Bankruptcy Update Blog

Former Tribune Shareholders Still Merit Safe Harbor Upon Revision

We have noodled on the impact that the Supreme Court’s decision in Merit Management Group, LP v. FTI Consulting, Inc.,[1] which held that the safe harbor provided in Section 546(e) of the Bankruptcy Code does not apply when the financial institutions[2] involved in a transaction are mere conduits or intermediaries, might have on “[t]he long-running litigation spawned by the leveraged buyout of Tribune Company . . . and the subsequent bankruptcy case.”[3]  So far, after a December decision by the Court of Appeals for the Second Circuit, the answer is: not much.

In 2016 the Court of Appeals had dismissed a fraudulent conveyance avoidance action commenced by creditors against former Tribune shareholders (among others) by applying its pre-Merit expansive interpretation of Section 546(e) under which the presence of a financial institution (as defined in note 2) even as a mere conduit would suffice.  Post-Merit, it has now issued an amended decision reaching the same result--the safe harbor of Section 546(e) shelters the defendants from liability.[4]

How did it reach that outcome despite Merit?  The Section 546(e) safe harbor applies to

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 . . ., commodity contract . . . or forward contract

and the financial institution (as defined in note 2) is not acting as a mere conduit or intermediary.[5]  “[F]inancial institution,” in turn, is defined in Section 101(22)(A) in relevant part as--

an entity that is a commercial . . . bank . . . [or] trust company . . . and, when any such . . . entity is acting as agent or custodian for a customer . . . in connection with a securities contract . . . such customer . . . .[6]

In other words, the customer for which a bank or trust company is acting as agent or custodian in connection with a securities contract is a “financial institution” (as defined in Section 101) for the purpose of satisfying the requirement for the application of Section 546(e) that a financial institution (as defined in note 2) be a party to or beneficiary of the “overarching transfer.”[7]

Tribune, the Court held, was exactly such a customer.  It contracted with an entity that was both a bank and a trust company to act as its agent[8] to hold and then disburse the LBO consideration in exchange for the shares it was acquiring.[9]  But was such use of an agent “in connection with a securities contract”?  Appellants argued that the approximately half of the LBO consideration that was used to redeem shares (rather than to purchase them in a more conventional sense) was not disbursed “in connection with a securities contract.”  The Court disagreed.  A redemption of shares is a repurchase of those shares, so a contract to redeem shares easily fits within the Code’s broad definition of a “securities contract,” and the redemption payments are sheltered in the safe harbor to the same extent as the ordinary purchase payments.[10]

[1]  583 U.S. __, 138 S. Ct. 883 (2018).

[2]  “Financial institution” is used here and sometimes elsewhere in this post as my shorthand for § 546(e)’s “commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency.”

[3]  Quotation from "Something New Under the Sun?" September 8, 2017.  See Major Section 546(c) Safe Harbor Issue Resolved by the Supreme Court February 28, 2018.

[4]  In re Tribune Co. Fraudulent Conveyance Litigation, 946 F.3d 66 (2d Cir. Dec. 19, 2019).  The Court also held that defendants in an avoidance adversary proceeding in which the plaintiff is not a trustee or trustee surrogate may benefit from the safe harbor; that issue is not further discussed in this post.

[5]  Many of the terms used in § 546(e) are defined elsewhere in the Code.

[6]  Section 101(22)(A) incorporates the definition of “securities contract” from § 741 but expressly rejects the application of the definition of “customer” also found in § 741, thereby requiring use of the “ordinary meaning” of that word.  946 F.3d at 78.

[7]  Merit Management, 138 S. Ct. at 888, 892-93, 897.

[8]  “Agent” is not defined in the Code, so the Court applied the “common-law meaning” of that term.  946 F.3d at 79.

[9]  Id. at 78-80.

[10]  Id. at 80-81.