Section 546(e) of the bankruptcy code prohibits a bankruptcy trustee from avoiding “settlement payment[s]”, or payments “made in connection with a securities contract,” that are “made by or to (or for the benefit of)” qualifying financial entities, including financial institutions, stockbrokers, commodities brokers and others.   In a ruling that conflicts with precedent from the Second, Third, Sixth, Eighth, and Tenth Circuits, a decision last week by a Seventh Circuit panel held that the safe harbor provision of section 546(e) does not preclude a trustee from recovering a transfer to a party that was not a qualifying financial entity, where a qualifying financial institution was merely the conduit for the transaction.  See FTI Consulting v. Merit Management Group, LP.

Shortly before filing for bankruptcy, the debtor acquired the shares of a competing company for approximately $55 million, but the combined company became insolvent and failed. The Trustee commenced an action against the 30% owner of the acquired company (Merit) seeking to recover the $16.5 million price paid for the purchase of Merit’s shares, claiming that the payment was a voidable as a fraudulent conveyance or a preference under the Bankruptcy Code, and the money was part of the bankruptcy estate.

The district judge found that, in the first instance, the payment was a “settlement payment” or a payment “in connection with a securities contract,” satisfying the first part of the safe harbor. The district judge also found that, even though neither Merit nor the debtor was a qualifying financial entity, the payment nevertheless was “made by or to” qualifying financial institutions because the funds passed through two banks before they were ultimately transferred by the debtor to Merit.  In particular, one bank acted as lender to the debtor and was the ultimate source of the funds that the debtor used to pay for the shares.  A second bank served as the escrow agent for the purchase of shares, and the funds passed through this institution before being released to Merit.  As such, the district court held that the criteria for the safe harbor were fully satisfied, and the payment could not be recovered from Merit.

On appeal, the Seventh Circuit agreed that the payment was a settlement payment or payment in connection with a securities contract, but disagreed that the payment was “made by or to (or for the benefit of)” a qualifying financial entity. Finding that the statutory language was vague, the Court found that Congress had intended to protect qualifying financial entities from the possibility of recovery by a trustee, but that Congress did not intend to protect entities that were not qualifying financial entities merely because a transfer passed through a financial intermediary.  If that were the case, the Court opined, only transactions “done in cold hard cash” would be excluded from the safe harbor and, in the Court’s view, Congress did not intend the safe harbor to be so broad.

The Panel’s decision also addressed Section 550 of the bankruptcy code, which permits a trustee to recover voidable transfers from the “initial transferee” or “any immediate or mediate transferee” of the initial trustee, and provides a defense to certain transferees who take in good faith. Prior decisions of the Seventh Circuit held that the term “transferee” did not include a financial institution that merely functioned as an intermediary and exercised no dominion over the money, with no right to put the money to its own purpose.   Applying these rulings to its interpretation of Section 546(e), the Court held that the safe harbor protected only transactions made to “transferees” as previously defined by the Court under Section 550.  As such, the safe harbor did not protect the transfer to Merit, despite the use of non-transferee banks as intermediaries.

Finally, the Seventh Circuit recognized that its decision was in conflict with a number of decisions in other circuits. Rulings in the Second, Third, Sixth, Eighth, and Tenth Circuits have found transfers to parties that were not qualifying financial entities to be nevertheless protected under Section 546(e), where a qualified financial entity acted as financial intermediary.  An Eleventh Circuit opinion held otherwise.  This conflict among the circuits may ultimately be resolved by the Supreme Court.

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Photo of James Anderson James Anderson

Jim Anderson is a litigator and trial lawyer. His practice focuses on complex commercial litigation involving leading technology and pharmaceutical companies, as well as private equity, private credit, and venture funds. Jim leverages his technological background and expertise to represent clients in high-stakes…

Jim Anderson is a litigator and trial lawyer. His practice focuses on complex commercial litigation involving leading technology and pharmaceutical companies, as well as private equity, private credit, and venture funds. Jim leverages his technological background and expertise to represent clients in high-stakes business and intellectual property disputes.

Jim has experience litigating cases for clients in the life sciences, biotech, software, consumer electronics, and financial services industries.  Jim has also handled lawsuits for venture and hedge funds, and real estate clients.   He has litigated cases in courts throughout the United States, as well as before the International Trade Commission and Patent Trial and Appeal Board.  He has also represented foreign and domestic companies in disputes before international arbitration tribunals under ICC and CPR Rules.

In addition to his commercial litigation practice, Jim counsels and advises private equity and private credit clients in fund-fund, lender-sponsor, and portfolio company disputes.  Jim leverages his courtroom experience to help these clients navigate regulatory and litigation risks.

Jim also advises clients on intellectual property strategy spanning the full range of patent, trademark, and trade secret protections. He has developed and maintained intellectual property portfolios in a broad range of industries, including consumer products, medical devices, machining and fabrication equipment, and semiconductor devices. Jim is registered to practice before the USPTO.

Jim also maintains an active pro bono practice. He has received awards for his work on behalf of victims of domestic violence and abuse.

Jim has a background in Mechanical Engineering, with a focus on energy, power, and fuel cell technologies. Prior to his career at Proskauer, Jim served as a judicial intern in the U.S. District Court for the District of Connecticut and represented clients with the UConn Intellectual Property and Entrepreneurship Law Clinic.