On February 27, 2018, the Supreme Court of the United States decided Merit Management Group, LP v. FTI Consulting, Inc., No. 16-784, holding that the only relevant transfer for purposes of the securities safe harbor provision in the bankruptcy code, 11 U.S.C. § 546(e), is the transfer that the trustee seeks to avoid, rather than the component parts of the transfer.
This bankruptcy decision arises out of the horse-racing business. In 2007, would-be racing casino Valley View Downs, LP agreed to purchase the stock of Bedford Downs Management Corporation, a company with which it had been competing for the last available harness-racing license in Pennsylvania. After Valley View was unable to secure another necessary gaming license in the time allotted for it to do so under a financing agreement, it and its parent company Centaur, LLC filed for Chapter 11 bankruptcy. The Bankruptcy Court confirmed a reorganization plan and appointed FTI Consulting, Inc. to serve as trustee of the Centaur litigation trust.
FTI Consulting thereafter filed a lawsuit against Merit Management to claw back $16.5 million in funds that Merit Management had received as a stockholder in Bedford Downs. As part of the stock acquisition agreement, Valley View had arranged for Credit Suisse to finance the transaction. Credit Suisse wired the purchase price to the Citizens Bank of Pennsylvania, which agreed to serve as the third-party escrow agent for the transaction. Merit Management, along with other Bedford Downs shareholders, deposited its stock certificates into escrow, and Citizens Bank of Pennsylvania distributed the purchase proceeds to stockholders including Merit Management.
In its defense to FTI’s clawback claim, Merit Management invoked the so-called “securities safe harbor” exception to the bankruptcy code, 11 U.S.C. § 546(e). The provision is an exception to the powers of a bankruptcy trustee to avoid, or “claw back,” certain transfers, and specifically precludes a bankruptcy trustee from clawing back transfers made “by or to (or for the benefit of)” certain entities, including financial institutions ” in connection with a securities contract.” According to Merit Management, the transfer of $16.5 million could not be clawed back by the trustee because it was made “by or to (or for the benefit of)” covered “financial institution[s],” specifically, Credit Suisse and Citizens Bank.
The district court agreed, reasoning that the § 546(e) safe harbor applied even when the covered entity was only a component part of the overall transfer. The United States Court of Appeals for the Seventh Circuit reversed, holding that the § 546(e) safe harbor did not apply to transfers made to financial institutions that served as “mere conduits.” The Supreme Court took the case to resolve a circuit split on the proper scope of § 546(e).
Ultimately, the Court concluded that the relevant transfer for purposes of the § 546(e) safe harbor is the same transfer that the trustee seeks to avoid. If an entity covered by the exception is only a “conduit” or a component part of an overall transfer, then the safe harbor does not apply. The Court based this holding on the specific language and context of the safe harbor exception, as well as the broader statutory structure. Here, the transfer the trustee sought to avoid was the transfer between Valley View and Merit Management, not the component transfers to and between the financial institutions. Because the parties did not assert that either Valley View or Merit Management was a “financial Institution,” or other covered entity, the transfer fell outside the § 546(e) safe harbor. The Court accordingly affirmed the Seventh Circuit and remanded the case for further proceedings.
Justice Sotomayor delivered the opinion for a unanimous Court.