The United States Supreme Court recently issued a ruling in which it held that the Bankruptcy Code’s safe harbor provision § 546(e) does not prevent a trustee from clawing back transfers involving securities and financial institutions in circumstances when such institutions serve as mere pass-through entities for the transfer.  The decision, Merit Management Group, LP v. FTI Consulting, Inc., Case No. 16-784, affirming the Seventh Circuit Court of Appeals, marked a resolution of a circuit split on an issue that will have significant impact in the bankruptcy world.

Lighthouse next to a harbor at sunset

The case involved the sale of stockholder interests by transferor, Merit Management Group, LP, to transferee, Valley View Downs.  Two financial institutions, Credit Suisse and Citizens Bank, were party to the transaction as lender and escrow agent.

The safe harbor defense to the trustee’s avoidance powers exempts transfers that are settlement payments “made by or to (or for the benefit of) a…financial institution.”  The Supreme Court reasoned that the relevant question in determining whether the safe harbor defense applies is the “overarching transfer” the trustee seeks to avoid.  Because the trustee sought to avoid the purchase of stock by Valley View from Merit Management, Credit Suisse and Citizens Bank’s role as conduits, or “component parts” as described by the Supreme Court, were irrelevant to the § 546(e) analysis.  The parties did not contend that either Valley View or Merit Management were covered entities under § 546(e) and accordingly, the transfer was not protected by the safe harbor defense.

The decision throws out previous law made by the Second, Third, Sixth, Eighth and Tenth Circuits on the safe harbor rule and will have significant effects on pending and future bankruptcy proceedings, by enlarging trustees’ avoidance power and narrowing a frequently-used defense by transferee defendants.