Contributed by Damon P. Meyer
Section 546(e) of the Bankruptcy Code limits a trustee’s power to avoid transactions that are, among other things, “settlement payments” made by, to, or for the benefit of a “financial institution,” or “financial participant.” In addition, section 546(e) applies to “transfers” made by, to, or for the benefit of such entities in connection with a “securities contract,” a “commodity contract,” or a “forward contract.” Congress added this “settlement payment exception” to the Bankruptcy Code to address the risk to the financial markets that could result from a securities transaction being unwound when such transactions are often hedged with other transactions, or securities are repledged as collateral. Because the Bankruptcy Code’s definitions of the terms used in section 546(e) are very broad, however, courts have disagreed over the scope of the exception. Much of the debate has focused on whether section 546(e) only applies to transactions made in connection with the public securities markets or whether it applies to private transactions as well. Whether the settlement payment exception applies may mean the difference between an estate successfully recovering payments (such as dividends or stock purchases) as fraudulent transfers, or not.
In the recent decision In re MacMenamin’s Grill, Ltd., Judge Robert Drain of the United States Bankruptcy Court for the Southern District of New York refused to interpret section 546(e) to apply to a private stock transaction. Judge Drain found that, despite the provision’s “plain” language, granting section 546(e)’s safe harbor to a private stock transaction “has little if anything to do with Congress’ stated purpose in enacting section 546(e): reducing systemic risk to the financial market.” In contrast, the Third Circuit in 2009, in In re Plassein International Corp., looked only to the plain language of section 546(e), and, in a case with facts similar to MacMenamin’s, held that the settlement payment exception does shield private stock transactions from the Bankruptcy Code’s avoidance provisions.
MacMenamin’s Grill was a restaurant and cooking school located in New Rochelle, New York. As part of an LBO transaction, the three shareholders of MacMenamin’s sold their stock back to MacMenamin’s. MacMenamin’s financed the stock purchase with a bank loan, and the lender wired the amounts payable to the shareholders to each shareholder’s bank.
After MacMenamin’s filed for chapter 11 protection, its chapter 11 trustee sought to recover the payments made to the shareholders as fraudulent transfers. The parties stipulated that the debtor did not receive fair consideration or reasonably equivalent value in exchange for the payments to the shareholders and that on the date the payments were made the debtor was insolvent or became insolvent as a result of the payments. In defense, the shareholders filed a motion for summary judgment asserting that section 546(e)’s settlement payment exception shielded the transfers from attack.
The parties essentially stipulated that, according to its plain language, section 546(e) applied to the transaction. “Settlement payment” is defined in section 741(a)(8) of the Bankruptcy Code as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade….” Because of this tautological definition and broad catch-all, the trustee did not dispute that the payment to purchase the stock could be viewed as a “settlement payment.” The parties also did not dispute that the transaction involved “financial institutions” and “securities.”
Nonetheless, Judge Drain found that, because of the circular and ambiguous set of definitions, which focused on the “trade or business of securities transactions,” it was appropriate for him to reference the legislative history of section 546(e) rather than simply apply the plain text of the statute. The legislative history indicates that “Congress enacted [section] 546 ‘to minimize the displacement caused in the commodities and securities markets in the event [of] a major bankruptcy affecting those industries’ and ‘to prevent the ‘ripple effect’ created by ‘the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected industry.’’” Based on this, Judge Drain held that applying section 546(e) to a private stock transaction where the defendant had produced no evidence that “the transactions at issue involved any entity in its capacity as a participant in any securities market, or that the avoidance of the transaction at issue poses any danger to the functioning of any securities market” would impose a result contrary to Congressional intent. Therefore, Judge Drain held that section 546(e)’s safe harbor did not apply to the transaction.
Some courts have likewise interpreted section 546(e) narrowly, while other courts have used the broad reasoning employed in Plassein. MacMenamin’s, though, sets up a clear conflict between bankruptcy courts in Delaware and S.D.N.Y. on whether private stock transactions should be exempt from avoidance actions. The decision certainly sets the stage for a conflict between the Third and Second Circuits on the scope of section 546(e). Whether or not other bankruptcy judges in S.D.N.Y. follow MacMenamin’s or whether Judge Drain’s decision will be appealed (and, if so, upheld) remain to be seen. At least for the time being, though, the decision may factor into a debtor’s choice of venue (and possibly creditors’ decisions to challenge venue), particularly where (as was the case in MacMenamin’s) a key asset of the debtor’s estate is its avoidance claims against stockholders.