Second Circuit Reinforces Bankruptcy Code Settlement Payment Safe Harbor

The Second Circuit affirmed the lower courts' judgment that a "transfer made … in connection with a securities contract … by a qualifying financial institution" was entitled "to the protection of [Bankruptcy] Code §546 (e)'s safe harbor, which pre-empts the trustee's state-law fraudulent [transfer] claims." In re Boston Generating, LLC, 2024 WL 4234886 (2d Cir. Sept. 19, 2024). The lower courts had dismissed the liquidating trustee's claims because Code §546 (e)'s safe harbor provision had preempted the state law fraudulent transfer claims, relying on binding precedent. In re Tribune Co. Fraudulent Conv. Litig., 946 F.3d. 66 (2d Cir. 2019) (Tribune II), cert. denied, 141 S. Ct. 2552 (2021) (Creditors could not circumvent §546(e) safe harbor by suing under state law). More significant, though, was the court's explanation of why: a) the payment here was part of a securities contract; and why b) the debtor parent and its debtor subsidiary were "each a 'financial institution' under Bankruptcy Code (Code) §101(22)(A)."

Facts

The debtor corporate parent, a holding company, had used its debtor subsidiary to finance its so-called "Leveraged Recap Transaction." In effect, the parent purchased equity from its members using the cash borrowed by its subsidiary. The debtor subsidiary received loan proceeds from its lenders and promptly sent the proceeds from its bank account (approximately $708 million) to its parent's bank account for transfer to the selling members. The trustee sought to recover the $708 million from the member defendants "who received payments for their equity securities pursuant to the Leveraged Recap Transaction." Id. at*1. He alleged an "initial transfer" with $708 million from the subsidiary and a "subsequent transfer" of those funds to the defendant members. The trustee admittedly split the transaction to get around Code §546(e), arguing that the initial subsidiary-to-parent transfer was not a settlement payment and not made as part of a "securities contract."

Safe Harbor Statutory Defense

The defendants relied on Code §546 (e) as an affirmative defense to shield the payments they received from the trustee's fraudulent transfer claim. According to Code §546 (e), "[n]otwithstanding [the substantive avoidance powers set forth in [the Code], the trustee may not avoid a transfer that is a … settlement payment … or … transfer made by or to (or for the benefit of) a … financial institution … in connection with a securities contract [.]" Most important here, the Code defines "financial institution" to include not only banks, but also a customer of a bank "when [the bank] is acting as agent or custodian for a customer… in connection with a securities contract." Id. quoting Code §101(22)(A) (emphasis added).