On February 27, 2018, a unanimous Supreme Court held in Merit Management Group, LP v. FTI Consulting, Inc. (link here) that an otherwise-avoidable transfer is not subject to the safe harbor in Section 546(e) (which provides, in relevant part, a trustee may not avoid a transfer that is a “settlement payment . . . made by or to (or for the benefit of) a . . . financial institution” or that “is a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract”) of the Bankruptcy Code merely because funds flow through covered financial entities. Rather, the availability of the Section 546(e) safe harbor depends on the particular transfer sought to be avoided.

Highly summarized, Valley View Downs, LP and Bedford Downs Management Corp. entered an agreement by which Valley View would purchase the stock of Bedford Downs for $55 million. Valley View “arranged for the Cayman Islands branch of Credit Suisse to wire $55 million to third-party escrow agent Citizens Bank of Pennsylvania.” Citizens Bank in fact disbursed $55 million in accordance with the escrow agreement.

Valley View and its parent company, Centaur LLC, later filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code. FTI Consulting, Inc., as trustee for the Centaur litigation trust, sought to avoid and recover the payment from Valley View to Merit Management Group, LP (a Bedford shareholder) as constructively fraudulent under Section 548(a)(1)(B). Merit moved for judgment on the pleadings. Merit successfully argued to the District Court that because the payments were received by covered financial entities (Credit Suisse and Citizens Bank) as part of a settlement payment or securities contract, the transfer was not subject to avoidance due to application of the Section 546(e) safe harbor.

The Seventh Circuit reversed, holding (as summarized by the Supreme Court) “that the §546(e) safe harbor did not protect transfers in which financial institutions served as mere conduits.” In so holding, the Seventh Circuit joined the Eleventh Circuit and departed from the Second, Third, Sixth, Eighth and Tenth Circuits, each of which held the safe harbor applied where funds flowed through a covered entity as intermediary.

The Supreme Court accepted the minority position adopted by the Seventh and Eleventh Circuits. The Court found that determining whether the safe harbor applies requires first to determine which transfer is sought to be avoided. In reaching that conclusion, the Court looked to the plain language and construction of the avoidance provisions of the Code and found that the safe harbor acts on a limitation of the avoiding powers otherwise available to a trustee or debtor-in-possession. The Court further found instructive that the safe harbor itself refers to “a transfer that is” a settlement payment or securities contract, not one that “involves” or “comprises” a settlement payment or securities contract.

The Court further held it is incumbent on the trustee or debtor-in-possession to identify the transfer it seeks to avoid. Once it does so, the Court reasoned, the transferee is free to argue that transfer, identified by the trustee or debtor-in-possession, is not avoidable. According to the Court, however, “[i]f a trustee properly identifies an avoidable transfer . . . the court has no reason to examine the relevance of component parts when considering a limit to the avoiding power, where that limit is defined by reference to an otherwise avoidable transfer as is the case with §546(e).” (Emphasis added). Because FTI identified the transfer it sought to avoid as the transfer between Valley View and Merit, and importantly, because Merit omitted to challenge whether FTI “improperly identified the Valley View-to-Merit transfer as the transfer to be avoided,” the Court concluded there was no proper basis on which to examine the “component parts” of the transaction by which Credit Suisse and Citizens Bank served as conduits.

This decision no doubt will draw consternation from transferees, but it is a boon for unsecured creditors who stand to benefit from potentially significant avoidance actions that otherwise would be barred by the safe harbor. Transferees should pay close heed to the Court’s admonition that Merit omitted to challenge whether FTI properly identified the transfer – certainly the Court implied that Merit could have mounted such a challenge, noting that a trustee is not free to define a transfer in any way it sees fit. Relatedly, the Court’s holding may breathe new life into the question of whether “mere conduits” of funds – those who do not exercise dominion and control over them – can be considered initial transferees under Section 550(a)(1) such that the ultimate transferee may avail itself of the additional defenses available under Section 550(b) to mediate or immediate transferees.