Supreme Court Resolves Circuit Split Over Application of Section 546(e) to Transactions Involving Conduits

Alerts / May 31, 2018

The Supreme Court’s recent decision in Merit Mgmt. Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018), held that transfers made by and to entities that are not “financial institutions” or other covered entities fall outside of the scope of the § 546(e) safe harbor even if they are made through financial institutions or other covered entities. The Supreme Court’s decision resolves a circuit split over how the § 546(e) safe harbor applies to transactions involving conduit entities and could impact future disputes involving safe harbors under the Bankruptcy Code.

FTI Consulting (“FTI”), acting as trustee of the Centaur, LLC Litigation Trust, brought a fraudulent transfer claim against Merit Management Group, LP (“Merit”). FTI sued Merit to recover approximately $16.5 million paid to Merit in connection with a cash-for-stock agreement involving the sale of Bedford Downs Management Corp. (“Bedford Downs”).

In 2002, Bedford Downs and Valley View Downs, LP (“Valley View”) both wanted to open a “racino,” or a racing facility with slot machines, in Pennsylvania. In order to do so, both entities needed to obtain two licenses—a harness-racing license (for racing) and a gaming license (for the slot machines). However, there was only one harness-racing license available in Pennsylvania. In order to ensure that it obtained this license, Valley View entered into a transaction to acquire Bedford Downs.

This transaction involved multiple entities and steps. First, Valley View borrowed funds from Credit Suisse and some other lenders. Credit Suisse then wired $55 million to Citizens Bank of Pennsylvania (“Citizens”), a third-party escrow agent. Bedford Downs’ shareholders, including Merit, deposited their stock certificates into escrow with Citizens. At closing, Valley View received Bedford Downs’ stock certificates from escrow, and Citizens disbursed funds to the shareholders. Merit received approximately $16.5 million for its stock in Bedford Downs.

With Bedford Downs out of the running, Valley View obtained the harness-racing license. Valley View, however, did not obtain the gaming license in the time set out in its financing package. As a result, Valley View and its parent company, Centaur, LLC, filed for bankruptcy. The Bankruptcy Court confirmed a reorganization plan that created the Centaur, LLC Litigation Trust and appointed FTI as trustee. FTI then sought to avoid as constructively fraudulent the $16.5 million transfer from Valley View to Merit for the sale of the Bedford Downs stock.

Merit moved for judgment on the pleadings and asserted that the $16.5 million transfer fell within the § 546(e) safe harbor. Section 546(e) operates as an exception to a trustee’s avoidance powers for a “settlement payment … made by or to (or for the benefit of)” a covered “financial institution … in connection with a securities contract.” Merit argued that the $16.5 million transfer was made by or to (or for the benefit of) Credit Suisse and Citizens and could not be avoided even if FTI proved that the transfer was constructively fraudulent.

FTI did not dispute that the transfer was a “settlement payment,” that it was made “in connection with a securities contract,” or that Credit Suisse and Citizens are “financial institutions.” FTI, however, argued that Credit Suisse and Citizens were mere conduits and had no beneficial interest in the funds, such that the transfer was not “made by or to (or for the benefit of)” of either institution. Rather, FTI asserted that the transfer was made by Valley View to or for the benefit of Merit. FTI argued that since neither Valley View nor Merit is a “financial institution” or other entity named in § 546(e), the safe harbor did not apply.

The District Court ruled in favor of Merit. See FTI Consulting, Inc. v. Merit Mgmt. Group, LP, 541 B.R. 850 (N.D. Ill. 2015). The District Court adopted what it termed the “Majority Position” and found that the § 546(e) “safe harbor” barred FTI from avoiding the $16.5 million transfer even if Credit Suisse and Citizens acted as an “intermediary or conduit.” Id. at 855. The District Court reasoned that the § 546(e) safe harbor applied since financial institutions—i.e., Credit Suisse and Citizens—“transferred or received funds in connection with a ‘settlement payment’ or ‘securities contract.’” Id. at 858.

On appeal, the Seventh Circuit reversed and held that § 546(e) does not protect “transfers that are simply conducted through financial institutions (or the other entities named in section 546(e)), where the entity is neither the debtor nor the transferee but only the conduit.” FTI Consulting, Inc. v. Merit Mgmt. Group, LP, 830 F.3d 690, 691 (7th Cir. 2016). The Seventh Circuit recognized that it was adopting a “different position from the one adopted by” the Second, Third, Sixth, Eighth and Tenth Circuits, which “interpreted section 546(e) to include the conduit situation.” Id. at 697. The Supreme Court granted a writ of certiorari to determine how the § 546(e) safe harbor operates in the conduit situation.

The Supreme Court affirmed the Seventh Circuit’s decision and found that the § 546(e) safe harbor did not apply to FTI’s attempt to avoid the $16.5 million transfer from Valley View to Merit for the Bedford Downs stock. Merit, 138 S.Ct. 883. The Court framed the issue as whether the Court should consider the end-to-end transfer (i.e., a transfer from A—D that was executed via B and C as intermediaries) or all of the “component parts” of the transaction (i.e., A—B—C—D). Id. at 888.

The Court’s analysis focused heavily on the text of § 546(e), which language the Court interpreted as creating an exception to the trustee’s avoidance powers under the Bankruptcy Code that “applies to the overarching transfer that the trustee seeks to avoid, not any component part of that transfer.” Id. at 893. The Court also emphasized that § 546(e)’s reference to “a transfer that is” either a “settlement payment” or made “in connection with a securities contract” “dispels [any] doubt” that § 546(e)’s focus is on the overall transfer and not a component transfer that “involves” or “comprises” such payment. Id. at 894.

The Court also rejected several arguments made by Merit, including the proposition that Congress intended § 546(e) to be a broad, prophylactic statute meant to protect securities and commodities transactions based on “the nature of the transaction generally.” Id. at 896. The Court found that this interpretation of § 546(e) amounted to “an attack on the text of the statute,” which is worded to protect transfers by an industry hub and not through an industry hub. Id. at 897.

The Supreme Court’s decision merits careful consideration. It is the first Supreme Court decision to address the § 546(e) safe harbor and is likely to be cited in future cases involving the rights of financial parties under qualified financial contracts. This case also may affect how parties structure transactions involving settlement payments made in connection with securities contracts. The Court’s focus on the transfer that the trustee seeks to avoid may also impact how trustees frame avoidance actions in complaints. If you have questions about this alert, please contact Eric R. Goodman at or 216.861.7418 or any member of BakerHostetler’s Bankruptcy, Restructuring and Creditors’ Rights team.

Authorship credit: Eric R. Goodman and Adam L. Fletcher.

Baker & Hostetler LLP publications are intended to inform our clients and other friends of the firm about current legal developments of general interest. They should not be construed as legal advice, and readers should not act upon the information contained in these publications without professional counsel. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you written information about our qualifications and experience.