On February 27, 2018, the United States Supreme Court in a significant ruling held in Merit Management Group, LP v. FTI Consulting, Inc. that transfers of property of a debtor in which financial institutions are mere conduits or intermediaries may be avoidable. The Court ruled that the safe harbor provisions of section 546(e) of the Bankruptcy Code do not protect such transfers from avoidance.

The Supreme Court’s ruling affirmed the Seventh Circuit Court of Appeals decision in FTI and resolved a split of Court of Appeals decisions (the Second, Third, Eighth, and Tenth Circuits had held that the safe harbor protected such transfers, and the Eleventh Circuit had held that it did not).¹

The suit by FTI Consulting, Inc. (“FTI”), as litigation trustee, was brought to recover an alleged fraudulent transfer made by a race track owner when it purchased the equity interest of a competitor. When the purchaser later filed chapter 11 FTI sued the seller to recover the purchase price alleging that the purchaser was insolvent at the time of the transfer and that the buyer “significantly overpaid” for the equity interest. In other words, the transfer or payment of the purchase price was not made for reasonably equivalent value. The seller moved to dismiss and argued that the safe harbor provisions of Section 546(e) protected the transfer because it was effected through two intermediary financial institutions. The Bankruptcy Court agreed with the seller and dismissed the action. On appeal, the Seventh Circuit Court of Appeals reversed and held that the safe harbor of Section 546(e) did not apply when a financial institution acts as a mere conduit or intermediary.

The Supreme Court held that the only transfer in the case that matters is the overarching transfer from the buyer to the seller that the trustee seeks to avoid, and that transfer was not made to or for the benefit of the financial institution acting as a mere conduit. That two intermediary financial institutions were involved as conduits was immaterial in the Court’s view. The Court held that under the language and intent of Section 546(e) it only made sense to view the pertinent transfer under Section 546(e) as the same transfer that the trustee sought to avoid pursuant to an avoiding power and not some other intermediate transfer or transfers.

The Supreme Court rejected the seller’s argument that Congress meant to protect transfers in which intermediaries act as conduits when it amended Section 546(e) to include transfers within the safe harbor that were made to “or for the benefit of” a financial institution. The Supreme Court held that the language in the amendment simply matched the substance of the avoiding power that enables a trustee to avoid transfers made to “or for the benefit of” the transferee.

The Supreme Court also rejected the seller’s argument, that by including “securities clearing agencies” as covered entities in Section 546(e), which are defined to include, among others, an intermediary in payments or deliveries made in connection with securities transactions, Congress intended to include within the safe harbor all payments made to or by conduits or intermediaries. The Court determined that its holding gave full meaning to the statute by focusing on the transfer that is intended to be avoided by the trustee or plaintiff. If the transfer in question had been made to or for the benefit of a financial institution it would be covered by the Section 546(e)’s safe harbor, but it was not.

Finally, the Supreme Court rejected the seller’s attempt to interpret the safe harbor provisions as a broad attempt to protect securities and commodities transactions in order to respect the finality of transactions. The Court viewed this argument as an attack on the plain language of the statute itself—emphasizing that the safe harbor provisions protect transfers made by or to (or for the benefit of) covered entities. Transfers “through” a covered entity, however, are not mentioned in the safe harbor provision, and therefore are not protected.

Even though FTI did not involve a leveraged buyout scenario, the Supreme Court’s decision has major implications in leverage buyout cases such as In re Tribune Fraudulent Conveyance Litigation, 818 F.3d 98 (2d Cir. 2016) and similar fraudulent conveyance cases. Plaintiffs in such actions have long awaited this ruling so they can now proceed against stockholders who received payments in connection with an LBO.

1. In re Quebecor World (USA) Inc., 719 F. 3d 94, 99 (2d Cir. 2013) (finding the safe harbor applicable where covered entity was intermediary); In re QSI Holdings, Inc., 571 F. 3d 545, 551 (6th Cir. 2009) (same); Contemporary Indus. Corp. v. Frost, 564 F. 3d 981, 987 (8th Cir. 2009) (same); In re Resorts Int’l, Inc., 181 F. 3d 505, 516 (3d Cir. 1999) (same); In re Kaiser Steel Corp., 952 F. 2d 1230, 1240 (10th Cir. 1991) (same), with In re Munford, Inc., 98 F. 3d 604, 610 (11th Cir. 1996) ( per curiam) (rejecting applicability of safe harbor where covered entity was intermediary).