The U.S. District Court for the Southern District of New York recently issued an important decision addressing the applicability of the Section 546(e) safe harbor provision to a transfer between two non-financial institutions where (a) the institution intermediating the transfer is a financial institution and (b) a party to the transaction qualifies as a "customer" within the scope of the definition of "financial institution" set forth in Section 101(22)(A). The author of this article discusses the decision

The U.S. Bankruptcy Code allows trustees (as well as debtors in possession and other estate representatives) to avoid certain fraudulent transfers on behalf of the estate but also contains a number of safe harbor provisions that limit the exercise of avoidance powers. The Section 546(e) safe harbor provision provides:

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract.

If applicable, this protects transferees from all avoidance claims, other than intentional fraudulent transfer claims under Section 548(a)(1)(A).

SUPREME COURT LIMITS SCOPE OF SECTION 546(e) SAFE HARBOR

In February 2018, the U.S. Supreme Court rendered a decision addressing the scope of the protections of the Section 546(e) safe harbor provision in Merit Management Group v. FTI Consulting. In Merit, two non-financial institutions engaged in a transfer and had used a financial institution as an intermediary. The Supreme Court overturned U.S. Courts of Appeals for the Second, Third, Sixth, Eighth, and Tenth Circuits decisions, all of which had held that a transfer is protected by the safe harbor provision of Section 546(e) so long as, in effectuating a transfer, transacting non-financial institution parties had used a financial institution as a conduit.

In its decision, the Supreme Court stated that the issue before it was to "determine how the safe harbor operates in the context of a transfer that was executed via one or more transactions, e.g., a transfer from A → D that was executed via B and C as intermediaries, such that the component parts of the transfer include A → B → C → D." The court noted that the transfer could be scrutinized as a whole (i.e., as a transfer from A → D where neither A nor D is a financial institution) or could be scrutinized taking into account the component parts of the overarching transfer (i.e., a transfer from A → B → C → D where B and C act as intermediary financial institutions between the transacting parties). The Supreme Court concluded that the plain meaning of Section 546(e) dictated that the appropriate way to analyze the transfer was holistically (i.e., A → D without taking into account the financial institution intermediaries). Accordingly, the court found that the transfer before it—which was between two non-financial institutions but conducted through a financial institution—did not fall under the protections of the Section 546(e) safe harbor provision.

In a noteworthy footnote to its Merit decision, the Supreme Court noted that neither party to the transaction had argued that it qualified as a "financial institution" by virtue of its status as a "customer."target=_blank1 Accordingly, the Supreme Court declined to address what impact, if any, Section 101(22)(A) would have in the application of the Section 546(e) safe harbor.

Footnotes

1. See 11 U.S.C. §101(22)(A) (definition of "financial institution").

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