Yesterday, the United States Supreme Court, in Merit Management Group, LP v. FTI Consulting, Inc., Case No. 16-784, ruled that the “securities safe harbor” under section 546(e) of the Bankruptcy Code, 11 U.S.C. §§ 101-1532, does not shield transferees from liability simply because a particular transaction was routed through a financial intermediary—so-called “conduit transactions.”

  • Prior to Merit Management, a number of lower courts, including the United States Court of Appeals for the Second Circuit, had ruled that a transfer routed through a financial institution would, in effect, immunize the ultimate beneficiary of that transfer from avoidance on a constructive fraud theory. See, e.g., In re Quebecor World (USA) Inc., 719 F.3d 94, 100 (2d Cir. 2013).
  • In June 2016, the United States Court of Appeals for the Seventh Circuit rejected application of the 546(e) safe harbor in this manner in FTI Consulting Group, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016).
  • The Supreme Court subsequently granted certiorari to resolve the split.

Like the Seventh Circuit, the Supreme Court rejected a broad-based application of 546(e).

  • Instead, the Supreme Court ruled that recipients of fraudulent transfers cannot, in effect, evade liability simply because a transfer was routed through a financial (“conduit”) institution.
  • In this analysis, the Supreme Court further rejected any application of section 546(e) that might involve a ‘step-by-step’ approach to limit liability. Rather, “[i]f a trustee properly identifies an avoidable transfer, . . . the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power.” Merit Mgmt., slip op. at 14.
  • In other words, the ultimate beneficiary of an avoidable transfer will not be immune from liability under section 546(e) simply by using a financial intermediary.

The Supreme Court was careful to note, however, that the section 546(e) safe harbor should still shield financial institutions in their role as intermediaries in this process.

  • For example, “[i]f the transfer that the trustee seeks to avoid was made ‘by’ or ‘to’ a securities clearing agency . . . , then § 546(e) will bar avoidance, and it will do so without regard to whether the entity acted only as an intermediary.” Merit Mgmt., slip op. at 17.
  • As a result, Merit Management should not signal an increased risk profile for financial institutions operating as conduits for financial transactions (e.g., escrow agents, clearinghouses, etc.)—notwithstanding the narrow scope applied to section 546(e) elsewhere in that opinion.

That said, Merit Management raises the question as to how state law preemption will be applied in light of the Supreme Court’s now-narrow application of section 546(e).

  • In 2016, the Second Circuit ruled that a broad range of state-law creditor remedies, such as constructive fraudulent transfer claims, were preempted by section 546(e). See In re Tribune Co. Fraudulent Conveyance Litig., 818 F.3d 98, 118 (2d Cir. 2016).
  • This ruling has been appealed, with a request for certiorari pending before the Supreme Court.
  • More recently, lower courts within the Third Circuit have rejected the Second Circuit’s approach on section 546(e)’s preemptive effect. See, e.g., In re Physiotherapy Holdings, Inc., 2016 WL 3611831 (Bankr. D. Del. June 20, 2016).
  • It remains to be seen whether, if at all, Merit Management will affect the Supreme Court’s consideration of the preemption issue.