In FTI Consulting, Inc. v. Merit Management Group, LP, 2016 BL 243677 (7th Cir. July 28, 2016), a three-judge panel of the U.S. Court of Appeals for the Seventh Circuit ruled that the “safe harbor” under section 546(e) of the Bankruptcy Code for settlement payments made in connection with securities contracts does not protect “transfers that are simply conducted through financial institutions (or the other entities named in section 546(e)), where the entity is neither the debtor nor the transferee but only the conduit.” The ruling deepens a split among the circuit courts of appeal on the issue and may be a candidate for review by the U.S. Supreme Court to resolve the dispute.

The Section 546(e) Safe Harbor

Section 546 of the Bankruptcy Code imposes a number of limitations on a bankruptcy trustee’s avoidance powers, including the power to avoid certain preferential and/or fraudulent transfers. In 1982, Congress broadened a limited safe harbor for securities transactions then set forth in section 764(c) of the Bankruptcy Code, which applied only in commodity broker liquidation cases under chapter 7, by replacing the provision with section 546(e) (then designated as section 546(d), until renumbering in 1984).

Section 546(e) provides:

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of [the Bankruptcy Code], the trustee may not avoid a transfer that is a margin payment, as defined in section 101, 741, or 761 of [the Bankruptcy Code], or settlement payment as defined in section 101 or 741 of [the Bankruptcy Code], 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, as defined in section 741(7) [of the Bankruptcy Code], commodity contract, as defined in section 761(4) [of the Bankruptcy Code], or forward contract, that is made before the commencement of the case, except under section 548(a)(1)(A) of [the Bankruptcy Code].

The purpose of section 546(e) is to prevent “the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market.” H.R. Rep. No. 97-420, at 1 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583, 1982 WL 25042. The provision was “intended to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.” Id. With the enactment of section 546(e), Congress also sought to promote customer confidence in the markets by protecting market stability. See Kaiser Steel Corp. v. Charles Schwab & Co., 913 F.2d 846 (10th Cir. 1990) (citing Sen. Rep. No. 989, at 8 (1978)).

If a transaction falls within the scope of section 546(e), it may not be avoided unless the transfer is avoidable under section 548(a)(1)(A) of the Bankruptcy Code—that is, because it was made with actual intent to hinder, delay, or defraud creditors. In determining whether a “constructively” fraudulent transfer (a transfer for which an insolvent debtor did not receive reasonably equivalent value in exchange) is shielded from avoidance under section 546(e), key issues are often whether the transfer qualifies as a “settlement payment” and whether the transfer is made under a “securities contract.” In addition, to be within the scope of the safe harbor, a transfer must have been “made by or to (or for the benefit of)” a commodity broker, a forward contract merchant, a stockbroker, a financial institution, a financial participant, or a securities clearing agency.

Five circuit courts of appeal have ruled that the section 546(e) safe harbor extends to transactions even where one of the entities named in the provision is merely a “conduit” for the transfer of funds from the debtor to the ultimate transferee. See In re Quebecor World (USA) Inc., 719 F.3d 94 (2d Cir. 2013) (safe harbor applicable where financial institution was trustee and actual exchange was between two private entities); In re QSI Holdings, Inc., 571 F.3d 545 (6th Cir. 2009) (safe harbor applied even though financial institution involved in leveraged buyout (“LBO”) was only an exchange agent); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009) (section 546(e) not limited to public securities transactions and protects from avoidance debtor’s payments deposited in national bank in exchange for shareholders’ privately held stock during LBO); In re Resorts Int’l, Inc., 181 F.3d 505, 516 (3d Cir. 1999) (noting that “the requirement that the ‘commodity brokers, forward contract merchants, stockbrokers, financial institutions, and securities clearing agencies’ obtain a ‘beneficial interest’ in the funds they handle . . . is not explicit in section 546”); In re Kaiser Steel Corp., 952 F.2d 1230, 1240 (10th Cir. 1991) (rejecting argument that “even if the payments were settlement payments, § 546(e) does not protect a settlement payment ‘by’ a stockbroker, financial institution, or clearing agency, unless that payment is to another participant in the clearance and settlement system and not to an equity security holder”).

The Eleventh Circuit ruled to the contrary in In re Munford, Inc., 98 F.3d 604 (11th Cir. 1996). In Munford, the court held that section 546(e) did not shield from avoidance payments made by the debtor to shareholders in an LBO because the “financial institution” involved was only a conduit for the transfer of funds and securities—the bank never had a “beneficial interest” sufficient to qualify as a “transferee” in the LBO. In so ruling, the Eleventh Circuit wrote:

None of the entities listed in section 546(e)—i.e., a commodity broker, forward contract merchant, stockbroker, financial institution, or a securities clearing agency—made or received a transfer/payment. Thus, section 546(e) is not applicable. . . . True, a section 546(e) financial institution was presumptively involved in this transaction. But the bank here was nothing more than an intermediary or conduit. Funds were deposited with the bank and when the bank received the shares from the selling shareholders, it sent funds to them in exchange. The bank never acquired a beneficial interest in either the funds or the shares. . . . Importantly, a trustee may only avoid a transfer to a “transferee.” See 11 U.S.C. § 550. Since the bank never acquired a beneficial interest in the funds, it was not a “transferee” in the LBO transaction.

Id. at 610.

The Seventh Circuit weighed in on this issue in FTI Consulting.

FTI Consulting

In 2007, Valley View Downs, LP (“Valley View”), the owner of a Pennsylvania racetrack, acquired all of the stock of a competitor, Bedford Downs (“Bedford”), in a $55 million LBO transaction styled as a “settlement agreement” because Bedford and Valley View were competing for “racino” licenses. Citizens Bank of Pennsylvania (“Citizens”) acted as escrow agent for the exchange. After the LBO, Valley View filed for chapter 11 protection in 2009 in the Northern District of Illinois because the Illinois gaming commission denied Valley View’s application for the gambling license.

The trustee of a litigation trust created under Valley View’s chapter 11 plan sued a 30 percent shareholder in Bedford, alleging that Valley View’s transfer to Bedford and thence to the shareholder of approximately $16.5 million (30 percent of the $55 million) was constructively fraudulent and therefore avoidable under sections 544 and 548(a)(1)(B) of the Bankruptcy Code. The bankruptcy court and, on appeal, the district court ruled that the transfer to the shareholder was protected by the section 546(e) safe harbor.

The Seventh Circuit’s Ruling

The Seventh Circuit reversed. “Although we have said that section 546(e) is to be understood broadly,” the court wrote, “that does not mean that there are no limits.” Here, the court explained, although the transaction resembled an LBO and “in that way touched on the securities market,” Valley View and the shareholder were not “parties in the securities industry,” but simply “corporations that wanted to exchange money for privately held stock.” Citizens, the “financial institution” involved as escrow agent, was merely a conduit.

In Bonded Financial Services, Inc. v. European American Bank, 838 F.2d 890, 893 (7th Cir. 1988), the Seventh Circuit explained, it had previously defined “transferee” as an entity with “dominion over the money” or “the right to put the money to one’s own purposes.” In Bonded Financial, the court ruled that a bank which “acted as a financial intermediary” and “received no benefit” was not a “transferee” for purposes of chapter 5 of the Bankruptcy Code. Id. In FTI Consulting, the Seventh Circuit extended that reasoning to the section 546(e) safe harbor. It accordingly ruled that transfers “made by or to (or for the benefit of)” in the context of 546(e) refer to transfers made to “transferees.”

Examining the history of section 546(e), the Seventh Circuit explained that nothing Congress did in originally enacting the safe harbor, or in later expanding its scope to other types of actors in the securities industry, including financial institutions, indicates “that the safe harbor applie[s] to those institutions in their capacity as intermediaries.” According to the court, “the safe harbor has ample work to do when an entity involved in the commodities trade is a debtor or actual recipient of a transfer, rather than simply a conduit for funds.”

The Seventh Circuit rejected the argument that Congress effectively overruled Munford by adding the phrase “(or for the benefit of)” to section 546(e) as part of the Financial Netting Improvements Act of 2006, Pub. L. No. 109-390 § 5(b)(1) (2006), in response to the Eleventh Circuit’s statement in Munford that “[t]he bank never acquired a beneficial interest in either the funds or the shares.” Munford, 98 F.3d at 610. The Seventh Circuit acknowledged that, in Quebecor, the Second Circuit construed the 2006 amendment to mean that section 546(e) was satisfied if one of the designated entities made a transfer, received a transfer, or acquired a beneficial interest in the transferred assets. See Quebecor, 719 F.3d at 100 n.3. Even so, the Seventh Circuit wrote that “[w]e do not believe that Congress would have jettisoned Munford’s rule by such a subtle and circuitous route.” According to the court, “If Congress had wanted to say that acting as a conduit for a transaction between non-named entities is enough to qualify for the safe harbor, it would have been easy to do that . . . [b]ut it did not.”


FTI Consulting effectively rekindles a two-decade-long circuit split that had largely faded into obscurity before the Seventh Circuit chose to resurrect the minority approach articulated in Munford but rejected by five other circuits. On August 11, 2016, the shareholder defendant filed a petition asking the Seventh Circuit to rehear the case en banc, claiming that the panel ruling conflicts with those of five other circuits, as well as with decisions within the Seventh Circuit, and that the panel’s decision would lead to inequitable results which Congress could not have intended. The Seventh Circuit denied the motion on August 30, 2016. It remains to be seen whether FTI Consulting will be overturned by the U.S. Supreme Court, should it grant a petition for certiorari to resolve the circuit split.

In the meantime, the ruling means that participants, such as selling shareholders, in LBO transactions involving companies whose solvency is questionable face different levels of exposure depending on the law on this issue in the circuit in which the LBO could later be challenged as a fraudulent transfer.