The Bankruptcy Code gives a bankruptcy trustee, or the debtor in possession, the power to “avoid” certain transfers made by the debtor at various times before filing for bankruptcy relief. Congress provided a number of limits on these significant avoidance powers, whether within the sections granting the powers themselves (e.g., in Section 547(c), which sets forth a number of transfers that a trustee or debtor may not avoid, and Section 547(b)’s statutory limitation with respect to potentially preferential transfers to non-insiders made beyond the 90 days preceding the bankruptcy filing) or in other sections of the Bankruptcy Code, such as Section 546, which is aptly entitled “Limitations on Avoiding Powers.” Subsection “(e)” of Section 546, which limits a trustee’s avoiding powers with regard to certain securities related transactions, has been the subject of noteworthy debate.

The implementation of Section 546(e)’s “safe harbor” provision was the central issue in Merit Management Group, LP v. FTI Consulting, Inc. In Merit, a racetrack casino, Valley View Downs, acquired another racetrack casino in Pennsylvania through a stock purchase transaction. In order to complete the transaction, Valley View arranged for a portion of the purchase price to be wired into the account of a third party escrow agent. Following closing, the third party escrow agent distributed funds as provided for by the parties’ purchase agreement, including to one of the seller’s shareholders, Merit Management Group. However, despite the foregoing stock acquisition, Valley View and its parent company ultimately filed a Chapter 11 bankruptcy.

Following confirmation of the plan of reorganization in Valley View and its parent’s bankruptcy, FTI Consulting, as trustee of the litigation trust, attempted to avoid those payments made to Merit by the third party escrow agent. FTI argued that such payments were constructively fraudulent. In response to FTI, Merit argued that because the payment it received was transferred to it from a financial institution, acting as an intermediary escrow agent, the payment was protected under the safe harbor in Section 546(e).

Courts have interpreted the safe harbor’s reach differently, with a majority of Circuit Courts of Appeal—the Second, Third, Sixth, Eighth, and Tenth Circuits—holding that the presence of a qualifying financial institution in a securities related transaction, even if acting as an intermediary or a conduit, is sufficient to trigger the protections of Section 546(e) for the entire transaction. A minority of Circuits that have addressed this issue—the Seventh and Eleventh Circuits—have held the opposite: that the mere presence of a qualifying financial institution in a securities related transaction, if only acting as a conduit or intermediary, is insufficient to trigger the safe harbor of Section 546(e). The Supreme Court granted certiorari from the Seventh Circuit in Merit and resolved this split of authority.

The Supreme Court sided with the minority of Circuits and affirmed the Seventh Circuit. In a unanimous decision, the Supreme Court held “that the only relevant transfer for the purposes of the [Section 546(e)] safe harbor is the transfer that the trustee seeks to avoid.” Said differently, the relevant transfer for the purposes of Section 546(e)’s safe harbor is the overarching transfer a trustee identifies for avoidance, rather than the intervening pass-through transfers that are part and parcel of that overarching transfer.

In reaching this conclusion, the Supreme Court began its analysis by looking at the statutory scheme of a trustee’s avoidance powers and the statutory history of Section 546, before turning to a textual analysis of the section. There, the Court emphasized that the text of Section 546(e) creates an exception to a transfer that would otherwise be avoidable. It reasoned that the “notwithstanding” clause, which lists each of the sections containing a trustee’s avoiding powers wholesale, signals that the safe harbor is intended to apply to the entirety of a trustee’s avoiding powers under such sections. Thus, the Court concluded, the starting point for determining the scope of the safe harbor is the trustee’s substantive avoiding powers and, “consequently, the transfer a trustee seeks to avoid as an exercise of those powers.”

The Supreme Court went on to identify other portions of the text that supported its analysis, such as the exception contained within the safe harbor which prevents its application to actually fraudulent transfers. The Court concluded that such an exception further signals Congress’ intent that the safe harbor applies to the overarching transfer, rather than a mere component part, by explicitly identifying an entire type of transfer that is outside the scope of the safe harbor. Memorably, the Supreme Court concluded its textual interpretation of Section 546(e) by stating, “Not a transfer that involves. Not at transfer that comprises. But a transfer that is a securities transaction covered under §546(e).”

The opinion concludes by discussing the role of Section 546(e) within the statutory structure of the Bankruptcy Code as a whole and then addressing and dismissing Merit’s counter arguments.

To be sure, given that the Supreme Court sided with the minority of Courts, those circuits which were abrogated by Merit will have to adjust their case law going forward. However, legal scholars are already speculating on the effect of the holding in Merit on leveraged-buyout transactions in bankruptcy and suggesting work-arounds. Accordingly, the long term effects of Merit remain to be seen.