The recent Supreme Court decision in Merit Management Group LP v. FTI Consulting, Inc.[1] eliminated any circuit split or confusion over the language of the section 546(e) safe harbor. The Court stated that the “only relevant transfer for purposes of the safe harbor is the transfer that the trustee seeks to avoid.”[2] Section 546(e) is used to defend against avoidance of transfers made as a margin or settlement payment or other transfers made in connection with a securities contract and by or to certain protected enumerated parties, including stockbrokers, financial institutions, financial participants, or securities clearing agency, as defined by the Bankruptcy Code.

The Supreme Court held that the proper inquiry is not necessarily whether the transfer was made by, to, or for the benefit of a protected party but rather what is the relevant transfer sought to be avoided. In other words, just because a protected entity is involved in the transfer as an escrow agent or holding company does not mean that the transfer, when viewed as a whole, ultimately involves a protected entity. The component parts of the transfer that may involve a protected entity should not and will not prevent a trustee from avoiding it.

How far will a party’s avoiding powers extend, then? In a chapter 15 case currently pending in the Southern District of New York, section 546(e) is again at issue, specifically regarding its extraterritorial effect. Fairfield Sentry Limited’s bankruptcy case[3] involves millions of dollars invested in funds located in the British Virgin Islands that were then ultimately invested with Bernie Madoff’s Ponzi schemes.  After the petition date, foreign liquidators filed 305 adversary proceedings[4] seeking to recover redemption payments made in 2004 ahead of the fraud that occurred. The parties seeking redemption, however, are foreign representatives in a chapter 15 case seeking to avoid foreign transfers under foreign insolvency laws.

The Fairfield court was faced with the question of whether the avoidance powers and exceptions contained in section 546(e) apply to extraterritorial chapter 15 cases. Judge Bernstein held that it does—by and through section 561(d). In a recent opinion, Judge Bernstein determined that section 561(d) applies in a case under chapter 15 to the same extent as under chapter 7 or 11 such that enforcement is not limited based on the presence or absence of assets of the debtor in the United States.[5] Accordingly, the court reasoned that the plain text of section 561(d) “makes the safe harbor applicable to proceedings brought by foreign representatives in a chapter 15 case seeking to avoid purely foreign transfers under foreign insolvency laws.”[6]

In other words, safe harbor protection is not restricted to creditors within the United States or even U.S. markets. This decision opens up the possibility of an effective affirmative defense rooted in U.S. law to be used in a lawsuit between foreign parties and based on foreign law concerning facts that occurred outside of the United States. Irrespective of location, a court must ultimately determine whether the true transfer participants are members of the enumerated entities afforded safe harbor protection in light of the Merit decision.

We may find section 546(e) to be before the Supreme Court again shortly.