In February 2018, the U.S. Supreme Court issued an opinion that, at first blush, appeared to severely curtail the scope of the transferee protections provided by Section 546(e) of the Bankruptcy Code, the “safe harbor” provision that shields specified types of payments from a bankruptcy trustee’s avoidance powers, including transfers “made by or to (or for the benefit of)” a “financial institution” in connection with a “securities contract.” A recent decision from the Second Circuit breathes fresh life into the defense.

Before 2018, courts of appeal had long been divided over whether the Section 546(e) safe harbor applied to protect transfers made in connection with a securities contract when neither the debtor/transferor nor the ultimate transferee was a qualifying financial institution — that is, when the only financial institutions involved in the transaction were banks, brokers, or other entities serving only as intermediaries or conduits. In Merit Management Group, L.P. v. FTI Consulting, Inc., 138 S.Ct. 883 (2018), the Supreme Court construed the safe harbor narrowly, holding that “the relevant transfer for purposes of the § 546(e) safe harbor is the overarching transfer that the trustee seeks to avoid.” Thus, if the trustee sought to avoid a transfer from a debtor, “A,” to an entity that was not a financial institution, “D,” it did not matter that the transfer may have passed through the hands of intermediaries, “B” and “C,” that were financial institutions — the transfer would not be safe-harbored.

The Supreme Court’s decision in Merit threatened to eliminate a defense frequently asserted by, among others, cashed-out shareholders in leveraged buyouts (LBOs), who will often both tender their shares and receive their distributions through financial institutions, e.g., banks. Left unaddressed by Merit, however, was a lingering argument that the shareholders themselves might qualify as financial institutions by virtue of a quirk of the statutory language, which appeared to leave room for treating nonfinancial institutions as financial institutions so long as they were customers of financial institutions in connection with a securities contract.

The Second Circuit, in its recent decision in the long-running fraudulent transfer litigation arising out of the failed LBO and ultimate bankruptcy of Tribune Company, becomes the first circuit court to address that argument. In In re Tribune Company Fraudulent Conveyance Litigation, 2019 WL 6971499 (2d Cir. Dec. 19, 2019) (Tribune II), the Second Circuit, adopting a plain-language analysis, held that a customer of a financial institution in connection with a securities contract is, indeed, a financial institution itself for purposes of the Section 546(e) safe harbor. As a result, because various financial institutions had served as intermediaries in the Tribune LBO, and because Tribune was a customer of such institutions, the cashed-out Tribune shareholders were able to avail themselves of the protections of Section 546(e).[1]

The Second Circuit’s decision greatly expands the reach of the Section 546(e) safe harbor, and is likely to return the focus, in many cases, to the issue — perhaps previously perceived as mooted by Merit — of whether a financial institution served as intermediary in connection with a securities contract. If so, and if the initial transferor or final transferee in the transaction was a customer of such financial institution, then the transfer may be protected by Section 546(e).

Section 546(e) and Merit

The Bankruptcy Code vests trustees (and other estate representatives) with various powers of avoidance, including the power to assert claims for the avoidance of fraudulent or preferential transfers. However, Section 546(e) of the Bankruptcy Code provides, in relevant part, that a trustee may not avoid a transfer that is “made by or to (or for the benefit of) a … financial institution … in connection with a securities contract.” 11 U.S.C. § 546(e).

The safe harbor, enacted in its present form by the Financial Netting Improvements Act of 2006, Pub. L. 109-390, 120 Stat. 2692 § 5 (Dec. 12, 2006), has generated significant litigation, including over the meaning of the words “by or to (or for the benefit of).” Prior to Merit, the Seventh and Eleventh Circuits had held that a financial institution must be more than an intermediary in a challenged transaction for the safe harbor to apply (reasoning, in essence, that a transfer was “to” a financial institution only if the institution was the ultimate recipient of the transfer), while the Second, Third, Sixth, Eighth and Tenth Circuits had held to the contrary (reasoning, in essence, that a transfer was “to” a financial institution so long as the institution was a link in the chain of custody).[2]

The Supreme Court took up the issue in Merit, a fraudulent transfer case in which the Court was asked to determine “how the safe harbor operates in the context of a transfer that was executed via one or more transactions, e.g., a transfer from A → D that was executed via B and C as intermediaries, such that the component parts of the transfer include A → B → C → D.” Merit, 138 S.Ct. at 888. A unanimous Court concluded that “[t]he language of § 546(e), the specific context in which that language is used, and the broader statutory structure all support the conclusion that the relevant transfer for purposes of the § 546(e) safe harbor inquiry is the overarching transfer that the trustee seeks to avoid under one of the substantive avoidance provisions,” id. at 892-93 — i.e., in the given example, the transfer from A → D.

At the time of its issuance, Merit was widely perceived as eliminating, or at least severely constraining, a fraudulent conveyance and preference defense upon which potential defendants in multiple jurisdictions had come to rely. The opinion itself, however, was not quite so definitive. Buried in footnote 2 was the suggestion of an argument — left unaddressed — with the potential to reinvigorate the safe harbor, perhaps to a breadth nearly coextensive with its previous scope. The parties, the Court pointedly observed, “do not contend that either the debtor or petitioner in this case qualified as a ‘financial institution’ by virtue of its status as a ‘customer’ under § 101(22)(A). ... We therefore do not address what impact, if any, § 101(22)(A) would have in the application of the § 546(e) safe harbor.” Merit, 138 S.Ct. at 890 n.2.


The Tribune litigants wasted little time in joining issue on the “customer” argument referenced in Merit’s footnote 2. The Second Circuit had previously held that the Section 546(e) safe harbor shielded Tribune’s cashed-out former shareholders from constructive fraud claims because (among other reasons) the payments passed through financial intermediaries. See In re Tribune Co. Fraudulent Conveyance Litig., 818 F.3d 98, 112, 120 (2d Cir. 2016). In the wake of Merit, however, the Tribune plaintiffs asked the Second Circuit to recall its mandate and vacate its earlier decision. In opposition, the shareholder defendants contended that the payments remained safe-harbored because the transfers were made by Tribune, a “customer” of a financial institution.

The shareholders’ argument turned on the meaning of “financial institution,” a term defined in relevant part as follows:

a Federal reserve bank or an entity that is a commercial or savings bank, industrial savings bank, savings and loan association, trust company, federally-insured credit union, or receiver, liquidating agent, or conservator for such entity and, when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer (whether or not a “customer” as defined in section 741) in connection with a securities contract (as defined in section 741) such customer

11 U.S.C. § 101(22)(A) (emphasis added). Pointing to the emphasized language, the shareholders contended that Tribune, as a customer of a financial institution in connection with the LBO, was a financial institution itself, and was thus covered by the Section 546(e) safe harbor.

The Second Circuit agreed. Addressing an issue of first impression, the court concluded (i) that the definitional language of Section 101(22) did indeed include customers of financial institutions within its scope, (ii) that the ordinary meaning (i.e., dictionary definition) of “customer” was either “someone who buys goods or services” or “a person … for whom a bank has agreed to collect items,” and (iii) that Tribune, which had retained a bank to act as depositary in the LBO, receiving tendered shares and paying the tendering shareholders, fit this plain-meaning definition of the term “customer,” had employed the depositary in question as its agent, and was therefore a financial institution itself.

Accordingly, notwithstanding Merit’s rejection of earlier Second Circuit precedent holding that the mere presence of a financial institution as an intermediary was sufficient to trigger the safe harbor, the Second Circuit adhered to its bottom-line ruling that the Tribune plaintiffs’ constructive fraud claims against the cashed-out shareholders were barred. See Tribune II, 2019 WL 6971499, at *4, 9 (vacating Tribune I, but concluding that payments remained subject to the safe harbor).[3]


Tribune II is but the first of what are sure to be many decisions examining the meaning of Section 101(22)(A) and its reference to “customer.” (Indeed, the plaintiffs in Tribune II have since petitioned for rehearing.) If the Second Circuit’s reasoning comes to represent the prevailing view, however, the decision threatens to undo much, if not all, of the narrowing of the Section 546(e) safe harbor that was wrought by the Supreme Court in Merit. Merit held that it was not enough, for safe harbor purposes, that a financial institution serve as mere intermediary — but Tribune II now holds that it is enough to trigger the safe harbor if the original transferor or final transferee is a customer of such a financial institution intermediary.

Individual cases may vary, of course. It will not be the case, in every transaction, that the mere presence of a bank triggers the safe harbor, as the transferee or transferor must still be a customer of the bank in connection with a securities contract, and the bank must have acted as agent or custodian. Moreover, it is unclear from the definition of “financial institution” that a customer of a “commercial or savings bank” — as opposed to a “Federal reserve bank” — may qualify as a financial institution, as the “customer” clause of the definition refers only to the latter. Compare 11 U.S.C. § 101(22)(A), first clause (defining “financial institution” to include “a Federal reserve bank or an entity that is a commercial or savings bank”) with id., second clause (including also a customer “when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer …”) (emphases added). In addition, some courts may find (in contrast to the Second Circuit) that the Supreme Court in Merit could not possibly have intended that its narrowing of the Section 546(e) safe harbor be so easily vitiated by an argument that the Court itself acknowledged in a footnote.

Nevertheless, for the time being, Tribune II represents a dramatic, and perhaps unexpected, extension of the safe harbor from the position it occupied in the immediate aftermath of Merit.