The Intent of Section 546(e)

Background

Bankruptcy Code § 546(e) prevents the avoidance of “a transfer made by or to (or for the benefit of)” a “financial institution” that was made “in connection with a securities contract.” 11 U.S.C. § 546(e). In In re TVGA Engineering, Surveying, P.C., years before the debtor filed its bankruptcy case, a privately held company agreed with the defendant shareholder to repurchase his shares. The company made payments to the defendant shareholder over a period of 65 months, aggregating $259,000. After the company's Chapter 11 case was converted to Chapter 7, the trustee commenced an adversary proceeding against the defendant shareholder to recover the payments he received in the year before the filing. In his Dec. 1, 2016 opinion, Judge Kaplan denied the defendant shareholder's motion to dismiss, which raised the safe harbor under Bankruptcy Code § 546(e) as a defense.

Distinguishing Second Circuit Precedent

Judge Kaplan distinguished the facts in TVGA Engineering from three other cases in which the Second Circuit recognized the safe harbor defense, each of which involved significantly larger amounts of money, and would arguably have affected the securities market if they were subject to avoidance. See In re Tribune Co. Fraudulent Conveyance Litigation, 818 F.3d 98 (2d Cir. 2016) (involving an $11 million debt); In re Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011) (involving the debtor's retirement or redemption of its own publicly traded debt in the amount of $1.1 billion); In re Quebecor World (USA) Inc., 719 F.3d 94 (2d Cir. 2013) (involving $376 million paid by the debtor to a financial institution serving as trustee).

Looking to Legislative Intent

Judge Kaplan likened this case to decisions by the U.S. Court of Appeals for the Eleventh Circuit in In re Munford, Inc., 98 F.3d 604 (1996) (holding that a bank's instrumental role in a transaction does not change that the payment may have been “by” a debtor “to” a shareholder), and by Bankruptcy Judge Robert D. Drain in In re MacMenamin's Grill, Ltd., 450 B.R. 414 (Bankr. S.D.N.Y. 2011) (denying safe harbor protection to transfers, and relying upon legislative history because language of Bankruptcy Code § 546(e) is ambiguous). Judge Kaplan agreed with Judge Drain that resorting to legislative history is necessary when analyzing a 546(e) defense, and relied upon Judge James Michael Peck's dictum in Quebecor concluding that Judge Drain's reliance upon legislative intent was responsible for Judge Drain's conclusion that Congress' intent was to shield from avoidance transfers between entities, which could seriously upset the securities market's ability to function, as opposed to transfers in a “small scale private stock transaction.” In re TVGA Engineering, Surveying, P.C., 14-1104 (K) p.6 (Bankr. W.D.N.Y. Dec. 1, 2016) (quoting Quebecor, 453 B.R. 201 (Bankr. S.D.N.Y. 2011) (citing In re MacMenamin's Grill, Ltd., 98 F.3d 604 (1996))).

Lessons from the Decision

Although Bankruptcy Code Section 546(e) does not contain a dollar threshold, the lesson of TVGA Engineering appears to be that even if the transfers at issue were “settlement payments” made “in connection with a securities contract,” the fact that those transfers were also made through a “financial institution” will not be sufficient to invoke the safe harbor unless the reversal of those transfers will “seriously upset the securities market's ability to function.” In other words, practitioners should consider whether the scope and nature of the transfers at issue were of the type contemplated by Congress when it created the safe harbor defense.

Notwithstanding the foregoing, Judge Kaplan made clear in his decision that the shareholder defendant's motion to dismiss was not a motion for summary judgment, and that his decision did not “foreclose a future motion to dismiss or summary judgment motion” based upon future discovery.

***** Sheryl P. Giugliano is a partner in Diamond McCarthy LLP's New York office. Her experience includes representing corporate debtors, trustees, secured and unsecured creditors in all aspects of bankruptcy cases, business litigation, and advising companies in distressed situations outside of bankruptcy. Ms. Giugliano can be reached at [email protected].