On April 23, 2019, the United States District Court for the Southern District of New York, in fraudulent transfer litigation arising out of the 2007 leveraged buyout of the Tribune Company,1 ruled on one of the significant issues left unresolved by the US Supreme Court in its Merit Management decision last year.2 The district court held Tribune’s post-bankruptcy litigation trustee was barred from asserting certain constructive fraudulent transfer claims against former Tribune shareholders based on what Judge Denise Cote termed a “straightforward” application of the Section 546(e) settlement payment safe harbor.3 In addressing the extent to which a party’s status as a customer of a “financial institution” (as defined in the Bankruptcy Code) affects the applicability of Section 546(e), the district court was the first court post-Merit Management to squarely address that question.
The pertinent facts for the court’s analysis in Tribune were fairly straightforward. In 2007, Tribune purchased all of its outstanding stock from its shareholders for about $8 billion in a two-step leveraged buyout. In the first step, Tribune remitted cash required to repurchase shares in connection with a tender offer to a trust company, pursuant to the trust company’s agreement to act as “Depositary.” In step two, Tribune engaged the trust company as an “Exchange Agent” to perform essentially the same services for a purchase of the remaining shares.
In Merit Management, the Supreme Court effectively overruled the Second Circuit’s prior interpretation of Section 546(e) that the safe harbor applies where a financial institution acts merely as a conduit for an overarching transfer of funds between entities that are not otherwise protected under the safe harbor. As a result, the litigation trustee in Tribune requested leave to amend his complaint to add claims against the former Tribune shareholders under Section 548(a)(1)(B). The court denied the motion on the basis that amendment would be futile because the claims were still barred under Section 546(e) post-Merit Management.
Section 546(e) provides, among other things, that a trustee may not avoid “a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a . . . financial institution [or] financial participant” or “a transfer made by or to (or for the benefit of) a . . . financial institution [or] financial participant . . . in connection with a securities contract . . . .”
The primary dispute remaining in Tribune was whether Tribune—as the maker of the payments to the shareholders—qualified as a financial institution, which the court considered a “straightforward question of statutory interpretation.”4 A “financial institution” is defined in Section 101(22)(A) to include, among others, “an entity that is a . . . trust company . . . and, when any such . . . entity is acting as agent or custodian for a customer . . . in connection with a securities contract . . . such customer . . . .” (emphasis supplied).
Under the facts, the court concluded that Tribune plainly qualified as a financial institution. First, Tribune was the trust company’s customer (as that term is ordinarily defined) in connection with the leveraged buyout because Tribune engaged the trust company as a depositary in exchange for a fee. Second, the trust company was acting as Tribune’s agent because it was entrusted with Tribune’s cash and was responsible for making payments to shareholders on Tribune’s behalf in connection with the buyout; in the court’s words, this was a “paradigmatic principal-agent relationship.” Third, the trust company acted “in connection with a securities contract,” which is defined in Section 741 of the Bankruptcy Code to include “a contract for the purchase, sale, or loan of a security . . . including any repurchase . . . transaction on any such security.” As a result, there was “no question” that the use of the trust company to repurchase Tribune stock from shareholders involved the purchase of securities.
Although it could have rested on its textualist analysis, the court also observed that its holding was, as a policy matter, “consistent with Section 546(e)’s goal of promoting stability and finality in securities markets and protecting investors from [the trustee’s constructive fraudulent transfer claims].” As the court noted, the trustee sued more than 5,000 former Tribune shareholders, whose only involvement in the transaction was receiving payment for their shares. In the court’s words, “[t]his is precisely the sort of risk that Section 546(e) was intended to minimize.”
The Tribune decision could have substantial practical implications, particularly on a trustee’s ability to recover fraudulent transfers in the context of large, public company leveraged buyouts where shares are purchased using the national securities clearance and settlement system. Although the decision may be subject to further appeals, Judge Cote’s decision, hewing closely both to a straightforward textual analysis and the stated policy reason underlying the statutory safe harbor, may give defendants in these types of cases greater leverage. That said, the facts of any particular case may generate disputes about whether there is a sufficient “agent” or “custodial” relationship between a customer and a traditional financial institution to trigger application of the safe harbor. The impact the Tribune decision may have in other contexts, as well as the evolution of the scope of Section 546(e) post-Merit Management generally, remains to be seen.
2 Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018). (See our previous Legal Update on the decision.)