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Home / Case News / Supreme Court Limits Ch. 11 Safe Harbor For Securities Clawbacks

Supreme Court Limits Ch. 11 Safe Harbor For Securities Clawbacks

February 27, 2018, New York – Resolving the circuit split over the scope of the Bankruptcy Code’s “safe harbor” provision exempting certain securities transactions from clawbacks, the U.S. Supreme Court unanimously concluded that a transfer could be undone in bankruptcy if funds simply move through a financial institution without benefiting it.

Debtors Valley View Downs, LP, and Bedford Downs Management Corp. entered into an agreement under which Valley View was to purchase all of Bedford Downs’ stock for $55 million if it got the last harness-racing license in Pennsylvania. Valley View was granted the license, and it arranged to wire $55 million to a third-party escrow agent, Citizens Bank of Pennsylvania. The Bedford Downs shareholders, including petitioner Merit Management Group, LP, deposited their stock certificates into escrow. Citizens Bank distributed the purchase proceeds to $55 million, to stockholders including Merit Management received $16.5 million.

Although Valley View secured the harness-racing license, it was unable to achieve its goal of opening a racetrack casino. Valley View and its parent company, Centaur, LLC, filed for Chapter 11 bankruptcy. FTI Consulting, Inc. was appointed to serve as trustee of the Centaur litigation trust. FTI then sought to avoid the transfer from Valley View to Merit for the sale of Bedford Downs’ stock, arguing that it was constructively fraudulent under §548(a)(1)(B).

Merit contended that the §546(e) safe harbor barred FTI from avoiding the transfer because it was a “settlement payment . . . made by or to (or for the benefit of)” two “financial institutions,” Credit Suisse and Citizens Bank. The District Court agreed with Merit, holding that the § 546(e) safe harbor applied even when the covered entity was only a component part of the overall transfer. However, the Seventh Circuit reversed, holding that §546(e) did not protect transfers in which financial institutions served as mere conduits.

The case was brought before the Supreme Court to resolve the circuit split regarding the scope of safe harbor provisions under Sec. 546 (e). The apex court clarified that if an entity covered by the exception is only a “conduit” or a component part of an overall transfer, then the safe harbor does not apply. The Court based this holding on the specific language and context of the safe harbor exception, as well as the broader statutory structure.

The Court held that in the case at bar, the transfer, the trustee sought to avoid was the transfer between Valley View and Merit Management, i.e. between the debtor and a shareholder who had sold its stock to the debtor, fell outside the § 546(e) safe harbor as neither the debtor nor the shareholder was a financial institution or other covered entity. It was not a component transfers to and between the financial institutions.  The Supreme Court accordingly affirmed the Seventh Circuit decision and remanded the case for further proceedings.

Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883, 200 L. Ed. 2d 183, 2018 U.S. LEXIS 1514, 86 U.S.L.W. 4088, 65 Bankr. Ct. Dec. 92, 2018 WL 1054879