Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018)
On February 27, 2018, Justice Sotomayer delivered the opinion for the Supreme Court in a 9-0 decision, that rejected an 11 U.S.C. § 546(e) safe harbor limitation on a trustee’s Section 548 fraudulent conveyance avoidance powers. Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018).
Chapter 5 of the Bankruptcy Code grants a trustee certain avoidance powers under Sections 544, 547, 548 and 550 to “claw back” pre-petition debtor transfers that were “of an interest of the debtor in property” from the recipients of those pre-petition transfers.
Defendants who have been sued pursuant to Sections 544, 547, 548 and 550 have potential fraudulent conveyance and/or preference defenses that need to be analyzed and asserted to limit the trustees powers.
In Merit, the trustee sought to avoid pursuant Section 548 as a constructive fraudulent conveyance a $16.5 million transfer from Valley View Downs, LP (“Valley View”), through various financial institutions, to Merit Management Group, L.P. (“Merit” or Merit Management”).
Merit Management, a shareholder and not a financial institution, asserted the securities safe harbor provision for financial institutions under Section 546(e) that the "the trustee may not avoid a transfer that is a ... settlement payment ... made by or to (or for the benefit of) a ... financial institution ... or that is a transfer made by or to (or for the benefit of) a ... financial institution ... in connection with a securities contract." Merit, 138 S.Ct. at 885.
In 2007, Valley View, a Pa. harness racing operation, entered into an agreement to purchase a competitor Bedford Downs Management Group (“Bedford”), for $55 million. Valley View financed the $55 million purchase price for Bedford’s shares through Credit Suisse, a financial institution. Bedford’s shareholders deposited their stock certificates with the third-party escrow agent Citizens Bank of Pennsylvania, a financial institution. Credit Suisse transferred on behalf of Valley View $55 million to Citizens Bank for the benefit of Bedford and its shareholders. Merit Management Group LP was Bedford’s largest shareholder and received $16.5 million. Id.
In 2010, after the Valley View purchase of Bedford and the transfers, Valley View’s parent company Centuar LLC filed a Chapter 11 bankruptcy petition in Delaware. Centuar LLC confirmed a plan in the Bankruptcy Court and FTI Consulting was appointed as the post-confirmation litigation trustee (the “Trustee”).
The Trustee strategically chose the Northern District of Illinois to file a Section 548(a)(1)(B) constructive fraudulent conveyance action against Merit Management seeking to avoid and claw back the $16.5 million transfer of Valley View to Merit. The Trustee argued Valley View was insolvent at the time of the transfer and Valley View “significantly overpaid” as the $16.5 million was in excess of the reasonably equivalent value of Merit’s shares. Id. at 891.
Merit argued that the $16.5 million was a “settlement payment”, pursuant to Section 546(e), “made by or to (or for the benefit of)” two “financial institutions,” Credit Suisse and Citizens Bank, and therefore not avoidable by the Trustee. Id. at 891, 892.
The District Court ruling on Merit’s Rule 12(c) motion for judgment on the pleadings, held in favor of Merit and the Section 546(e) safe harbor defense. Id.at 892; (see also 541 B.R. 850, 858 (N.D.Ill.2015)). The District Court focused on the financial institutions involvement in applying the safe harbor.
The Trustee appealed to the Seventh Circuit, and the Seventh Circuit overturned the District Court, and ruled in favor of the Trustee, “holding that § 546(e) did not protect the transfers in which financial institutions served as mere conduits.” Id. at 892, (see also 830 F.3d 690, 691 (2016)).
There was a split among the Circuits, as the Second, Third, Sixth, Eighth and Tenth Circuits followed the broad safe harbor interpretation of the District Court in favor of Merit. However, the Seventh and Eleventh Circuits followed the narrower interpretation of Section 546(e) that benefited the Trustee.
The Trustee did not file this action in Delaware, as the Third Circuit’s interpretation regarding Section 546(e) “provides an obstacle to pursuit of the Trustee’s avoidance actions against former shareholders”. Instead the Trustee filed in the Northern District of Illinois and appealed to the Seventh Circuit who held in favor of the Trustee.
Merit Management filed a writ of certiorari to the Supreme Court.
The Supreme Court addressed this question: “When determining whether the § 546(e) securities safe harbor saves the transfer from avoidance, should courts look to the transfer that the trustee seeks to avoid (i.e., A → D) to determine whether that transfer meets the safe-harbor criteria, or should courts look also to any component parts of the overarching transfer (i.e., A → B → C → D)?” Id. at 888.
The Supreme Court affirmed the Seventh Circuit and in favor of the Trustee, holding “[t]he only relevant transfer for purposes of the § 546(e) safe harbor is the transfer that the trustee seeks to avoid.” Id. at 886. The Trustee argued the transfer was (A) Valley View to (D) Merit. Id. at 886, 892. The Trustee’s position was “that transfer was not made by, to, or for the benefit of a financial institution”, so therefore the safe harbor provision did not apply. Id.
Merit argued the entire transfer was made by (A) Valley View to (B) Credit Suisse, to (C) Citizens Bank, to (D) Merit Management. Id. at 886, 892.
Neither Valley View or Merit Management argued that they were financial institutions. Id. at 887.
Merit was relying on Credit Suisse and Citizens Bank as the financial institutions in the entire transfer chain for the safe harbor provision to apply. The Supreme Court disagreed.
The Supreme Court held Credit Suisse and Citizens Bank were “simply irrelevant to the analysis”. Id. at 895. The Supreme Court affirmed the Seventh Circuit holding that the financial institutions, Credit Suisse and Citizens Bank, were “mere conduits” with no financial interest or “benefit” in the transfer, as the actual transfer was made by Valley View to Merit Management.
The Supreme Court stated for clarity that neither Valley View the transferor or Merit Management the transferee were financial institutions, but if either Valley View or Merit were a financial institution, then the safe harbor would have shielded the $16.5 million from avoidance. Id. at 896.
The Section 546(e) safe harbor provision did not apply, the entire $16.5 million was avoidable from Merit to pay to the Trustee.
The Supreme Court’s decision in Merit Management, may encourage other trustees or debtors to more aggressively pursue fraudulent conveyance actions against individuals, investors, investment funds or other entities that receive pre-petition transfers from the debtor.
The Supreme Court did not address or answer all the questions or other issues around Section 546(e), those shall remain for defendants to address in the future.
If you or your company has been sued in a preference or fraudulent conveyance action Cooch and Taylor is here to serve you, analyze your defenses, and represent you in Court.
Note the Results of Counsel’s Strategy. In 2012, this same Centaur Trustee filed a separate action against different Bedford shareholders in Florida, in the Eleventh Judicial Circuit which also favored the Trustee’s position on Section 546(e). However, the defendants moved to transfer the venue of the lawsuit to Delaware, (the location of the Debtors’ bankruptcy case), which was granted. The Third Circuit’s interpretation of Section 546(e) was against the Trustee’s position. So, in the Delaware Bankruptcy Court, the Trustee requested the re-transfer of the action back to Florida. Judge Carey denied the Trustee’s re-transfer motion. Three weeks later, in January 2015, the day before the Delaware hearing on defendants’ motion to dismiss the avoidance action based on Section 546(e), the Trustee voluntarily dismissed the $5 million dollar action. D.N. 39. Defendant’s counsel, knowing the case law of the Circuits on Section 546(e), made the wise strategic decision to transfer the Florida case to Delaware, and saved their clients millions of dollars. Delaware Bankruptcy Court, Adv. No. 12-50436.
 11 U.S.C. § 546(e): “(e) Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment, as defined in section 101, 741, or 761 of this title, or settlement payment, as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract, as defined in section 741(7), commodity contract, as defined in section 761(4), or forward contract, that is made before the commencement of the case, except under section 548(a)(1)(A) of this title.”
 Brandt v. B.A. capital Co., LP (In re Plassein Int’l Corp.), 590 F.3d 242 (3d Cir. 2009).
 Delaware Bankruptcy Court, Adv. No. 12-50436, D.N. 35, p. 2.