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Two Clear-Cut Decisions of the Supreme Court – Narrowing Both Section 546(e)’s Securities Safe Harbor in Merit and the Standard of Review for Non-Statutory Insider Determinations in U.S. Bank

Merit Mgmt. Group, LP v. FTI Consulting, Inc., 583 U.S. __ (2018)

U.S. Bank Nat’l Ass’n v. Vill. at Lakeridge, LLC, 583 U.S. __ (2018)

On February 27, 2018, the United States Supreme Court issued its unanimous holding in Merit Management Group, LP v. FTI Consulting, Inc.  The Opinion, delivered by Justice Sotomayor, addressed a Congressional limitation placed on a trustee’s power to avoid certain transfers, such as preferential transfers under 11 U.S.C. § 547 or constructively fraudulent transfers under 11 U.S.C. § 548(a)(1)(B).  More specifically, section 546(e) of the Bankruptcy Code, dubbed the “securities safe harbor”, provides that “the trustee may not avoid a transfer that is a margin payment . . . or settlement payment . . . made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or a securities clearing agency [(together, “Financial Institutions”)], or that is a transfer made by or to (or for the benefit of) [Financial Institutions], in connection with a securities contract, that is made before the commencement of the case, except under section 548(a)(1)(A) of [the Bankruptcy Code, i.e. the avoidance of actual fraudulent transfers].”  This seemingly narrow exception has been broadly and liberally interpreted by certain courts, including those in the Third Circuit that have applied it to certain transfers made ultimately to non-Financial Institutions when the transfers implicated Financial Institutions.  See, e.g., In re Resorts Int’l, 181 F.3d 505 (3d Cir. 1999) (holding that the definition of “settlement payment” is broad and includes payments for publicly-traded shares during leveraged buyouts that implicate Financial Institutions); see also Brandt v. B.A. Capital Co. LP (In re Plassein Int’l Corp.), 590 F.3d 252 (3d Cir. 2009) (applying the Resorts holding to privately-traded shares).  For instance, in Merit, the trustee-respondent (“FTI”) sought to avoid as constructively fraudulent a transfer (the “Transfer”) of funds that flowed from a debtor (“Valley View”), through a funding institution (“Credit Suisse”), to a third-party escrow agent (“Citizens Bank”), and finally to the subject transferee-petitioner (“Merit”). Merit sought the protection of the securities safe harbor, asserting that the Transfer was a settlement payment “made by or to (or for the benefit of)” Financial Institutions – i.e. Credit Suisse and Citizens Bank.  While many arguments have been made by courts and parties in support of this application, the Merit Court decisively ruled against it, holding that the threshold matter for courts confronted with a section 546(e) defense is to determine the relevant transfer to be analyzed, which is the one that the trustee seeks to avoid.  In the case before the Court, the Transfer was the Valley View to Merit transfer – not the transfers from Valley View to Credit Suisse, Credit Suisse to Citizens Bank, or Citizens Bank to Merit.  Because neither Valley View nor Merit are Financial Institutions, section 546(e)’s securities safe harbor is inapplicable.

On March 5, 2018, the Supreme Court issued another unanimous Opinion in U.S. Bank National Association v. Village at Lakeridge, LLC, delivered by Justice Kagan with concurrences filed by Justices Kennedy and Sotomayor.  The narrow issue before the U.S. Bank Court was the correct standard of appellate review to be applied to a bankruptcy court’s determination of whether a particular person qualifies as a non-statutory insider.  According to the Court, this “mixed question” of law and fact requires a clear-error standard because answering the question entails primarily factual work – i.e. determining and applying relevant facts about the subject person and applying them to the established legal framework for identifying non-statutory insiders.  Interestingly, while the propriety of such legal framework applicable in the matter as set forth by the Ninth Circuit Court of Appeals was not a question before the Court, nor was the bankruptcy court’s application of the standard to the applicable facts, the concurring opinions called both into question.  Accordingly, practitioners should not forget to review the short concurrences by Justice Kennedy and Justice Sotomayor to pick up some helpful future arguments on these topics.