Supreme Court Argument in "High Stakes" Bankruptcy Case
Monday, November 13, 2017
Posted by: Amy Tieperman
Supreme Court Argument in “High Stakes” Bankruptcy Case
The United States Supreme Court heard arguments on November 6th in a high stakes case that could affect corporate buyouts that are mostly debt financed. The issue in the case is whether the “safe harbor rule” prevents a bankruptcy trustee from suing to undo the pre-bankruptcy sale of stock deemed fraudulent when the transfers were made through banks, even if the banks acted only as conduits.
The safe harbor rule was enacted by Congress to protect financial institutions from instability resulting from a reversal of settled securities transactions. The intent was to minimize displacement in the markets in the event of a major bankruptcy that affected the industry and to prevent any ripple effects created by the insolvency from spreading to the affected industry.
There has been a deep split in the circuits on the issue and now the high Court will decide of 11 U.S.C. §546(e) prohibits trustee avoidance actions even when the financial institutions are not defendants and/or do not have a beneficial interest in the transfer.
The case before the Court stems from a Pennsylvania dispute where Valley View Downs L.P. and Bedford Downs Management Corporation both sought the last state license available for harness racing as they intended to create a race track and casino. Both companies opposed the granting of the license to the other. Valley View Downs eventually agreed to buy Bedford Downs stock so it could pursue the license unopposed. Merit Management Group L.P., the petitioner, owned about 30 percent of Bedford Downs. About $16.5 million passed through an escrow held by Citizens Bank of Pennsylvania to Merit Management for its shares in Bedford Downs. Valley View got the harness racing license, but it couldn't secure a gaming license for the casino and wound up filing Chapter 11.
A reorganization plan was confirmed, and FTI Consulting Inc. became trustee of a litigation trust. That trust sued Merit Management to recover the $16.5 million it received as a constructive fraudulent conveyance. Merit Management answered that Section 546(e) of the Bankruptcy Code was a defense to the action. That section provides that a settlement payment made “by or to (or for the benefit of)” certain protected financial institutions can't be sued for constructive fraudulent conveyances (as opposed to cases of intentional fraud). Even though the parties to the transfer were Valley View as the purchaser of the Bedford Downs stock and Merit Management as the seller, Merit Management argued that because the banks are protected financial institutions, the Section 546(e) safe harbor applies to bar the action.
The concern is that many noteworthy transactions will come under scrutiny that previously would have fallen within the safe harbor, depending on which view the Supreme Court will adopt.