A recent decision from the United States District Court for the Southern District of New York, In re Tribune Co. Fraudulent Conveyance Litigation, Case No. 12-2652, 2019 WL 1771786 (S.D.N.Y. April 23, 2019) (Cote, J.), has re-examined application of the “securities safe harbor” under section 546(e) of the Bankruptcy Code, 11 U.S.C. §§ 101–1532, to the transferees of “financial institutions” in so-called “conduit transactions,” following the United States Supreme Court’s 2018 decision in Merit Management Group, LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018).
- In Merit Management, as detailed here, the Supreme Court held the “securities safe harbor” under section 546(e) of the Bankruptcy Code does not automatically benefit transferees simply because a transfer was routed through a “conduit” that would otherwise benefit from the securities safe harbor.
- However, the Supreme Court in Merit Management explicitly left open the question as to whether a debtor’s or transferee’s status as a “financial institution” under section 101(22)(A) of the Bankruptcy Code would change the analysis. Merit Mgmt., 138 S. Ct. at 890 n.2. (“The parties here do not contend that either the debtor or petitioner in this case qualified as a ‘financial institution’ by virtue of its status as a ‘customer’ under § 101(22)(A).”).
- On April 23, 2019, the district court in Tribune addressed the question left open by Merit Management, concluding that a debtor-transferor’s status as a “financial institution,” or the customer of a “financial institution,” did trigger application of the securities safe harbor for subsequent transferees with respect to constructive fraud claims in LBO-related litigation.
- In the district court’s words:
- “This result is consistent with Section 546(e)’s goal of promoting stability and finality in securities markets and protecting investors from claims precisely like these.” In re Tribune Co. Fraudulent Conveyance Litig., 2019 WL 1771786 at *12.
- Under Tribune, analysis of whether a transferee is afforded the protections of section 546(e) should then focus on whether the debtor is a “financial institution” or the customer of a “financial institution” with respect to a challenged transfer.1
Case Background
- The dispute in Tribune arose out of a two-step leveraged buyout of the Tribune Company and certain affiliates (collectively, “Tribune”) occurring in 2007. Significantly, Tribune utilized the services of Computershare Trust Company, N.A. (“CTC”) as its “Exchange Agent” in that transaction. In that capacity, CTC, on Tribune’s behalf, accepted and held tendered shares and paid the tendering shareholders with the applicable cash purchase price for the LBO.
- Following Tribune’s 2008 bankruptcy, a series of actions were filed seeking to claw back various shareholder distributions under various fraudulent transfer theories.
- Previously, a wide swathe of constructive fraud claims had been dismissed based on application of the securities safe harbor pre-Merit Management. See generally In re Tribune Co. Fraudulent Conveyance Litig., 818 F. 3d 98 (2d Cir. 2016).
- Following Merit Management, the plaintiff, a litigation trust, sought to amend its still-pending complaint to add back certain federal constructive fraud claims in light of, in its view, the limitations on the securities safe harbor imposed by Merit Management. In re Tribune Co. Fraudulent Conveyance Litig., 2019 WL 1771786 at *5; see also Fed. R. Civ. P. 15.
- Certain defendants, in turn, opposed the motion to amend on the basis of “futility” — namely, that the securities safe harbor still extended to transfers between “financial institutions” and their transferees post-Merit Management.
- The district court’s Tribune opinion was issued in the context of that motion to amend.
The District Court’s Ruling
- In ruling, the district court determined that the allegedly fraudulent transfers in question (i.e., payments of cash by a paying agent to shareholders in connection with an LBO) were made by a “financial institution” in relation to a securities contract and, therefore, fully sheltered by section 546(e)’s safe harbor. Id. at *12.
- In determining that such payments were made by a “financial institution” the district court focused on the role of CTC, as exchange agent, in particular.
- In this regard, the district court undertook a two-step analysis in relevant part:
- First, the district court determined that Tribune was a “customer” of its exchange agent, CTC. Further, it was undisputed that CTC was both a “bank” and a “trust company,” and, therefore, a “financial institution” per section 101(22)(A). Id. at *10–*11.
- Second, the district court determined that Tribune, by utilizing CTC as its exchange agent in the LBO, was a “financial institution” given that CTC was “acting as [Tribune’s] agent” per section 101(22)(A). Id. at *11 (“CTC was entrusted with billions of dollars of Tribune cash and was tasked with making payments on Tribune’s behalf to Shareholders upon the tender of their stock certificates to CTC.”).
- As a result, payments made by CTC, as Tribune’s agent, in exchange for Tribune stock were made “in connection with a securities contract” by a “financial institution” (i.e., CTC) within section 546(e)’s protections:
- “The text of Section 101(22)(A) compels the conclusion that Tribune itself was a ‘financial institution.’ The Trustee’s [federal constructive fraudulent transfer] claims are therefore barred by the safe harbor provided in Section 546(e). This result is consistent with Section 546(e)’s goal of promoting stability and finality in securities markets and protecting investors from claims precisely like these.” Id. at *12.
Implications
- Post-Merit Management, a substantial body of commentary had suggested that the section 546(e) safe harbor would be unavailable, full stop, to the beneficiaries (as opposed to “conduits”) of various securities transactions.
- Of course, this commentary overlooked a point clearly left open by Merit Management — i.e., whether a debtor’s status as a “financial institution” would impact a safe harbor analysis.
- Tribune clearly answers that question in the affirmative.
- Under Tribune,the existence of a principal/agent relationship between a debtor and an exchange agent or paying agent may, under appropriate facts, continue to shelter transfers or distributions within the ambit of section 546(e).
- Of course, much may depend on the particular facts of a given case and the structure of a particular transaction.
- We encourage you to contact your Weil team for further discussion.
Footnotes:
- Section 101(22)(A) of the Bankruptcy Code defines a “Financial Institution” as “a Federal reserve bank, or an entity that is a commercial or savings bank, industrial savings bank, savings and loan association, trust company, federally-insured credit union, or receiver, liquidating agent, or conservator for such entity and, when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer (whether or not a ‘customer’, as defined in section 741) in connection with a securities contract (as defined in section 741) such customer[.]”