By Todd Zerega and Luke Sizemore
For the second time in three years, the United States Court of Appeals for the Second Circuit (the “Court”) has taken a broad view of the “safe harbor” provision found in section 546(e) of the Bankruptcy Code for certain “settlement payments” and transfers in connection with securities contracts. In 2011, the Court held that payments made to redeem commercial paper before the maturity date are protected from avoidance under section 546(e) as “settlement payments,” because they were transfers of cash made to complete a securities transaction. In June 2013, the Court held that payments made to a trustee to purchase notes previously issued by an affiliated company to beneficial holders under note purchase agreements are protected from avoidance under section 546(e) as transfers made to a financial institution in connection with a securities contract. This post discusses the second of these opinions.
FACTUAL AND PROCEDURAL BACKGROUND
In 2000, a Canadian printing company (“Issuer”) raised $371 million by issuing private placement notes (the “Notes”) to certain noteholders (the “Holders”) pursuant to two note purchase agreements (the “Agreements”). Pursuant the Agreements, any of Issuer’s affiliates were permitted to purchase the Notes prior to maturity so long as the affiliates complied with the prepayment provisions of the Agreements. On October 29, 2007, an affiliate (“Affiliate”) of Issuer purchased the Notes from the Holders by transferring approximately $376 million to the Holders’ trustee (the “Trustee”). Thereafter, the Trustee distributed the funds to the Holders, and the Holders surrendered the Notes. Less than ninety days after purchasing the Notes, Affiliate filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code.
The official committee of unsecured creditors (the “Committee”) in Affiliate’s bankruptcy case filed an adversary proceeding against the Holders seeking to avoid and recover the October 29 payment as a preferential transfer under section 547 of the Bankruptcy Code. Upon the Holders’ motion for summary judgment, the bankruptcy court held that the payment was exempt from avoidance under the “safe harbor” provision of section 546(e) of the Bankruptcy Code. The district court affirmed. The Committee appealed.
Section 546(e) of the Bankruptcy Code provides in relevant part that a bankruptcy trustee may not avoid (a) a settlement payment made by or to (or for the benefit of) a financial institution or (b) a transfer made by or to (or for the benefit of) a financial institution in connection with a securities contract. On appeal, the Committee argued that this “safe harbor” does not exempt the October 29 payment from avoidance because (1) the October 29 payment constituted a redemption, rather than a purchase, of the Notes, and (2) the recipient of the payment, the Trustee, acted merely as a conduit or intermediary for ultimate recipients, the Holders, most of which are not financial institutions.
The Court’s analysis is simple. Affiliate transferred funds to the Trustee, a financial institution, in the amount and manner prescribed by the Agreements for purchasing the Notes. The Agreements clearly were “securities contracts” because they provided for the original purchase and repurchase of the Notes. Accordingly, the Court held that the October 29 payment was exempt from avoidance under section 546(e) of the Bankruptcy Code as a “transfer made to a financial institution in connection with a securities contract.”
In response to the Committee’s first argument, the Court found that Affiliate did not redeem the Notes, but purchased them. The Court explained that Affiliate was not regaining its own Notes; it was acquiring the Issuer’s securities for the first time. Indeed, the Court noted that only Issuer had the right to redeem the Notes under the terms of the Agreements; its affiliates only could purchase the Notes if they complied with the prepayment provisions. The Court declined to decide whether the transfer still would be exempt if the October 29 payment constituted a redemption rather than a purchase.
In response to the Committee’s second argument, the Court expressly followed the Third, Sixth, and Eighth Circuits in holding that a transfer may qualify for the section 546(e) safe harbor even if the financial institution to which the funds are transferred (i.e., the Trustee) does not take title to the funds and is merely a conduit or intermediary for beneficial holders who are not themselves financial institutions. The Court acknowledged that its holding splits with the Eleventh Circuit, which has held that the financial institution receiving the transfer must acquire a beneficial interest in the transferred funds or securities for the safe harbor to apply.
The Court concluded by noting that its broad view of the Bankruptcy Code safe harbor furthers the purpose for which the safe harbor was enacted: to promote stability in the securities market in the event of a major bankruptcy filing affecting the industry.
The case may be found here.
Good day. Good interpretation. TSR