The United States Court of Appeals for the Second Circuit (the “Second Circuit”) recently followed the emerging trend of affording the safe harbor protections of section 546(e) of the Bankruptcy Code (the “Code”) to intermediary financial institutions acting as only conduits in otherwise voidable transactions. By explicitly holding that a financial intermediary does not need to retain a beneficial interest in the transaction in order for it to qualify for exemption from avoidance, the Second Circuit resolved any ambiguity left in this regard by its Enron decision and followed the development advanced by the third, sixth, and eighth circuit courts.  

THE TRUSTEE’S AVOIDANCE POWER AND SECTION 546(e)  

Section 547 of the Code permits the bankruptcy trustee to avoid transfers that occur during the ninety days preceding the filing of a bankruptcy petition and that give the transferee an advantage to which it is not entitled. This provision allows the trustee to effectuate the two policy goals of bankruptcy law: the preservation of the bankruptcy estate and the even-handed treatment of creditors. The trustee’s avoidance power, however, is not without limitation. For example, section 546(e) of the Code provides two relevant exceptions to the trustee’s avoidance power: first, for settlement payments made by, to, or for the benefit of a financial institution and second, for transfers made by, to, or for the benefit of a financial institution in connection with a securities contract.  

THE QUEBECOR DECISION  

In 2000, Quebecor World Capital Corporation (“QWCC”), a subsidiary of the Canadian printing company Quebecor World, Inc. (“QWI”), raised $371 million for QWI’s subsidiaries through an issuance of private placement notes. The notes were issued pursuant to two Note Purchase Agreements (the “NPAs”) which provided that Quebecor affiliates had an option to purchase the notes under certain circumstances and contemplated an acceleration of the notes’ maturity if QWI failed to maintain a specified debt-to-capitalization ratio. During 2007, the financial health of the Quebecor enterprise began to deteriorate. With the acceleration of the notes’ maturity and related financial hardships looming, another QWI subsidiary, Quebecor World (USA), Inc. (“QWUSA”), exercised its option to purchase the notes. QWUSA completed the purchase by transferring $376 million to CBIC Mellon, the indenture trustee in the transaction. CBIC Mellon subsequently disbursed the funds to the noteholders. Less than ninety days after the transfer to CBIC Mellon, QWUSA filed for bankruptcy.  

The Official Committee of Unsecured Creditors filed an adversary proceeding against the noteholders and sought to avoid and recover QWUSA’s transfer to CBIC Mellon pursuant to section 547 of the Code as a preferential payment. The noteholders filed a motion for summary judgment. The United States Bankruptcy Court for the Southern District of New York granted the noteholders’ motion for summary judgment and held that the $376 million transfer qualified for exemption as both a “settlement payment” and a “transfer made to a financial institution in connection with a securities contract” under section 546(e), regardless of whether the notes were redeemed or purchased.  

On appeal, the United States District Court for the Southern District of New York held that the notes were purchased by QWUSA. Consequently, the District Court ruled that the transfer qualified for the “settlement payment” and “securities contract” exemptions under section 546(e) and affirmed summary judgment. The District Court, however, disagreed that a transfer to a financial institution to redeem securities could qualify for the securities contract exemption, on the basis that section 546(e) does not extend to contracts for the redemption of a security because the term securities contract “is limited to contracts for the purchase, sale, or loan of a security.”  

The Committee appealed the District Court’s decision to the Second Circuit. After conducting a plenary review of the District Court’s rulings, the Second Circuit agreed that the notes were purchased because the NPAs provided for both the notes’ initial purchase by the noteholders and QWUSA’s “repurchase.” Therefore, the Second Circuit held, QWUSA’s $376 million transfer “fit squarely” into the wording of the securities contract exemption and affirmed the judgment of the District Court holding that the purchase was exempt as a transfer made by or to a financial institution in connection with a securities contract.  

FINANCIAL INTERMEDIARIES NEED NOT RECEIVE A BENEFICIAL INTEREST IN THE TRANSFER

The Committee argued that some of the transfers were not exempt from avoidance because CBIC Mellon merely acted as a conduit in the transaction and some of the appellees were not “financial institutions.” The Second Circuit was not persuaded by this argument and pointed to its Enron decision, the plain language of section 546(e), and cases in the third, sixth, and eighth circuits to hold that a “transfer may be either for the benefit of a financial institution or to a financial institution but need not be both.” Accordingly, the transfer was exempt from avoidance because it was made to CBIC Mellon, in its capacity as indenture trustee for the benefit of the holders of the notes.  

CONCLUSION  

While intermediary financial institutions and investors can take some comfort in the Quebecor decision and the trend to which it subscribes, it is not yet clear whether other courts around the country will follow the approach of the Second Circuit or whether a split in authority will emerge. There continue to be substantial differences within and among the circuits regarding the treatment of private securities transactions and transactions that involve dollar amounts that are likely to have a palpable impact on securities markets. With these issues in mind, investors contemplating the purchase of securities should be mindful of pertinent circuit law. Nothing is guaranteed while the law continues to evolve but Quebecor, at least, provides a plausible avenue for utilizing a financial institution as an intermediary. Financial institutions that regularly serve as indenture trustees should be mindful of the details of the agreements underlying the transaction so as not to place themselves at risk unintentionally.