Analyzing the inner workings of the elements required for the securities contract "safe harbor" protection under Section 546(e) of the Bankruptcy Code, the Bankruptcy Court for the SDNY dismissed a complaint seeking to recover approximately $1 billion in allegedly fraudulent transfers brought against various transferees as part of the Boston Generating Chapter 11 case. The Court found that the transfers at issue, $925 million in tender offer payments made to equity holders and $35 million dividends in a leveraged recapitalization, were safe harbored under Section 546(e) and thus excepted from avoidance and recovery. In reaching this conclusion, the Court relied on the debtor-transferors' status as "customers" of "financial institutions" and outlined the circumstances under which safe harbor protection would be available based on such status. See In re Boston Generating LLC, No. 10-14419 (SCC), 2020 WL 3286207 (Bankr. S.D.N.Y. June 18, 2020).
The Securities Safe Harbor—Brief Background
Pursuant to Section 546(e) of the Bankruptcy Code, certain
securities-related transfers are shielded from fraudulent transfer
attacks. To qualify for this safe harbor, the payments sought to be
avoided must be (i) qualifying payments, such as "settlement
payment[s]" or "transfer[s]...in connection with a
securities contract," and (ii) made by, or to (or for the
benefit of) a "financial institution."
The Bankruptcy Code's definition of "financial
institution" covers not only entities such as banks and loan
associations, but also the "customers" for whom such
entities are acting as agents or custodians "in connection
with a securities contract." In In re Tribune Co.
Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019), for
example, the Second Circuit held that the transferor-debtor
itself met the statutory definition of a "financial
institution" because it was a "customer" of a trust
company and bank that was acting as an agent for its customer (the
debtor) in connection with a securities contract.
Boston Generating—The Transfer Meets Section 546(e)
The fraudulent transfer complaint in Boston Generating
was brought by a trustee of a liquidating trust created to pursue
claims on behalf of the debtors' unsecured creditors. Among
other interesting issues, the Court focused on whether Section
546(e) applied to the transfers the trustee sought to avoid. The
Court concluded that it did, finding the
debtor-transferors—Boston Generating LLC and EBG Holdings
LLC—qualified as "financial institutions" by virtue
of their status as customers of "financial
institutions"—in this case, banks—in connection
with the challenged transfers.
The Court explained that "for the customer to qualify as a
financial institution, the bank that sends or receives the relevant
transfer must be acting as the customer's agent or custodian in
connection with a securities contract." The Court found that
this test was met because financial institutions—US Bank and
BONY—sent the applicable funds, as the transferors'
agents, in connection with the securities transfer. BONY acted as
the transferors' depository in connection with the tender offer
and the leveraged recapitalization, such that it was appointed to
receive the tendered membership interests, hold them for the
benefit of the transferors, and pay the tender price on behalf of
the transferors to the tendering members.
In reaching this conclusion, the Court analyzed the
transferors' relationships with the banks and found that an
agency relationship existed. Such relationship, the Court
explained, requires three elements, all of which were present: (1)
a manifestation by the principal that the agent shall act for it;
(2) acceptance of the undertaking by the agent; and (3) an
understanding between the parties that the principal is to be in
control of the undertaking. Of these elements, "the critical
element is control of the agent by the principal."
Finally, as required under Section 546(e), the Court concluded that the transfers themselves satisfied the statute's conditions. While Section 546(e) requires that the transfer be either a "settlement payment" or made "in connection with a securities contract," in this case both alternatives were met.
The Boston Generating decision follows in the footsteps
of the Second Circuit's Tribune precedent and
reinforces the broad application of Section 546(e) to securities
contracts among private parties, provided that the transfers were
made by or to a financial institution that, while merely an
intermediary, was acting as an agent or custodian for the
transferor or transferee.
Originally published June 26, 2020.
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