Discussing: Holliday v. Credit Suisse Securities (USA) LLC, No. 20-5404 (S.D.N.Y. Sept. 13, 2021)
Subject to certain defenses, in a bankruptcy proceeding, transfers made to a creditor within 90 days of the transferor filing bankruptcy can be clawed back as a preference under the Bankruptcy Code. In addition, transfers deemed fraudulent transfers within four years under the Uniform Fraudulent Transfer Act (State Law) or two years under the Bankruptcy Code can be clawed back.
Safe Harbor Defense
One of the defenses that can be asserted when the Bankruptcy Trustee seeks to avoid a “settlement payment” made to equity holders is what is known as the “Safe Harbor” defense under Section 546(e) of the Bankruptcy Code. Section 546(e) provides that that a trustee may not avoid a “settlement payment . . . made by or to (or for the benefit of) . . . a financial institution.” Generally speaking, a settlement payment is defined under the Bankruptcy Code as a payment made on account of a securities trade. Section 546(e) was intended to protect financial institutions when payments are made to equity on account of a settlement payment.
Recently, the U.S. Supreme Court in Merit Management Group LP v. FTI Consulting Inc., 138 S. Ct. 883 (2018), restricted this defense, holding that the presence of a financial institution as a conduit in the chain of payments in a leveraged buyout was insufficient to invoke the safe harbor when the “the relevant transfer for purposes of the Section 546(e) safe-harbor inquiry is the overarching transfer that the trustee seeks to avoid.” Id. at 888, 893. In other words, the Supreme Court focused on the “end to end” transfer from the acquiring entity to the defendant shareholder – as opposed to “any component part of that transfer” – the transfer between the Intermediaries. Id. at 893.
Expanding the Safe Harbor Defense?
Yet, the U.S. District Court in Holliday v. Credit Suisse Securities (USA) LLC, No. 20-5404 (S.D.N.Y. Sept. 13, 2021) (affirming the bankruptcy court decision), seemed to expand the Safe Harbor defense. As part of its recapitalization, the operating company transferred loan proceeds to the bank account of its holding company, which then transferred the loan proceeds to a second bank, which then distributed the loan proceeds to its shareholders in consideration of redemption of warrants and equity interests to pay a dividend.
The liquidating Trustee of the Debtor sought to claw back the loan proceeds from the banks. To avoid the ramifications of Section 546(e), the Trustee argued that relevant transfer was the transfer from the operating company to the holding company and therefore the transfer was not a settlement payment for securities.. The district court disagreed. The court found the transfer to the initial bank account of the holding company and then the transfer to the second bank account, which was the account where the distributions were made to the shareholders, was one transaction. Thus, the transfer from the second bank account was a settlement payment that invoked the safe harbor under Section 546(e).
In doing so, the district court found the holding company was a financial institution by invoking the provisions under Section 101(22) of the Bankruptcy Code. Under this section, if a financial institution acts as an agent of a non-financial institution, then the non-financial institution becomes a financial institution.
Thus, by finding that the holding company was a financial institution, the shareholders were able to invoke the Safe Harbor provisions under Section 546(e) and avoid the consequences of a claw back.
Looking ahead, if an entity transfers funds to its equity holders in consideration of a settlement payment, it may want to use its financial institutions as conduits with instructions to transfer the funds to its shareholders.