The Bankruptcy Code gives a trustee the power to avoid pre-petition fraudulent and preference transfers made by a debtor, except that a trustee may not avoid a transfer that is "made by or to (or for the benefit of)" a party enumerated in 546(e) of the Code "in connection with a securities contract." Although 546(e) has been applied in various circumstances, there is little court guidance on whether 546(e) protects transfers made to repay commercial mortgage-backed securities ("CMBS") loans. One case in particular has applied 546(e) to dismiss such an avoidance action: Krol v. Key Bank Nat'l Ass'n (In re MCK Millennium Centre Parking, LLC), 532 B.R. 716 (Bankr. N.D. Ill. 2015).

Section 546(e)

In determining which transfers fall under 546(e), circuit courts have taken either a broad approach or a narrow approach. A majority of circuit courts have applied a broad approach, finding that the plain language of the Code does not expressly require a specific type of transfer or interest obtained by a party enumerated under 546(e), and that any participation by an enumerated party is sufficient to protect the transaction. In particular, the Second Circuit has found that "the language of Section 546(e) covers all transfers by or to financial intermediaries that are `settlement payment[s]' or `in connection with a securities contract.'" "Transfers in which either the transferor or transferee is not such an intermediary are clearly included in the language" because 546(e) is meant to protect the transaction and not just the entities involved in the transaction. Therefore, under the broad approach the analysis hinges on whether the transfer itself is included in the language of 546(e) rather than focusing on whether the transferor or transferee is a financial intermediary.

A minority of courts have taken a more narrow approach, holding that transfers are not protected under 546(e) unless a party enumerated in the statute is the "transferee" that acquired a beneficial interest in the transferred property. The Eleventh Circuit's decision in Munford set the framework for the minority approach. Since Munford, Congress amended 546(e) to include the language "(or for the benefit of)." In July 2016, the Seventh Circuit issued an opinion adopting Munford and reaffirming the pre-2006 approach despite the added language. In rendering its opinion, the Seventh Circuit disregarded the 2006 amendment as inconsequential, stating that "Congress would not have jettisoned Munford's rule by such a subtle and circuitous route." Other courts have distinguished Munford, finding that Congress did enough to differentiate a transfer "for the benefit of" from a transfer made "by or to." As a result, those courts found that a transfer can be made for the benefit of an enumerated party, but not necessarily "to" that party, and still be protected under 546(e). As the application of 546(e) varies across circuits, it is essential to recognize how each approach would apply in the context of CMBS loans.

CMBS Loans

To understand how 546(e) applies in the context of CMBS loans, it is important to understand how they function, including the roles of parties acting on behalf of the securitized trust. Traditionally, under the securitization process "lenders transfer mortgage loans into a single pool or trust." After the loans are transferred to the trust, certificates generally are sold "entitling the holders to payments from principal and interest on [the] large pool of mortgages."

This type of securitization is typically memorialized in a pooling and servicing agreement ("PSA"), which "is an agreement creating a trust that defines the terms under which promissory notes and their related mortgages are placed into a trust, describes how the notes and mortgages and related loan documents are transferred by and between the parties to the trust, and sets forth the various responsibilities of the parties to the trust." Traditionally, such a trust is managed by a master servicer that handles the day-to-day loan administration functions and services the loans.

In re MCK Millennium

The United States Bankruptcy Court for the Northern District of Illinois in In re MCK Millennium, has analyzed 546(e) in the context of a CMBS loan. The court went through a two-part analysis to determine whether a transfer made to a master servicer of a CMBS loan, who held the funds temporarily before transferring them to a securitized trust, would be a protected transfer under 546(e).

First, the court looked at whether the transfers were made "by or to" a party enumerated under the statute. The master servicer under the PSA was a commercial bank, which is included within the Code's definition of a "financial institution," an enumerated party under 546(e). The more complicated question the court had to answer was whether the transfer was made "to" the bank. The court recognized the split among circuits in addressing whether payments made to financial institutions that act as an intermediary for avoidable transfers are "transferees" under the statute. The court found that the language "by or to" was clear and held that payments made either by or to a financial institution without any beneficial interest in the payments, such as the master servicer of a CMBS loan, can still be protected under 546(e).

Second, the court looked at whether the transfer was made "in connection with a securities contract."  "[T]he term `securities contract' expansively includes contracts for the purchase or sale of securities, as well as any agreements that are similar or related to contracts for the purchase or sale of securities." The court found that although the CMBS loan payment is a twotiered transaction, it fit within the definition of a securities contract under 741(7)(A) because the integration of the loan with the PSA and the subsequent sale of certificates under the PSA representing investors' interests in the loan sufficiently relates the loan to the PSA, which is a contract for the purchase and sale of securities. Additionally, the court found that the payments were made "in connection with" because that term should be broadly interpreted to include payments related to a security agreement, particularly payments made in relation to a PSA.

The Seventh Circuit's subsequent decision in FTI Consulting, Inc. chips away at the analysis in In re MCK Millennium regarding whether a transfer is made "by or to" an enumerated party. The Seventh Circuit held that payments are not made "by or to" an enumerated party unless the enumerated party is a transferee that acquired a beneficial interest in the transferred property. The bankruptcy court's first part of the analysis in In re MCK Millennium may have been abrogated by the Seventh Circuit's decision in FTI Consulting, Inc. because the bankruptcy court found that the master servicer did not obtain a beneficial interest in the payments. However, if the beneficial interest of the payments is held in the securitized trust, which holds legal title to the payments under the traditional PSA, the securitized trust, and not the master servicer, may be the "transferee" that acquired the beneficial interest. If the securitized trust is both the "transferee" and a party enumerated under 546(e), payments made on the CMBS loan may still be protected, even in the Seventh Circuit.

Despite the fact that the Seventh Circuit has a narrow view of what made "by or to" means, In re MCK Millennium is still persuasive authority for whether payments made on a CMBS loan can be made "in connection with a securities contract" as defined in 546(e). Additionally, if the facts in In re MCK Millennium are revisited, different arguments regarding the identity of the "transferee," which may include the securitized trust or trustee under the PSA, can be made to prevent the trustee from avoiding and recovering payments made on a CMBS loan. A party may argue that the transfer is still protected if the securitized trust is an enumerated party because the transfer was made "by or to" an enumerated party as the securitized trust received the benefit of the transfer. The court In re MCK Millennium did not need to address these arguments because the transfer was already protected under the broad approach, which was later rejected by the Seventh Circuit in FTI Consulting, Inc. However, whether analyzed under the narrow or broad approach, 546(e) should protect payments made on a CMBS loan.