Section 546(e) of the Bankruptcy Code shields certain transfers involving settlement payments and other payments in connection with securities contracts (for example, payment for stock) made to certain financial intermediaries, such as banks, from avoidance as a fraudulent conveyance or preferential transfer.  In recent years, several circuit courts interpreted 546(e) as applying to a transfer that flows through a financial intermediary, even if the ultimate recipient of the transfer would not qualify for the protection of 546(e). This interpretation was used to shield from avoidance payments for shares sold in an LBO made to shareholders who were not financial intermediaries.   

On February 27, 2018, the Supreme Court of the United States issued a unanimous decision holding that, for purposes of determining whether the safe harbor in 546(e) applies to shield a transfer from an avoidance action, the only relevant transfer is the transfer to the end recipient, and not whether the transfer was executed through one or more financial intermediaries. As a result, because the fraudulent transfer the trustee sought to avoid in Merit Management did not begin or end with a financial institution who is a protected party under the section 546(e) safe harbor, the safe-harbor did not apply, even though the transaction involved financial institutions as intermediaries.  This decision is in line with the view of two Circuit Courts of Appeals but diverges with the majority of Circuit Courts that had previously construed the scope of the section 546(e) safe harbor to apply to transfers effected through one or more financial intermediaries.


Two companies, Valley View Downs, L.P. and Bedford Downs Management Corporation, were competing to obtain a license for a harness-racing track. Eventually, the companies entered into an agreement where Bedford Downs withdrew as a competitor for the license, and Valley View agreed to purchase all of Bedford Downs' stock for $55 million after obtaining the license. Valley View proceeded with the license acquisition and arranged for Credit Suisse to finance the $55 million purchase price. Credit Suisse wired the $55 million to Citizens Bank of Pennsylvania as third-party escrow agent for the transaction. At closing, Citizens Bank disbursed the $55 million to the Bedford Downs shareholders in two installments. Merit Management Group, LP, a Bedford Downs shareholder, received approximately $16.5 million from the sale of its stock.

Despite securing the harness-racing license, Valley View was unable to secure a separate gaming license as required by its financing package, and subsequently filed for chapter 11 bankruptcy relief along with its parent company, Centaur, LLC. FTI Consulting, Inc., as trustee of the Centaur litigation trust, filed suit against Merit in the Northern District of Illinois seeking to avoid the $16.5 million transfers from Valley View to Merit for the sale of Bedford Downs' stock, alleging that the transfer was constructively fraudulent1. Merit argued that the Bankruptcy Code's section 546(e) safe harbor2 barred the trustee  from avoiding the transfer, as the transfer was a settlement payment or a payment in connection with a securities contract made by or to (or for the benefit of) a covered financial institution—i.e., Credit Suisse and Citizens Bank. In other words, Merit argued that the analysis should not be conducted solely with respect to the ultimate Valley View-to-Merit transfer, but also with respect to all its component steps, including the transactions with the banks as intermediaries. In contrast, the trustee argued that the only relevant transfer for purposes of the section 546(e) safe-harbor inquiry is the end-to-end transfer between Valley View and Merit of $16.5 million for the stock purchase.

The District Court agreed with Merit, reasoning that the safe harbor applied because the transfer was a settlement payment or a payment in connection with a securities contract made by or to (or for the benefit of) a covered financial institution. The Court of Appeals for the Seventh Circuit reversed, holding that the safe harbor did not protect transfers in which financial institutions served as mere conduits. The Supreme Court granted certiorari.


The Supreme Court agreed with the Seventh Circuit's interpretation of the section 546(e) safe harbor, finding that the safe harbor does not shield a transfer from an entity that is not within the category of parties protected by the safe harbor to another entity that is likewise not within the category of protected parties, even where the transfer was effected through financial intermediaries that are within the categories of protected parties under section 546(e). The Supreme Court held that a court must first identify the relevant transfer in order to then determine whether the transfer was made by or to or for the benefit of a safe-harbored entity, and that the relevant transfer is the overarching transfer that the trustee seeks to avoid under one of the Bankruptcy Code's substantive avoidance provisions. Here, because the transfer that the trustee sought to avoid as constructively fraudulent was between Valley View and Merit, and was not made by, to or for the benefit of a financial institution, the safe harbor was not applicable.

The Supreme Court provided three specific reasons for its conclusion. First, the language of the statute itself indicates that section 546(e) operates as an exception to the trustee's avoiding powers under the substantive avoidance provisions. Indeed, to qualify for protection under the securities safe harbor in the first place, section 546(e) provides that the otherwise avoidable transfer itself be a transfer that meets the safe-harbor criteria.3   Merit argued that the parenthetical "(or for the benefit of)," which was added to section 546(e) by Congress in 2006, was meant to abrogate a prior decision from the Eleventh Circuit Court of Appeals4  which held that the safe harbor was inapplicable to transfers in which a financial institution acted only as an intermediary, as was the case here.  Specifically, Merit argued that the addition of such phrase made it clear that a protected party that is a financial intermediary need not acquire a beneficial interest in the property that is subject to the avoidance claim in order for the safe harbor to apply.5]   The Supreme Court disagreed, stating that nothing in the text or legislative history supports the proposition that this was Congress's intention.6  Moreover, the statute specifies the transfer that the trustee may not avoid to be a transfer that is – not involves or comprises – a settlement payment or made in connection with a securities contract.   

Second, the Supreme Court found that the specific context in which the language of the statute is used also supports its conclusion.  The Supreme Court noted that the statute's section heading for the safe-harbor, "Limitations on avoiding powers," demonstrates the close connection between the transfer that the trustee seeks to avoid and the transfer that is safe-harbored from that avoiding power.  The fact that the safe harbor provides that the trustee may not avoid certain transfers invites scrutiny of the transfers that the trustee may avoid.  

Third, the Supreme Court stated that the structure of the Bankruptcy Code allows for both the avoidance of transfers and a safe harbor from avoidance.  As a result, it is logical to view the pertinent transfer for the safe-harbor analysis as the ultimate transfer that the trustee seeks to avoid. As the Supreme Court concisely put it, "[t]he language of § 546(e), the specific context in which that language is used, and the broader statutory structure all support the conclusion that the relevant transfer for purposes of the § 546(e) safe-harbor inquiry is the overarching transfer that the trustee seeks to avoid under one of the substantive avoidance provisions."  

Finally, the Supreme Court specifically declined to address whether the language of section 101(22)(A) of the Bankruptcy Code warranted an application of the safe harbor that would shield a transfer made through a financial institution, because the defendant/appellant did not contend such portion of the statute controlled the outcome of the case, and the defendant did not raise the issue in the lower courts.  Section 101(22)(A) provides that "financial institution" (a protected party under the section 546(e) safe harbor) includes a customer where the financial institution acts as an agent or custodian for such customer in connection with a securities contract.  


The Supreme Court was unanimous in its holding rejecting the interpretation of section 546(e) adopted by a majority of Circuit Courts which shielded transfers made through financial intermediaries from avoidance.  This decision likely will make it significantly more difficult for parties to utilize section 546(e)'s safe harbor as a defense against an avoidance action with respect to transfers made in connection with sales of securities to shareholders (such as payment for shares sold in an LBO) who are not within the categories of section 546(e)'s protected parties, even if payment made for the securities is routed through a bank or another financial intermediary.  As long as the transfer that is the subject of the avoidance action itself is not subject to the safe harbor, the fact that intermediate transactions may involve financial institutions—or, presumably, other entities covered by the safe-harbor—will not allow for a section 546(e) safe-harbor defense to avoidance.  

With the Supreme Court's focus on the ultimate transferee, it is possible that avoidance plaintiffs will be discouraged from naming intermediate transferees in future avoidance actions against an ultimate recipient.  It is also possible that defendants will attempt to define what constitutes the relevant transfer as being the transfer to a financial intermediary, such that the transfer from that entity will be considered a protected transfer "by" the financial institution.    

Finally, as noted above, the Supreme Court did not consider the argument that the term "financial institution" expressly includes a customer of such entity where the financial institution acts as agent or custodian in connection with a securities contract for the customer.  While this argument was not properly raised by Merit on appeal, it arguably lends strong textual support to the interpretation of section 546(e) rejected by the Supreme Court in the present case.  Indeed, at oral argument, Justice Breyer made statements to suggest that such an argument might control the outcome of the case if it were properly raised.  It will be interesting to see whether parties that are not financial intermediaries or otherwise protected under section 546(e) attempt to avail themselves of this argument in future litigation over the scope of the safe harbor.


1 The complaint alleged that the transfer was constructively fraudulent under § 548(a)(1)(B) of the Bankruptcy Code because Valley View was insolvent when it purchased Bedford Downs, and significantly overpaid for the Bedford Downs stock.

2 The securities safe harbor set forth in section 546(e) of the Bankruptcy Code provides in part: "Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a ... settlement payment made by or to (or for the benefit of) a... financial institution... that is made before the commencement of the case, except under section 548(a)(1)(A) of this title." 11 U.S.C. § 546(e).

3 The Supreme Court also pointed out that the safe harbor saves from avoidance certain transactions made by or to, or for the benefit of, covered entities; conversely, transfers through a covered entity are not mentioned in the statute.

4 In re Munford, Inc., 98 F.3d 604, 610 (11th Cir. 1996).

5 The Supreme Court also rejected certain other arguments of Merit, including that the addition of a "securities clearing agency" as a protected party under safe harbor evinced Congress' intent to exempt transfers made via financial intermediaries in circumstances such as the case at bar. 

6 The Supreme Court noted that a number of substantive avoidance provisions include the "or for the benefit of" language, giving a trustee the power to avoid a transfer that was made to "or for the benefit of" certain actors.

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