The Safe Harbor Provided for Settlement Payments by Section 546(e)

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1 The Safe Harbor Provided for Settlement Payments by Section 546(e) George V. Utlik and Schuyler G. Carroll I. Introduction II. The Legislative History A. The Legislative History and Historical Background of Section 546(e) B. Section 546(e) s Boundaries, Its Traditional Scope and Application III. Recent Case Law Developments A. Application of the Safe Harbor to LBO Transactions 1. Eighth Circuit s Decision 2. Sixth Circuit s Decision 3. Third Circuit s Decision B. Application of Safe Harbor in Debt Settlement Transactions IV. Practical Considerations V. Conclusion George V. Utlik is an attorney in the Bankruptcy and Financial Restructuring Group at Arent Fox LLP. He represents clients in corporate reorganization and liquidation matters. Immediately prior to joining Arent Fox, George served as the law clerk for the Honorable Mary F. Walrath, U.S. Bankruptcy Judge for the District of Delaware, where he gained experience working on some of the largest bankruptcy cases filed under Chapter 11 of the Bankruptcy Code. In 2008, he obtained the LL.M. in Bankruptcy from St. John s University School of Law. Schuyler G. Carroll is a partner in the Bankruptcy and Financial Restructuring Group at Arent Fox LLP. Mr. Carroll s practice focuses on complex restructuring, transaction, litigation, and advisory work, protecting and maximizing his client s position. He has represented a wide variety of debtors, committees, creditors, bondholders, indenture trustees, trustees, landlords, investors, and purchasers in Chapters 11 and 7 bankruptcy proceedings, out-of-court workouts and nonjudicial reorganizations, and restructurings in a variety of industries. 321

2 322 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] I. Introduction The Bankruptcy Code 1 contains several safe harbor provisions that grant significant benefits to certain participants in financial markets. 2 Among the safe harbor provisions is section 546(e), often referred to as the Safe Harbor, which limits the power of a trustee or debtor in possession to avoid certain types of transfers made by or to enumerated financial market participants or financial institution(s) 3 unless these transfers were made with actual intent to hinder, delay, or defraud creditors. 4 The types of transfers that are exempt under the Safe Harbor are a margin payment and a settlement payment. 5 In recent years, courts have dealt with the Safe Harbor primarily in a leveraged buyout (LBO) context. In 2009, several courts expanded the scope of protection for settlement payments related to certain types of securities transactions covered by the Safe Harbor. The Courts of Appeals for the Sixth, Eighth, and Third Circuits held that payments made in connection with an LBO to holders of private company securities are protected by the Safe Harbor. 6 Further, the District Court for the Southern District of New York joined these courts in expanding the scope of the Safe Harbor by holding that a premature redemption of a debt security is a securities transaction that qualifies for protection as a settlement payment under the Safe Harbor. 7 In applying the Safe Harbor, these courts considered, among other things, whether the transactions involved a public versus private company and whether a financial institution or an attorney escrow agent was involved, as well as how many parties and how much money were implicated. This article will first discuss the historical background of section 546(e), its boundaries, and traditional scope and application. It will next highlight important recent decisions helping to define the scope of transactions protected under the Safe Harbor and will also raise a couple of practical questions as to whether the statutory language of the Safe Harbor says what Congress intended. II. The Legislative History and Historical Background of Section 546(e), Its Boundaries, and Traditional Scope and Application A. The Legislative History and Historical Background of Section 546(e) Prior to the enactment of the Bankruptcy Code, the Safe Harbor did not exist, and courts did not prohibit a trustee of a bankrupt commodity customer from recovering, as a fraudulent conveyance, margin payments that had been made by the debtor to the commodity clearing organization, if the debtor was insolvent when it made the payment or was rendered insolvent by the payment. 8

3 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) 323 In 1978, the Safe Harbor was first enacted as section 764(c) of the Bankruptcy Code, overruling prior case law on the issue. 9 Section 764(c) applied exclusively to margin payments made from commodities clearing organizations and therefore only protected transfers made in the ordinary course of business in the [commodities] market. 10 In 1982, Congress amended the safe harbor provision, replacing section 764(c) with three provisions, codified at 546(e) and 741(5) and (8), to clarify and, in some instances, broaden the commodities market protections and expressly extend similar protections to the securities markets. 11 Section 546(e) limits the trustee s ability to recover fraudulent or preferential transfers if the transfers are settlement or margin payments as defined in the Bankruptcy Code. 12 Congress thus broadened the Safe Harbor by extending its scope to include the securities markets and by expanding the protection to capture transactions beyond the ordinary course of business to include margin and settlement payments to and from brokers, clearing organizations, and financial institutions. 13 The purpose of the Safe Harbor is to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries. 14 Congress sought to prevent the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market. 15 This broad protection was designed to ensure settlement finality, and therefore market stability. 16 B. Section 546(e) s Boundaries, Its Traditional Scope, and Application In relevant part, the Safe Harbor provides that a trustee may not avoid a transfer that is a settlement payment, as defined in section 101 or 741 of the Bankruptcy Code, made by or to (or for the benefit of) a financial institution. 17 By its terms, the Safe Harbor extends to any avoidance action under 544, 545, 547, and 548(a)(1)(B) and (b) of the Bankruptcy Code. 18 Only a transfer made with intentional fraud under 548(a) (1)(A) is not excepted under the Safe Harbor. 19 A settlement payment is defined in 741(8) of the Bankruptcy Code tautologically, as a preliminary settlement payment, a partial settlement payment, an interim settlement payment, or any other similar payment commonly used in the securities trade. 20 According to Norton Bankruptcy Law and Practice 3d, a settlement payment is any transfer made toward completion of the settlement process, whether made on trade date, the scheduled settlement date or any other date within that process. 21 Most recently, the District Court for the Southern District of New York defined a settlement payment as any payment made in the securities trade to consummate securities transactions. 22

4 324 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] The term settlement payment must be interpreted broadly, according to the Courts of Appeals for the Third, Ninth, and Tenth Circuits. 23 All three appellate courts rejected the argument that a payment could not qualify as a settlement payment if it was not made as part of a so-called ordinary course securities transaction. 24 A settlement payment is construed broadly to include almost all securities transactions. 25 In the LBO context, for example, several courts have held that the LBO payments made to shareholders through a financial institution do qualify as settlement payments and are therefore exempt from avoidance under the Safe Harbor. 26 Among these courts is the Court of Appeals for the Tenth Circuit, holding that the LBO consideration qualified as a settlement payment that was made to stockbrokers and therefore was exempt from recovery by the debtor from stockbrokers under the Safe Harbor. 27 Courts, however, appear to be split as to whether the language of the Safe Harbor is clear. On one hand, the Court of Appeals for the Tenth Circuit found that the language of 546(e) is clear. 28 On the other hand, the Court of Appeals for the Eleventh Circuit and several lower courts found the language of section 546(e) to be not dispositive. 29 Further, some lower courts appear to have been split as to whether the Safe Harbor applies to LBO transactions involving payments for privately-held shares of a nonpublic corporation. Some courts found that application of 546(e) is not limited to public LBOs. 30 Other courts, however, declined to extend the Safe Harbor to LBO transactions involving privately held shares that do not involve a financial intermediary, concluding that such transactions do not implicate the kinds of concerns about the stability and integrity of the securities markets that section 546(e) was enacted to protect. 31 III. Recent Case Law Developments In 2009, the Courts of Appeals for the Sixth, Eighth, and Third Circuits held that certain payments made through a financial institution in connection with an LBO are protected by the Safe Harbor, whether or not the company involved is publicly traded or privately held. 32 Further, the District Court for the Southern District of New York held that a premature redemption of a debt security is a securities transaction that is protected under the Safe Harbor. 33 A. Application of the Safe Harbor to LBO Transactions 1. Eighth Circuit s Decision On April 29, 2009, the Court of Appeals for the Eighth Circuit in Contemporary Industries Corp. v. Frost 34 considered the issue of whether payments made to shareholders of a privately held corporation in

5 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) 325 exchange for their shares during an LBO of the corporation were exempt from avoidance as settlement payments under the Safe Harbor. 35 There, the shareholders sold their shares of the privately held corporation to an outside investment group, which obtained significant loans to finance the purchase of the shares and pledged the corporation s assets to the lenders as collateral. 36 The distribution of the purchase price to the shareholders was accomplished through First National Bank of Omaha after the shareholders deposited their shares and the investors deposited the funds that they borrowed with First National. 37 Later, the corporation experienced financial difficulties and filed its voluntary petition under Chapter 11 of the Bankruptcy Code, and the debtor sued the shareholders seeking to recover the payments as avoidable fraudulent transfers. 38 The shareholders moved for summary judgment, asserting that the payments were exempt from avoidance under the Safe Harbor, and the bankruptcy court granted summary judgment to the shareholders, a decision which was affirmed by the district court. 39 The Court of Appeals for the Eighth Circuit considered the following two issues (within the meaning of the Safe Harbor): (1) whether the payments to shareholders are settlement payments and (2) whether the payments were made by or to a financial institution. 40 With respect to the first issue, the court began its analysis by looking to the relevant statutory text and considering (a) whether the text plainly and unambiguously encompasses the transfers and if so, (b) whether the plain language does not lead to an absurd result. 41 The court relied heavily on decisions from the Third, Ninth, and Tenth Circuits, holding that 741(8) is extremely broad and intended to encompass most payments that can be considered settlement payments. 42 The court began and ended its analysis with the statutory text, concluding that the relevant text has a sufficiently plain and unambiguous meaning. 43 Nothing in the relevant statutory language suggests Congress intended to exclude these payments from the statutory definition of settlement payment simply because the stock at issue was privately held. 44 Thus the court concluded that the payments made to the shareholders in exchange for their privately held shares during the LBO were settlement payments within the plain meaning of 546(e) and 741(8). 45 With respect to the second issue, the Court of Appeals for the Eighth Circuit similarly concluded that the payments were made by or to a financial institution within the plain meaning of 546(e). 46 By its terms, 546(e) protects settlement payments made by or to a financial institution, and does not expressly require that the financial institution obtain a beneficial interest in the funds. 47 The court acknowledged that a divided panel of the Eleventh Circuit adopted [the argument that

6 326 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] a financial institution must obtain a beneficial interest in the payments to fall under 546(e)] in refusing to apply 546(e) to protect similar payments made to selling shareholders in the course of a leveraged buyout. 48 However, the court again agreed with the Third Circuit that the holding in [the Eleventh Circuit s decision in Munford] cannot be squared with 546(e) s plain language. 49 The court found that First National received the payments from the investors and then distributed the payments to the shareholders in exchange for their stock. 50 Thus the court concluded that the payments were made through the financial institution and therefore [u]nder a literal reading of the relevant statutory language, the payments satisfy both requirements necessary to involve the protections of 546(e). 51 Further, the court explained that the application of the plain language does not lead to an absurd result because the transactions where so much money is at stake could affect the markets stability. 52 Therefore, the Court of Appeals for the Eighth Circuit held that the Safe Harbor protects payments made through a financial institution in connection with an LBO even if the company involved is privately traded. 2. Sixth Circuit s Decision On July 6, 2009, shortly after Contemporary Indus. was decided, the Court of Appeals for the Sixth Circuit in QSI Holdings, Inc. v. Alford (In re QSI Holdings, Inc.) 53 considered the same issue for the first time: whether the Safe Harbor applies to privately traded securities. 54 There, pursuant to a merger agreement, a privately held corporation merged with and into another company, and the shareholders received cash and stock in the other company for their respective equity interests in the corporation. 55 To effectuate the merger, the parties utilized an exchange agent, HSBC Bank USA, to collect and to transfer the shares and to collect and to distribute the funds. 56 The merger entailed substantial integration costs that, along with the business expansion, led the merged company to financial difficulties and a subsequent bankruptcy filing under Chapter 11 of the Bankruptcy Code. 57 A fraudulent conveyance action was commenced against the shareholders, and the shareholders moved for summary judgment asserting that the LBO transfers were settlement payments made by a financial institution and thus protected by the Safe Harbor. 58 The bankruptcy court granted summary judgment for the shareholders, and the district court affirmed. The Court of Appeals for the Sixth Circuit first considered whether the transfers made to purchase the shares of the privately held corporation in connection with the LBO were exempt as settlement payments under the Safe Harbor. 59 The court looked to the statutory text, noted

7 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) 327 that other courts have recognized that the term settlement payment is extremely broad, and agreed with the Eighth Circuit s recent decision in Contemporary Indus. that the statutory definition of settlement payment was intended to include securities that were privately held. 60 Further, the court explained that [t]he value of the privately held securities at issue is substantial and there is no reason to think that unwinding that settlement would have any less of an impact on financial markets than publicly traded securities. 61 The court also distinguished the instant case from In re Norstan Apparel Shops, Inc., 62 which, according to the Court of Appeals for the Sixth Circuit, involved the two sole shareholders of a closely held Subchapter S corporation, did not implicate public securities markets, and lacked many of the indicia of transactions commonly used in the securities trade. 63 Second, the Court of Appeals for the Sixth Circuit considered whether the activities of HSBC Bank, the exchange agent, constituted transfers made by or to a financial institution. 64 The court agreed with both the Third and Eighth Circuits that the plain language of the Safe Harbor does not require a financial institution to have a beneficial interest and rejected the argument (adopted by the Eleventh Circuit in Matter of Munford, Inc. 65 ) that HSBC Bank was a mere conduit lacking dominion or control over the funds. 66 The court held that: (1) the bank s role was sufficient to satisfy the requirement that the transfers were made to a financial institution and (2) therefore the Safe Harbor protected the transfers. 67 Thus the Court of Appeals for the Sixth Circuit joined the Court of Appeals for the Eighth Circuit in holding that the Safe Harbor protects payments made to holders of privately traded securities in connection with an LBO. 3. Third Circuit s Decision Most recently, the Court of Appeals for the Third Circuit in Brandt v. B.A. Capital Co. (In re Plassein Intern. Corp.) 68 considered the issue of whether the Safe Harbor protects payments made to holders of privately traded securities in connection with an LBO. 69 Plassein International Corporation acquired several privately held corporations (with most having only a few shareholders) through LBOs. 70 In the process, each newly acquired corporation pledged its assets as collateral for the loans given to Plassein to finance the purchases. 71 [T]he selling shareholders delivered their shares to Plassein, which directed its bank (Fleet Bank) to wire funds to the shareholders private accounts at their various banks to pay for the shares delivered. 72 The parties did not utilize the settlement system the system of intermediaries and guarantees usually

8 328 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] employed in securities transactions. 73 A few months after the LBOs, Plassein and the acquired companies defaulted on the loans and eventually filed bankruptcy petitions under Chapter 11 of the Bankruptcy Code, which later were converted to Chapter 7 cases. 74 The appointed Chapter 7 trustee commenced adversary proceedings against the selling shareholders, seeking to recover the payments made in connection with the LBOs as avoidable fraudulent transfers. 75 The shareholders filed motions to dismiss the adversary proceedings, asserting that the payments were settlement payments protected by the Safe Harbor. 76 The bankruptcy court granted the motions to dismiss, relying primarily on Lowenschuss v. Resorts International, Inc. (In re Resorts Intern., Inc.), 77 and the district court affirmed the bankruptcy court s decision. 78 On review, the Court of Appeals for the Third Circuit concluded that its prior decision in Resorts directly controlled the instant case s outcome. 79 First, in Resorts, the court had held that the definition of settlement payment [is] broad and that in the securities trade, a settlement payment is generally the transfer of cash or securities made to complete a transfer payment. 80 Further, in Resorts, the court had concluded that [a] payment for shares during [a leveraged buyout] is obviously a common securities transaction and therefore had held that such payment is also a settlement payment protected under the Safe Harbor. 81 Moreover, in Resorts, the court had already rejected the Eleventh Circuit s decision (which required a financial institution to acquire a beneficial interest in the exchanged shares to be protected under the Safe Harbor) and found that the Safe Harbor applied even though a clearing agency had not been involved in the settlement for [the publicly traded] shares and that the financial institutions acted only as conduits. 82 Therefore, the Plassein court was left to consider only whether distinguishing privately traded shares from publicly traded shares could lead to a different outcome. The court rejected the trustee s attempt to distinguish Resorts on that ground. 83 [T]he meaning of settlement payment is best understood by examining how the term is used by those who work in the public securities market. 84 Resorts expressly rejected the argument that settlement payments must travel through the settlement system. 85 In Resorts, the shares were sold in a transaction outside of the publicly traded securities settlement system. 86 Looking at the way the shares in Resorts were actually traded, the court could not ignore the plain language in that case which governs the present dispute. Thus the Plassein court held that the Safe Harbor shielded the payments made to the holders of the privately traded securities in connection with the LBO. 87 Therefore, the Court of Appeals for the Third Circuit, bound by its decision in Resorts, joined both the Sixth and Eighth Circuits in holding that the Safe Harbor applies to privately traded securities.

9 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) 329 B. Application of Safe Harbor in Debt Settlement Transactions On November 20, 2009, in AFLA, S.A.B. de C.V. v. Enron Creditors Recovery Corp. (In re Enron Creditors Recovery Corp.), 88 the District Court for the Southern District of New York held that the Safe Harbor extends to securities transactions in which debt evidenced by commercial paper is redeemed by the issuer prior to maturity, using the customary mechanism of the Depository Trust Company (the DTC) for trading in commercial paper. 89 Prior to filing its bankruptcy case under Chapter 11 of the Bankruptcy Code, Enron Corporation and its affiliates issued commercial paper, which was prohibited from redemption or voluntary prepayment by Enron prior to maturity. 90 Notwithstanding the prohibition, Enron redeemed $1.1 billion of the commercial paper by using the DTC between October 26 and November 6, 2001 and filed its Chapter 11 petition on December 2, Later, an avoidance action was commenced against the holders of the commercial paper ING VP Balanced Portfolio, Inc, ING VP Bond Portfolio, Inc., and ALFA, S.A.B. de C.V. (collectively, the Defendants) to recover the payments made to them for the redemption of the commercial paper as preferences and fraudulent transfers. 92 In response, the Defendants asserted that the payments were protected by the Safe Harbor. On a motion for summary judgment, the bankruptcy court held that the premature payment of debt is not a transaction in securities, and therefore the transfers were not settlement payments protected under the Safe Harbor. 93 First, the bankruptcy court concluded that the procedures that were followed to repay or redeem the commercial paper were not of a type commonly used in the securities trade, as required in the definition of settlement payment. 94 The bankruptcy court noted that (a) some of the commercial paper was redeemed prior to maturity rather than held until, and paid upon, maturity; and (b) the commercial paper was extinguished as a result of the transfers rather than resold on the secondary market according to the general practice. 95 Thus the bankruptcy court found that the transfers did not fit the definition of settlement payment. Second, the bankruptcy court ruled as a matter of law that a securities transaction had to involve a purchase or sale that resulted in the transfer of title-and held, as a matter of ostensibly undisputed fact, that there was neither a purchase nor a sale because Enron never acquired title to the notes. 96 The bankruptcy court concluded that only a securities transaction involving a transfer of ownership could be followed by a settlement payment that qualified for protection under the Safe Harbor. 97

10 330 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] In a detailed and well-reasoned decision, the district court reversed the bankruptcy court s decision and held that section 741(8) of the Bankruptcy Code does not limit the definition of settlement payment to payments commonly used in the securities trade. 98 The district court first discussed the legislative history of the Safe Harbor and judicial interpretation and application of the Safe Harbor by the Third, Tenth, Ninth, Sixth, and Eighth Circuits, as well as by several district and bankruptcy courts that declined to extend the Safe Harbor to purely private securities transactions that do not involve a financial intermediary the case law that is, according to the district court, either neutral or counsels in favor of interpreting the [Safe Harbor] as reaching transactions beyond the ordinary course. 99 Further, based on the conventions of statutory construction, i.e., the rule of the last antecedent, the district court concluded that settlement payment as defined in section 741(8) of the Bankruptcy Code is not limited to payments commonly used in the securities transactions. 100 Pursuant to the plain language of the Bankruptcy Code, the district court concluded that notes are included in the definition of security under section 101(49) and that the payments to redeem the commercial paper were settlement payments, which the district court defined as payments made in the securities trade to consummate securities transactions. 101 The district court held that because the redemption of the notes (a security) involved the delivery and receipt of funds and securities, it qualifies as a securities transaction for safe harbor purposes, regardless of whether Enron, itself or through an agent, acquired title to the notes. 102 Finally, the district court revived the five key factors (announced by Judge Marrero in Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.) 103 and later cited with approval by Judge Lynch in American Tissue, Inc. v. Donaldson, Lufkin & Jenrette Securities Corp. 104 ) that should be considered in determining the applicability of the safe harbor to any particular transaction. 105 These five key factors are: (1) the transactions have long settled by means of actual transfers of consideration, so that subsequent reversal of the trade may result in disruption of the securities industry, creating a potential chain reaction that could threaten collapse of the affected market; (2) consideration was paid out in exchange for the securities or property interest as part of settlement of the transaction; (3) the transfer of cash or securities effected contemplates consummation of a securities transaction; (4) the transfers were made to financial intermediaries involved in the national clearance and settlement system;

11 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) 331 (5) the transaction implicated participants in the system of intermediaries and guarantees which characterize the clearing and settlement process of public markets and therefore would create the potential for adverse impacts on the functioning of the securities market if any of those guarantees in the chain were invoked. 106 Applying these factors, the district court concluded that all five Jackson factors are present in the securities transaction at bar, [and therefore] there is no policy reason to depart from what appears to this Court to be the plain meaning of the literal language of the Bankruptcy Code. 107 Therefore, the District Court for the Southern District of New York expanded the Safe Harbor by holding that securities transactions involving a premature redemption of a debt security using a financial institution fall within the literal language of the statute. 108 IV. Practical Considerations Since enactment of section 546(e) of the Bankruptcy Code in 1978, the scope of protection under the Safe Harbor has been significantly expanded. Today, the Third, Sixth, and Eighth Circuit Courts of Appeals agree that virtually every transfer that concludes or consummates a securities transaction falls within the Safe Harbor. It is perhaps less clear whether the Sixth Circuit s recent decision is as expansive as those of the other two circuits. Some commentators, for example, noted that considering that the Sixth Circuit distinguished Norstan based on the limited number of the shareholders involved in the LBO transaction, it may be argued that the Sixth Circuit s decision does not expand the application of 546(e) as broadly as the Eighth Circuit, and is limited to private companies with a substantial number of shareholders. 109 Some commentators suggest that by using a financial institution, instead of a law firm, to act as an escrow agent for a sale of nonpublic securities pursuant to an LBO, an otherwise preferential or fraudulent transfer of funds to the selling shareholders may be exempt under the Safe Harbor. 110 From a policy point view, the outcomes [of the recent decisions] may not make sense. After all, there is no policy reason why Congress would have wanted to permit a shareholder of an insolvent company to extract from the company funds for themselves while saddling the company with debt through an LBO that directly results in the company filing for bankruptcy relief and leaving creditors of the company unpaid. 111

12 332 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] Similarly, it would be strange that a shareholder can obtain the benefits of the Safe Harbor simply by structuring the payments through a financial intermediary instead of an attorney. Evidently, the Court of Appeals for the Eighth Circuit has foreseen such attacks when it noted that [where] such abuse seems evident, a statutory safety valve exists [B]y definition, a settlement payment must be commonly used in the securities trade [and it is] unlikely that a transaction that is a clear abuse of the exemption could be said to be commonly used in [that] trade. 112 The Court of Appeals for the Eighth Circuit, however, did not expand on that thought and did not provide an indication as to what may be considered a clear abuse of the exemption. V. Conclusion The recent decisions expanded the Safe Harbor provided by section 546(e) of the Bankruptcy Code by holding that the Safe Harbor applies to privately traded securities and protects securities transactions in which debt evidenced by commercial paper is prematurely redeemed by the issuer through a financial institution. The question, however, is whether such expansion overreached the boundaries established by Congress. If the purpose of enacting the Safe Harbor was protection of financial markets, does protection of payments of insignificant funds made by a privately held corporation to a small number of its shareholders in connection with an LBO that resulted in creditors being unable to collect from the insolvent company comply with Congressional purpose, or does it fall outside the boundaries established by Congress? While the plain language approach (which is followed by the majority of the courts interpreting the Safe Harbor) is the correct one from the statutory interpretation point of view, perhaps Congress should consider whether the language in the statute says what it should say or whether it is time to redraft the statute. NOTES 1. The Bankruptcy Code is codified in 11 U.S.C.A. 101 et seq. and is referred to herein as the Bankruptcy Code. 2. See Mark D. Sherrill, Limitations of Market Participants Protections Against Fraudulent-Conveyance Actions, 28 Am. Bankr. Inst. J. 28, at 28 (May 2009) (citing 11 U.S.C.A. 362(b)(6), (7), (17), (27); 546(e), (f), (g), and (j); 555 to 556; 559 to 561). 3. Financial institutions include commodities brokers, forward contract merchants, stockbrokers, financial participants, and securities clearing agencies. See 11 U.S.C.A. 546(e) U.S.C.A. 546(e) U.S.C.A. 546(e). 6. See In re QSI Holdings, Inc., 571 F.3d 545, 51 Bankr. Ct. Dec. (CRR) 222, Bankr. L. Rep. (CCH) P (6th Cir. 2009), cert. denied, 130 S. Ct (2010); Contemporary Industries Corp. v. Frost, 564 F.3d 981, 51 Bankr. Ct. Dec. (CRR) 157, Bankr. L. Rep. (CCH) P

13 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) (8th Cir. 2009); In re Plassein Intern. Corp., 590 F.3d 252, 52 Bankr. Ct. Dec. (CRR) 145, Bankr. L. Rep. (CCH) P (3d Cir. 2009), cert. denied, 2010 WL (U.S. 2010). 7. See In re Enron Creditors Recovery Corp., 422 B.R. 423 (S.D. N.Y. 2009). 8. See, e.g., Seligson v. New York Produce Exchange, 394 F. Supp. 125, (S.D. N.Y. 1975). 9. See S. Rep , at 106 (1978), as reprinted in 1978 U.S.C.C.A.N. 5787, 5892 (citing Seligson, 394 F. Supp. 125). 10. Enron Creditors Recovery, 422 B.R. 423 (citing H.R. Rep , at 392 (1978), as reprinted in 1978 U.S.C.C.A.N. 5963, 6348). 11. H.R. Rep , at 2 (1982), as reprinted in 1982 U.S.C.C.A.N. 583, 583. Section 546(e) of the Bankruptcy Code was amended several times since. In 2005, the section was amended by adding financial participant to the listed transferors and transferees and adding section 546(i) concerning master netting agreements to the exceptions from the trustee s avoidance powers. See Pub. L. No , 119 Stat 23, 907(o) & (e) (Apr. 20, 2005). In 2006, the section was further amended by the Financial Netting Improvements Act, Pub. L , 120 Stat See 11 U.S.C.A. 741(5) (defining margin payments) and 741(8) (defining settlement payments). The phrase settlement payment can also be found at 101(51A), as it relates to forward contracts. 13. Kaiser Steel Corp. v. Charles Schwab & Co., Inc., 913 F.2d 846, 849, 20 Bankr. Ct. Dec. (CRR) 1650, 23 Collier Bankr. Cas. 2d (MB) 1403, Bankr. L. Rep. (CCH) P (10th Cir. 1990). 14. H.R. Rep , at 2 (1982), as reprinted in 1982 U.S.C.C.A.N. 583, Jewel Recovery, L.P. v. Gordon, 196 B.R. 348, 352 (N.D. Tex. 1996) (citing H.R. Rep , at 2 (1982), as reprinted in 1982 U.S.C.C.A.N. 583, 583). 16. Enron Creditors Recovery, 422 B.R See 11 U.S.C.A. 546(e) U.S.C.A. 546(e) U.S.C.A. 546(e) U.S.C.A. 741(8). See also In re Grafton Partners, 321 B.R. 527, 532, 44 Bankr. Ct. Dec. (CRR) 115, 53 Collier Bankr. Cas. 2d (MB) 1589 (B.A.P. 9th Cir. 2005)) ( The difficulty with the definition of settlement payment is that it relies on a conclusory laundry list of securities industry terms of art that contain the words settlement payment without articulating the elements of a security payment. ) See Norton Bankruptcy Law and Practice 3d 87: Enron Creditors Recovery, 422 B.R See Norton Bankruptcy Law and Practice 3d 87:45. See also Gordon, 196 B.R. at 353 (citing Bevill, Bresler & Schulman Asset Management Corp. v. Spencer Sav. & Loan Ass n, 878 F.2d 742, 745, 19 Bankr. Ct. Dec. (CRR) 962, 21 Collier Bankr. Cas. 2d (MB) 298, Bankr. L. Rep. (CCH) P (3d Cir. 1989); In re Kaiser Steel Corp., 952 F.2d 1230, , 26 Collier Bankr. Cas. 2d (MB) 443, Bankr. L. Rep. (CCH) P (10th Cir. 1991); In re Comark, 971 F.2d 322, 324, 23 Bankr. Ct. Dec. (CRR) 385, 27 Collier Bankr. Cas. 2d (MB) 360, Bankr. L. Rep. (CCH) P (9th Cir. 1992)). 24. Enron Creditors Recovery, 422 B.R In re Resorts Intern., Inc., 181 F.3d 505, 515, 34 Bankr. Ct. Dec. (CRR) 736, Bankr. L. Rep. (CCH) P (3d Cir. 1999). See also In re Hechinger Investment Co. of Delaware, 274 B.R. 71, (D. Del. 2002). 26. See, e.g., Resorts Intern., 181 F.3d at 515 (agreeing with the Tenth Circuit and adopting a broad approach to the term settlement payment ); Kaiser Steel, 952 F.2d at See Kaiser Steel Corp. v. Charles Schwab & Co., Inc., 913 F.2d 846, 850, 20 Bankr. Ct. Dec. (CRR) 1650, 23 Collier Bankr. Cas. 2d (MB) 1403, Bankr. L. Rep. (CCH) P 73620

14 334 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] (10th Cir. 1990) (finding persuasive the Securities and Exchange Commission s view that the consummation of an LBO is a settlement payment exempted from avoidance ). 28. Kaiser Steel, 952 F.2d at 1240: On its face the statute is clear. Certainly, we cannot say that the clear application is absurd, given the fact that disruption in the securities industry an inevitable result if leveraged buyouts can freely be unwound years after they occurred is also a harm the status was designed to avoid. 29. Matter of Munford, Inc., 98 F.3d 604, 36 Collier Bankr. Cas. 2d (MB) 1673 (11th Cir. 1996) (rejected by, In re QSI Holdings, Inc., 571 F.3d 545, 51 Bankr. Ct. Dec. (CRR) 222, Bankr. L. Rep. (CCH) P (6th Cir. 2009)) (stating that section 546(e) does not bar the trustee in bankruptcy from avoiding payments the debtor corporation made to its shareholders in a leveraged buy-out ); Wieboldt Stores, Inc. By and Through Raleigh v. Schottenstein, 131 B.R. 655, 663 (N.D. Ill. 1991) (rejected by, Matter of Munford, Inc., 98 F.3d 604, 36 Collier Bankr. Cas. 2d (MB) 1673 (11th Cir. 1996)) (examining legislative history of section 546(e) and finding that recovering LBO payments to shareholders poses no significant threat to those in the clearance and settlement chain ). 30. See In re Plassein Intern. Corp., 366 B.R. 318, 48 Bankr. Ct. Dec. (CRR) 62, 28 A.L.R. Fed. 2d 829 (Bankr. D. Del. 2007), aff d, 388 B.R. 46 (D. Del. 2008), order aff d, 590 F.3d 252, 52 Bankr. Ct. Dec. (CRR) 145, Bankr. L. Rep. (CCH) P (3d Cir. 2009), cert. denied, 2010 WL (U.S. 2010) (holding that term settlement payment is not restricted in its application only to payments made in connection with publicly traded securities); In Matter of Contemporary Industries Corp., 2007 WL (Bankr. D. Neb. 2007), subsequently aff d, 564 F.3d 981, 51 Bankr. Ct. Dec. (CRR) 157, Bankr. L. Rep. (CCH) P (8th Cir. 2009). 31. Enron Creditors Recovery, 422 B.R. 423 (S.D. N.Y. 2009) (citing In re Bankest Capital Corp., 374 B.R. 333, (Bankr. S.D. Fla. 2007); In re Norstan Apparel Shops, Inc., 367 B.R. 68, 77, 48 Bankr. Ct. Dec. (CRR) 9 (Bankr. E.D. N.Y. 2007) ( If the term settlement payment is construed to encompass any payment made for securities, whether or not involving a public securities market, then any leveraged buyout would fall within 546(e) s safe harbor ); Zahn v. Yucaipa Capital Fund, 218 B.R. 656, (D.R.I. 1998); Gordon, 196 B.R. at 353; Schottenstein, 131 B.R. at (refusing to apply the 546(e) exemption to payments of LBO consideration made by a depositary to the selling shareholders in an LBO)). See also Grafton Partners, 321 B.R. at 539 ( The boundary that emerges from such decisions approximates the line between public transactions that involve the clearance and settlement process and non-public transactions that do not involve that process (emphasis in original)). 32. See QSI Holdings, 571 F.3d 545; Contemporary Indus., 564 F.3d 981; Plassein Intern., 590 F.3d See Enron Creditors Recovery, 422 B.R Contemporary Indus., 564 F.3d Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at & Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at 985 (citing Resorts Intern., 181 F.3d at 515; Comark, 971 F.2d at 326; Kaiser Steel, 913 F.2d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at 986 (citing QSI Holdings, Inc. v. Alford, 382 B.R. 731, (W.D. Mich. 2007), judgment aff d, 571 F.3d 545, 51 Bankr. Ct. Dec. (CRR) 222,

15 SAFE HARBOR PROVIDED FOR SETTLEMENT PAYMENTS BY SECTION 546(e) 335 Bankr. L. Rep. (CCH) P (6th Cir. 2009), cert. denied, 130 S. Ct (2010) (concluding that similar payments made to selling shareholders in exchange for privately held stock were settlement payments within the plain meaning of those sections)). 46. Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at 986. (citing Munford, 98 F.3d at 610). 49. Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at Contemporary Indus., 564 F.3d at In re QSI Holdings, Inc., 571 F.3d 545, 51 Bankr. Ct. Dec. (CRR) 222, Bankr. L. Rep. (CCH) P (6th Cir. 2009), cert. denied, 130 S. Ct (2010). 54. QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at In re Norstan Apparel Shops, Inc., 367 B.R. 68, 48 Bankr. Ct. Dec. (CRR) 9 (Bankr. E.D. N.Y. 2007). 63. QSI Holdings, 571 F.3d at 550 (citing Norstan, 367 B.R. at 73). 64. QSI Holdings, 571 F.3d at Munford, 98 F.3d at QSI Holdings, 571 F.3d at QSI Holdings, 571 F.3d at Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Resorts Intern., 181 F.3d at 509 (analyzing section 546(e) and concluding that challenged transfer could not be avoided). 78. Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d 252 (citing Resorts Intern., 181 F.3d at 515). 81. Plassein Intern., 590 F.3d 252 (citing Resorts Intern., 181 F.3d at 516). 82. Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d 252 (restating the court s conclusion in Resorts). 85. Plassein Intern., 590 F.3d Plassein Intern., 590 F.3d 252.

16 336 Norton Journal of Bankruptcy Law and Practice [Vol. 19 # 3] 87. Plassein Intern., 590 F.3d Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R. 423 (reversing the holding of the Bankruptcy Court insofar as it limited the definition of settlement payment and restricted the availability of Section 546(e) s safe harbor from avoidance to payments commonly made in the securities trade (i.e., made in connection with ordinary course securities transactions) ). 90. Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R. 423 (citing In re Enron Creditors Recovery Corp., 407 B.R. 17, 37-41, 51 Bankr. Ct. Dec. (CRR) 240 (Bankr. S.D. N.Y. 2009), motion to certify appeal granted, 2009 WL (S.D. N.Y. 2009) and rev d, 422 B.R. 423 (S.D. N.Y. 2009) (Enron II)). 95. Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R. 423 (citing Enron II, 407 B.R. at 39). 98. Enron Creditors Recovery, 422 B.R. 423 (citing 11 U.S.C.A. 741(8)). 99. Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R. 423 (citing 11 U.S.C.A. 741(8)) Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R. 423 (citing Kaiser Steel, 913 F.2d at 850 (quoting National Securities Clearing Corp., 42 Fed. Reg. 3916, 3920 n.56 (1977)) In re Adler, Coleman Clearing Corp., 263 B.R. 406, , 44 U.C.C. Rep. Serv. 2d 1125 (S.D. N.Y. 2001) American Tissue, Inc. v. Donaldson, Lufkin & Jenrette Securities Corp., 351 F. Supp. 2d 79, 107 (S.D. N.Y. 2004) Enron Creditors Recovery, 422 B.R. 423 (citing Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406, (S.D.N.Y. 2001)) Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R Enron Creditors Recovery, 422 B.R Irving E. Walker and G. David Dean, Structuring a Sale of Privately Held Stock to Reduce Fraudulent-Transfer Claims Risk, 28 Am. Bankr. Inst. J. 16, 20 (Sept. 2009) See Walker and Dean, 28 Am. Bankr. Inst. J. at 20 (assuming that there is no intentional fraud and that a subsequent bankruptcy case is filed in the jurisdiction that affords protection to privately-held securities under section 546(e) of the Bankruptcy Code) Walker and Dean, 28 Am. Bankr. Inst. J. at Contemporary Indus., 564 F.3d at 988 n.5 (quoting QSI Holdings, 382 B.R. at 743 (internal citations omitted)).

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