . . and the subsequent bankruptcy case.”[3] So far, after a December decision by the Court of Appeals for the Second Circuit, the answer is: not much.
In 2016 the Court of Appeals had dismissed a fraudulent conveyance avoidance action commenced by creditors against former Tribune shareholders (among others) by applying its pre-Merit expansive interpretation of Section 546(e) under which the presence of a financial institution (as defined in note 2) even as a mere conduit would suffice. Post-Merit, it has now issued an amended decision reaching the same result--the safe harbor of Section 546(e) shelters the defendants from liability.[4]
How did it reach that outcome despite Merit? The Section 546(e) safe harbor applies to
a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract . . ., commodity contract . . . or forward contract
and the financial institution (as defined in note 2) is not acting as a mere conduit or intermediary.[5] “[F]inancial institution,” in turn, is defined in Section 101(22)(A) in relevant part as--
an entity that is a commercial . . . bank . . . [or] trust company . . . and, when any such . . . entity is acting as agent or custodian for a customer . . . in connection with a securities contract . . . such customer . . . .[6]
In other words, the customer for which a bank or trust company is acting as agent or custodian in connection with a securities contract is a “financial institution” (as defined in Section 101) for the purpose of satisfying the requirement for the application of Section 546(e) that a financial institution (as defined in note 2) be a party to or beneficiary of the “overarching transfer.”[7]
Tribune, the Court held, was exactly such a customer. It contracted with an entity that was both a bank and a trust company to act as its agent[8] to hold and then disburse the LBO consideration in exchange for the shares it was acquiring.[9] But was such use of an agent “in connection with a securities contract”? Appellants argued that the approximately half of the LBO consideration that was used to redeem shares (rather than to purchase them in a more conventional sense) was not disbursed “in connection with a securities contract.” The Court disagreed. A redemption of shares is a repurchase of those shares, so a contract to redeem shares easily fits within the Code’s broad definition of a “securities contract,” and the redemption payments are sheltered in the safe harbor to the same extent as the ordinary purchase payments.[10]
[1] 583 U.S. __, 138 S. Ct. 883 (2018).
[2] “Financial institution” is used here and sometimes elsewhere in this post as my shorthand for § 546(e)’s “commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency.”
[4] In re Tribune Co. Fraudulent Conveyance Litigation, 946 F.3d 66 (2d Cir. Dec. 19, 2019). The Court also held that defendants in an avoidance adversary proceeding in which the plaintiff is not a trustee or trustee surrogate may benefit from the safe harbor; that issue is not further discussed in this post.
[5] Many of the terms used in § 546(e) are defined elsewhere in the Code.
[6] Section 101(22)(A) incorporates the definition of “securities contract” from § 741 but expressly rejects the application of the definition of “customer” also found in § 741, thereby requiring use of the “ordinary meaning” of that word. 946 F.3d at 78.
[7] Merit Management, 138 S. Ct. at 888, 892-93, 897.
[8] “Agent” is not defined in the Code, so the Court applied the “common-law meaning” of that term. 946 F.3d at 79.
