Our post last year concerning “[t]he long-running litigation spawned by the leveraged buyout of Tribune Company . . . and the subsequent bankruptcy case” described a case--FTI v. Merit--that was then pending in the Supreme Court. In that case, the Court of Appeals for the Seventh Circuit had construed the safe harbor provided in Section 546(e) of the Bankruptcy Code in conflict with its construction by the Second and Third Circuits (among others). On February 27, the Supreme Court announced its unanimous decision affirming the Seventh Circuit.
Section 546(e), which has been amended frequently, immunizes margin payments, settlement payments, and payments made in connection with securities, commodities and forward contracts to, by or for the benefit of certain brokers, financial institutions and other financial participants from avoidance pursuant to many (but not all) of a bankruptcy trustee’s avoidance powers. An issue that has stirred considerable controversy is whether an indirect payment to a recipient that is not one of the described entities (brokers, financial institutions &c.) is protected from avoidance as a result of the participation in the transaction of one of the described entities acting merely as a conduit of the payment. The Second and Third Circuits (and others) had given Section 546(e) a broad reading that afforded safe-harbor protection to such an indirect recipient, whereas the Seventh (and others) had given it a narrow reading to deny such protection.
Justice Sotomayor’s opinion for a unanimous court held that an avoidance adversary proceeding defendant that is not an entity of the kind described in Section 546(e) may not assert the safe-harbor defense based upon the involvement of such an entity in the transaction whether or not its role was as a mere conduit. Rather, it held, the proper application of Section 546(e) disregards the intermediate links in a chain of transfers between the debtor and the indirect recipient that is the defendant in the avoidance adversary proceeding and focuses solely on what it characterized repeatedly as the “overarching transfer” (which I interpret to mean the transfer from the debtor to the indirect recipient as if it had been a direct transfer without intermediate links).
Justice Sotomayor’s focus on the “overarching transfer” appears to me to extend the benefit of the Section 546(e) safe harbor to one of the described entities, if sued by a trustee in an avoidance adversary proceeding, even if it was acting as a mere conduit. It also appears to me to deny the benefit of the safe harbor to an avoidance adversary proceeding defendant that is not one of the described entities even if such an entity was involved in the transaction in a capacity that was not a mere conduit. But, while the implications of the decision for the Tribune litigation that was the subject of our original post remain to be seen, it is clear that Merit will significantly affect the course and outcome of many avoidance adversary proceedings in the Second and Third Circuits (and others).