Section 546(e) of the Bankruptcy Code's "safe harbor" preventing avoidance in bankruptcy of certain securities, commodity, or forward-contract payments has long been a magnet for controversy. Several noteworthy court rulings have been issued in bankruptcy cases addressing the application of the provision, including application to financial institutions, its preemptive scope, and its application to non-publicly traded securities.One of the latest chapters in the ongoing debate was written by the U.S. District Court for the Southern District of Indiana in Petr v. BMO Harris Bank N.A., 2023 WL 3203113 (S.D. Ind. May 2, 2023), appeal filed, No. 23-1931 (7th Cir. May 17, 2023). The district court broadly construed the section 546(e) safe harbor to bar a chapter 7 trustee from suing under state law and section 544(b) of the Bankruptcy Code to avoid an alleged constructive fraudulent transfer made by the debtor shortly after it had been acquired in a leveraged buy-out ("LBO"). According to the district court: (i) all of the agre

In 2019, the U.S. Court of Appeals for the Second Circuit made headlines when it ruled that creditors' state law fraudulent transfer claims arising from the 2007 leveraged buyout ("LBO") of Tribune Co. ("Tribune") were preempted by the safe harbor for certain securities, commodity, or forward contract payments set forth in section 546(e) of the Bankruptcy Code. In that ruling, In re Tribune Co. Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019), cert. denied, 209 L. Ed. 2d 568 (U.S. Apr. 19, 2021) ("Tribune 2"), the Second Circuit also concluded that a debtor may itself qualify as a "financial institution" covered by the safe harbor, and thus avoid the implications of the U.S. Supreme Court's decision in Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018), by retaining a bank or trust company as an agent to handle LBO payments, redemptions, and cancellations.

On Feb. 27, 2018, the Supreme Court handed down a unanimous opinion, authored by Justice Sotomayor, resolving a Circuit split over the interpretation of Section 546(e) of the Bankruptcy Code, the “safe harbor” provision that shields specified types of payments “made by or to (or for the benefit of)” a financial institution from avoidance on fraudulent transfer grounds. Bankruptcy Code Section 546(e) provides that a debtor or trustee cannot avoid settlement payments, payments made in connection with a securities contract, or certain other specified types of transfers if “made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency . . . .” 11 U.S.C. Section 546(e) (emphasis added). Courts of appeal have been divided for decades over whether this safe harbor applies when neither the debtor/transferor nor the ultimate transferee is a financial institution — that is, when the only financial institutions involved in the transaction are banks, brokers, or other institutions serving merely as intermediaries or conduits in connection with a transfer.

On February 27, 2018, the Supreme Court of the United States issued a unanimous decision delivered by Justice Sotomayor holding that a party otherwise subject to an avoidance action under the Bankruptcy Code is not shielded from such avoidance by virtue of the safe harbor under 11 U.S.C. § 546(e) simply because one or more financial institutions were conduits for such transfer. The Court explained that, for purposes of applying the § 546(e) safe harbor, the only transfer that is relevant is the overarching end-to-end transfer sought to be avoided and the component parts of such transfer should be ignored.

In his final opinion, Judge Robert D. Drain of the United States Bankruptcy Court for the Southern District of New York held that dividends paid from proceeds of safe-harbored transactions under section 546(e) of the Bankruptcy Code are not safe-harbored. While only approximately 15 pages of Judge Drain’s 109-page final opus are dedicated to consideration of the section 546(e) issue, the relevant analysis ends with a pressing question to Congress and an appeal to modify section 546(e) to “restrict to public transactions its currently overly broad free pass . . . that has informed the playbook of private loan and equity participants to loot privately held companies to the detriment of their non-insider creditors with effective impunity.” The logic of the opinion poses a clear hurdle to private equity participants looking to protect their dividends by arguing that such dividends are part of an integrated transaction that is otherwise safe-harbored under section 546(e).The salient facts leading up to the opinion are as follows: debtor Tops II Holding Corporation (“Tops”) owned and operated 169 supermarkets in upstate New York, northern Pennsylvania and Vermont, employing about 14,000 people, including 12,300 union m

On the other hand, the trustee argued that the safe harbor’s reference to a “trustee” must be read to exclude actions like these, where the plaintiff purports to stand in the shoes of the debtor’s creditors and not as the statutory representative of the bankruptcy estate. Section 546(e) of the Bankruptcy Code provides, in relevant part, that: [T]he trustee may not avoid a transfer that is a margin payment . . . or settlement payment . . . 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 . . . .[emphasis added] 11 U.S.C. § 546(e). The bankruptcy court observed that the Second Circuit discussed the scope of the section 546(e) safe harbor provision in Tribune.

The Supreme Court’s recent decision in Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018), held that transfers made by or to entities that are not “financial institutions” or other covered entities fall outside the scope of 11 U.S.C. § 546(e)’s “safe harbor” from a trustee’s avoidance powers under the Bankruptcy Code, even if those transfers are made through financial institutions or other covered entities. In a unanimous decision, the Supreme Court jettisoned the majority view adopted by the Second, Third, Sixth, Eighth and Tenth Circuits, all of which applied the “safe harbor” to transactions made through covered entities.

Title 11 of the U.S. Bankruptcy Code contains provisions that allow some pre-bankruptcy transfers to be avoided, or "unwound," by a debtor in possession, trustee, or other party granted standing to do so. Among the types of transfers that may be avoided are fraudulent transfers, which arise when a bankrupt debtor previously transferred assets to another party while insolvent and for less than reasonably equivalent value.But the Bankruptcy Code also limits the scope of these avoidance powers. One limitation is 11 U.S.C. § 546(e), which contains a "safe harbor" that provides that "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." 11 U.S.C. § 546(e).

The United States Bankruptcy Court for the Southern District of New York (the “Court”) in Weisfelner v. Fund 1 (In Re Lyondell Chemical Co.), 2014 WL 118036 (Bankr. S.D.N.Y. Jan. 14, 2014) recently held that the safe harbor provision of 11 U.S.C. § 546(e) did not bar unsecured creditors from seeking, under state fraudulent transfer law, to recover payouts made to former shareholders of a company acquired in a leveraged buyout. This case highlights the limitations in section 546(e)’s so-called safe harbor provision, which protects settlement payments made to complete pre-bankruptcy securities contracts from later being attacked and avoided by the bankruptcy estate representative as fraudulent transfers.

On August 18, 2022, the United States Bankruptcy Court for the Southern District of Indiana, in In re BWGS, LLC, No. 19-01487-JMC-7A, 2022 WL 3568045 (Bankr. S.D. Ind. Aug. 18, 2022), narrowly interpreted the safe harbor provision in section 546(e) of the Bankruptcy Code by refusing to dismiss a lawsuit against a guarantor whose liability was eliminated by the debtor’s payment to the bank that held the guarantee.Overview on Section 546(e) of the Bankruptcy CodeCongress re-designated section 546(d) as § 546(e) in 1984,[1] and further amended the provision in December 2006 to clarify that the safe harbor applies to all transfers (other than actual fraudulent transfers) made to designated financial intermediaries in connection with their facilitation of trades executed through the Securities Clearance and Settlement System or the commodities clearance system.