United States: The Seventh Circuit Holds Section 546(e) Does Not Extend To Conduits

Last Updated: August 11 2016
Article by Harris Winsberg and Brett D. Goodman

On July 28, 2016, the Seventh Circuit rendered an opinion in FTI Consulting, Inc. v. Merit Management Group, LP,1 holding that a transfer is not protected by the safe harbor provision of section 546(e) when a financial institution or other named entity acts merely as a conduit for the transferred funds. The decision, which sides with the Eleventh Circuit in Munford v. Valuation Research Corp. (In re Munford, Inc.),2 and strikes a further divide with five other circuits that have interpreted 546(e) to include a conduit situation, has practical implications for parties to securities transactions, and in particular shareholders that cashed out as part of a leveraged buyout.

Background

In 2003, Valley View Downs, a racetrack operator, acquired all of the shares of Bedford Downs for $55 million. Valley View borrowed the money to purchase Bedford Downs from Credit Suisse (and other lenders) and placed the funds with Citizens Bank, as escrow agent. Citizens Bank, in turn, transferred the funds upon the closing. After the closing, Valley View failed to obtain its gambling license and filed for bankruptcy under chapter 11.

FTI Consulting, Inc., as trustee, brought suit against Merit Management Group, a 30% shareholder in Bedford Downs, alleging that Valley View's transfer ultimately to Merit Management of approximately $16.5 million was avoidable under sections 544, 548(a)(1)(B), and 550 of the Bankruptcy Code as a constructive fraudulent transfer. Merit Management argued that that transfer was "made by or to (or for the benefit of)" an entity named in section 546(e) (namely, a financial institution) and therefore was protected by the safe harbor. The district court agreed with Merit Management that the transfer was "made by or to" a financial institution because the funds passed through Citizens Bank and Credit Suisse. FTI then appealed.

The Seventh Circuit Decision

The Seventh Circuit considered one question on appeal, whether the section 546(e) safe harbor protects transfers that are simply conducted through financial institutions (or the other entities named in section 546(e)), when the entity is neither the debtor nor the transferee but only the conduit. The Seventh Circuit held it did not and reversed the district court.

In arriving at its decision, the Seventh Circuit found that the phrases "by or to" and "for the benefit of" were ambiguous and it was unclear from the plain language of the statute whether the safe harbor was meant to include intermediaries. As a result, the court examined the statute's purpose and context for guidance. In doing so, the court agreed with FTI's arguments that (i) since the other sections of chapter 5 of the Bankruptcy Code established that only transfers made by the debtor prior to the bankruptcy petition are avoidable, transfers made by a named entity in section 546(e) should also refer to a transfer of property by the debtor, and (ii) because sections 544, 547, and 548 of the Bankruptcy Code refer to avoidance of transfers to or for the benefit of entities subject to fraudulent transfer liability, section 546(e)'s safe harbor must refer only to transfers made to a named entity that is a creditor. The court also relied on its prior decision in Bonded Financial Services, Inc. v. European American Bank,3 in which it found that a bank that acted as a financial intermediary and received no benefit was not a transferee under chapter 5 of the Bankruptcy Code. The court stressed that Merit Management's alternative interpretation of the safe harbor "would be so broad as to render any transfer non-avoidable unless it were done in cold hard cash, ... ."4

The Seventh Circuit also examined the legislative history of section 546(e) and concluded that none of the actions taken by Congress indicated that the safe harbor applied to covered institutions in their capacity as intermediaries. According to the court, "[a]lthough we have said that section 546(e) is to be understood broadly, ... that does not mean that there are no limits. While Valley View's settlement with Bedford resembled a leveraged buyout, and in that way touched on the securities market, neither Valley View nor Merit were 'parties in the securities industry.' They are simply corporations that wanted to exchange money for privately held stock."5 Recognizing that the purpose of the safe harbor was to reduce systemic risk in the financial markets, the court was not troubled that there would be any ripple effect from the return of the funds to FTI.

Finally, the court disagreed with Merit Management's argument that Congress disapproved the Eleventh Circuit's opinion in Munford finding 546(e) inapplicable to conduits by passing the 2006 Amendment adding "(or for the benefit of)" to the statute. The Seventh Circuit reasoned that Congress would not have jettisoned the ruling in such a subtle and circuitous manner, but would have instead provided that acting as a conduit qualified.

Practical Considerations

The decision represents a win for bankrupt estates seeking to avoid transfers made to shareholders as part of a leveraged buyout, particularly with respect to shares held privately. Shareholders may now be at risk (at least in the Seventh and Eleventh Circuits) that trustees may seek to recover transfers under a constructive fraudulent transfer theory. As a practical matter, given the split in authority and the potential for forum shopping, disputes among stakeholders regarding where a company should file for bankruptcy may arise. The circuit split in authority also makes this an issue to monitor closely since a decision by the Supreme Court would have profound ramifications on the scope of the safe harbor and leverage buyouts.

Footnotes

1 No. 15-3388, 2016 U.S. App. LEXIS 13705 (7th Cir. July 28, 2016).

2 98 F.3d 604 (11th Cir. 1996).

3 838 F.2d 890, 893 (7th Cir. 1988).

4 2016 U.S. App. LEXIS 13705, at *11.

5 Id . at * 15-16.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Harris Winsberg
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions