Restructuring

Contributed by Lee Jason Goldberg
Section 546(e) Safe Harbor Jurisprudence in the Second Circuit
Section 547(b) of the Bankruptcy Code enables a debtor in possession to avoid a transfer made on or within 90 days of a debtor’s bankruptcy filing if the transfer meets certain enumerated statutory conditions.  Even if those conditions are met, however, section 546(e) of the Bankruptcy Code provides a “safe harbor” that exempts the transfer from avoidance if, among other things, the transfer is a “settlement payment” or a “transfer . . . in connection with a securities contract,” in each case “made by or to (or for the benefit of) a . . . financial institution.”
According to the Second Circuit, a “settlement payment” is a “transfer of cash made to complete a securities transaction,” and, according to section 741(7) of the Bankruptcy Code a “securities contract” is a “contract for the purchase, sale, or loan of a security . . . including any repurchase or reverse repurchase transaction on any such security.”
In Official Comm. of Unsecured Creditors of Quebecor World (USA) Inc. v. Am. United Life Ins. Co., et al. (In re Quebecor World (USA) Inc.), the Second Circuit noted the existence of a split of authority regarding what role a financial institution must play in a transaction for it to qualify for the section 546(e) safe harbor.  Holding that “transfer[s] made  . . . in connection with a securities contract” may qualify for the safe harbor even if the financial institution at issue is merely a conduit, the Second Circuit reiterated its agreement with the Third Circuit, Sixth Circuit, and Eighth Circuit, as it set forth in Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V. (In re Enron Creditors Recovery Corp.), that “the absence of a financial intermediary that takes title to the transacted securities during the course of the transaction is [not] a proper basis on which to deny safe-harbor protection.”  This contrasts with the holding of Eleventh Circuit that a financial institution must acquire a beneficial interest in the transferred funds or securities for safe harbor to apply.
This entry, on the Second Circuit’s decision in Quebecor, continues our examination of the development of section 546(e) safe harbor jurisprudence in Second Circuit courts, where Enron represents a turning point:

•  In our first entry on the section 546(e) safe harbor, we reported on Geltzer v. Mooney (In re MacMenamin’s Grill, Inc.), where the Southern District of New York bankruptcy court refused to interpret section 546(e) to apply to a private stock transaction.
• A few months later, we discussed the Enron decision, which provided Second Circuit courts with fresh guidance for analyzing the section 546(e) safe harbor.
• Post-Enron, we looked at Picard v. Katz, where the Southern District of New York district court held that section 546(e) protected payments received by a customer from a stockbroker, except in cases of actual fraud.
• Post-Enron, we also looked at AP Services LLP v. Silva, where the Southern District of New York district court held that the section 546(e) safe harbor for settlement payments may apply regardless of whether the unwinding of the transaction in question would have an adverse effect on financial markets.  An appeal of the district court’s decision is pending before the Second Circuit.
• Finally, we have covered the Quebecor case, from the Southern District of New York bankruptcy court (during which proceedings Enron was decided), through the Southern District of New York district court, and, now, on to the Second Circuit.

The Dispute in Quebecor
Quebecor involved a multi-party transaction among the Canadian printing company Quebecor World, Inc. (“Quebecor World”), its subsidiaries Quebecor World (USA) Inc. (“Quebecor USA”) and Quebecor World Capital Corp. (“Quebecor Capital”), and holders of private placement notes with a face value of $371 million issued by Quebecor Capital.
As Quebecor World’s financial difficulties gave rise to concerns about a potential debt-to-capitalization ratio default under the private placement notes and a consequent cross-default under Quebecor World’s separate $1 billion credit facility, Quebecor World sought to redeem the notes from the noteholders.  To avoid adverse Canadian tax consequences, however, Quebecor World structured the transaction so that Quebecor USA would purchase the notes from the noteholders for cash and then Quebecor Capital would redeem the notes from Quebecor USA in exchange for forgiveness of debt that Quebecor USA owed to Quebecor Capital.
Fewer than 90 days before Quebecor USA filed for chapter 11 protection, it transferred approximately $376 million to the noteholders’ trustee, CIBC Mellon Trust Co.  CIBC Mellon distributed the funds to the noteholders, and the noteholders eventually surrendered the notes directly to Quebecor World.  Debtor Quebecor USA’s creditors’ committee sought to avoid and recover the transfer pursuant to section 547 of the Bankruptcy Code.  The noteholders moved for summary judgment, arguing that the transfer was exempt from avoidance under section 546(e).
The Lower Courts’ Decisions
Before the bankruptcy court decided the summary judgment motion, the Second Circuit decided Enron, where it held that payments made to redeem commercial paper before its maturity date were “settlement payments,” within the meaning of section 546(e), because they were “transfer[s] of cash made to complete a securities transaction.”
The bankruptcy court conducted additional briefing and granted the noteholders’ summary judgment motion, holding primarily that Quebecor USA’s payment fit the Enron court’s definition of “settlement payment.”  The bankruptcy court held that the payment also qualified as a “transfer made  . . . in connection with a securities contract” because Enron had made clear that the section 546(e) safe harbor applied to redemptions of commercial paper.
The district court affirmed the bankruptcy court’s decision, agreeing that Quebecor USA’s payment was a “settlement payment” under Enron.  The district court did not agree that a transfer to “redeem” securities could qualify as a “transfer made . . . in connection with a securities contract” because section 741(7)(A)(i) of the Bankruptcy Code defines a “securities contract” as one “for the purchase, sale, or loan of a security.”  The district court nonetheless affirmed the bankruptcy court’s alternative holding on the basis that the transaction was a “purchase” and not a “redemption.”
The Second Circuit’s Analysis
The Second Circuit decided that it did not need to reach the “settlement payment” prong of the section 546(e) safe harbor because the payment by Quebecor USA fit squarely within the plain wording of the “securities contract” prong of the safe harbor, as it was a “transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract.”  The payment was made to CIBC Mellon, a financial institution, in the amount and manner prescribed by note purchase agreements, which provided for both the original purchase and “repurchase” of the notes.  Thus, the transfer was exempt from avoidance under the “securities contract” prong of the safe harbor. (This prong of the safe harbor—which was added to the statute after Enron filed for bankruptcy and the applicable adversary proceeding was commenced—was not at issue in Enron.)
The court also declined to decide whether the transfer would still be exempt if Quebecor USA had “redeemed” its own securities because the Second Circuit agreed with the district court that Quebecor USA made the transfer to “purchase” the notes, which had been issued by another corporation, Quebecor Capital.  While the note purchase agreements gave only Quebecor Capital the right to “pre-pay” or redeem the notes, the agreements gave Quebecor Capital’s affiliates only the right to “purchase” the notes if the affiliates complied with the note purchase agreements’ pre-payment provisions.
The Second Circuit rejected the creditors’ committee’s arguments that the transfer was a redemption and not a purchase.  First, the court found that certain noteholders’ subjective understanding at the time of the transaction of its being a redemption was not dispositive because, from the noteholders’ perspective, the note purchase agreements treated redemptions and purchases the same way, and the noteholders received the same “pre-payment” price.  Second, the court found that a cooperation agreement entered into among the noteholders both explicitly allowed for sale of the notes to certain Quebecor entities and failed to prohibit the noteholders as a group from selling (or Quebecor USA from purchasing) all of the notes in a single transaction.  Moreover, none of the Quebecor entities was a party to the cooperation agreement, so any breach of that agreement would only create liability among the noteholders and not affect the validity of the transaction.
Most importantly, the court rejected the creditors’ committee’s argument that even if Quebecor USA “purchased” the notes, not all of the transfers were exempt because CIBC Mellon was merely a conduit and some of the noteholders were not financial institutions.  The court noted that Enron rejected a similar argument, holding that the financial intermediary need not have a beneficial interest in the transfer.  The Second Circuit concluded that “to the extent Enron left any ambiguity in this regard, we expressly follow the Third, Sixth, and Eighth Circuits in holding that a transfer may qualify for the section 546(e) safe harbor even if the financial intermediary is merely a conduit.”
The Second Circuit’s “Conduit” Rationale
To reach its conclusion, the court looked to the plain language of section 546(e), which refers to transfers made “by or to (or for the benefit of)” a financial institution, and found that a transfer may be either “for the benefit of” a financial institution or “to” a financial institution, but need not be both.  (The court speculated that the phrase “(or for the benefit of),” which was added to section 546(e) after the circuit split arose, may have been intended to resolve the split, but the court refused to rely on the legislative history, as it found the words of the statute unambiguous.)
Quoting the Enron court’s analysis of the “settlement payment” prong of the section 546(e) safe harbor, the Second Circuit also noted that its construction furthered the purpose behind the exemption.  The Enron court explained that Congress enacted section 546(e) to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.  If a firm were required to repay amounts received in settled securities transactions, it could have insufficient capital or liquidity to meet its current securities trading obligations, placing other market participants and the securities markets themselves at risk.  Thus, the Quebecor court found, a transaction involving one of these financial intermediaries, even as a conduit, necessarily touches upon these at-risk markets.
The Second Circuit also observed that the enumerated intermediaries are typically facilitators of, rather than participants with a beneficial interest in, the underlying transfers:  “A clear safe harbor for transactions made through these financial intermediaries promotes stability in their respective markets and ensures that otherwise avoidable transfers are made out in the open, reducing the risk that they were made to defraud creditors.”  In a footnote, the court cautioned that the “securities contract” safe harbor is not without limitation and, for example, mere structuring of a transfer as a “securities transaction” may not be sufficient to preclude avoidance, such as in the case of actual fraudulent transfers under section 548(a)(1)(A).
What Are the Potential Limitations on the Section 546(e) Safe Harbor in the Second Circuit?