Elaborating on its Resorts decision of ten years ago concerning payments to shareholders in a public leveraged buyout,1 the Court of Appeals for the Third Circuit recently ruled in In re Plassein Int’l, Corp.2 that the “settlement payment” exemption of section 546(e) of the Bankruptcy Code also insulates selling shareholders in a private LBO from fraudulent transfer liability.

Plassein involved an LBO launched in 1999 through which Plassein acquired various privatelyheld manufacturing companies. The shareholders of the acquired companies delivered their shares to Plassein, which directed its bank to wire payments for the shares to the shareholders’ private accounts at various banks.

Because in a leveraged buyout the buyer typically funds the acquisition of the target with borrowed money secured by the target’s assets, courts have long scrutinized and often found that such transactions result in fraudulent transfers, since a good part of the loan proceeds ends up in the hands of the selling shareholders, allegedly without any corresponding benefit to the indebted company. In Plassein, each acquired corporation pledged its assets to cover all of the money that Plassein borrowed for the inter-related leveraged buyouts; in doing so, each took on debts that far exceeded its assets. Shortly after the acquisitions, Plassein and the acquired companies defaulted on the acquisition loans. The companies first sought relief under chapter 11 of the Bankruptcy Code, but the cases ended up as chapter 7 liquidations.

The chapter 7 trustee sued to recover the shareholder payments as fraudulent transfers under Delaware law, using section 544 of the Bankruptcy Code. The shareholders moved to dismiss, claiming chiefly that the loan payments qualified as “settlement payments” under section 546(e). That section provides a safe harbor for a “settlement payment” by or to a financial institution, which, as defined by section 741, includes a payment commonly used in the securities trade.3 The Bankruptcy Court, relying on the Third Circuit’s 1999 decision in Resorts, granted the motions to dismiss and agreed that the payments constituted “settlement payments” for purposes of section 546(e) and the District Court affirmed.4

At the Third Circuit level, the arguments centered on the meaning of Resorts. As noted, that case involved a publicly-traded corporation purchased in an LBO. In reviewing a fraudulent transfer challenge to the shareholder payments, the Resorts Court of Appeals rejected reading “settlement payment” to require a payment through the securities settlement system and rejected as well the argument that the 546(e) safe harbor did not apply when a financial institution functions merely as a payment conduit. It concluded that in the securities trade, a “settlement payment is generally the transfer of cash or securities made to complete a transfer payment”5 and decided that, “[a] payment for shares during an [LBO] is obviously a common securities transaction” and thus a settlement payment for purposes of section 546(e).”6 In immunizing the shareholder payments from avoidance and recovery, the Third Circuit acknowledged that the financial institutions involved in effecting the payments played a very limited role in the transaction, but it found that the definition of “settlement payment” included the banks’ implementation of those shareholder payments.

In Plassein, the trustee tried to deal with Resorts by arguing for a public versus private distinction. Resorts should not apply because the rule of Resorts only protected public, not private, LBO payments to shareholders, the trustee argued. The trustee also argued that Resorts had interpreted the phrase “securities trade” too broadly; that term, the trustee maintained, refers to “the industry dealing in publicly-traded securities”—an industry limited to the business of buying and selling publicly-traded securities or transactions made for securities in the actual public securities market.

While acknowledging that for more than twenty years courts had applied the fraudulent transfer laws to LBOs, the Third Circuit in Plassein rejected the trustee’s public versus private distinction. Consistent with Resorts and reiterating its reasoning in that case, it once again broadly read the term “settlement payment” under section 546(e)—this time to include settlement payments made to selling shareholders of private companies through a financial institution that acted only as a payment conduit.