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What Has Merit Management Changed?
It has been nearly two years since the Supreme Court upended the world of the Bankruptcy Code securities safe harbor with its decision in Merit Management Group, LP v. FTI Consulting, Inc., 583 U. S. ____, 138 S.Ct. 883, 200 L.Ed. 2d 183 (2018). For all of the speculation regarding its consequences, there have been few subsequent lower court decisions applying Merit Management, and the courts of appeal have yet to make rulings in the pending cases dealing with some of the major safe harbor issues. However, those cases provide valuable guidance to practitioners facing safe harbor litigation as well as transactional lawyers looking to take advantage of safe harbor protections.
The Securities Safe Harbor
The securities safe harbor has become increasingly important as a defense to avoidance actions. It consists of several related provisions that generally tend to insulate certain securities transactions from the effects of bankruptcies. For the safe harbor to apply, there must be a qualifying transaction, such as a margin payment, a settlement payment, or a payment in connection with a securities contract, a forward contract, a commodity contract, a repurchase agreement or a swap agreement. The transaction must also be made by, made to, or be made for the benefit of, a qualifying institution, such as a commodity broker, a forward contract merchant, a stockbroker, a securities clearing agency, or a Financial Institution, or a Financial Participant. (The scope of these last two defined terms is discussed further below.)
Among the benefits of the safe harbor are that it: 1) allows protected securities positions to be closed out, notwithstanding the automatic stay; 2) overrides bankruptcy ipso facto provisions, which otherwise would negate contractual termination clauses that are triggered by a counterparty's bankruptcy; and 3) shields protected transactions from being unwound in subsequent avoidance actions.
Most safe harbor-related litigation has arisen in the context of avoidance actions. Bankruptcy Code section 546 generally provides that if there has been a qualifying transaction made by, to, or for the benefit of a qualifying institution, a trustee is precluded from bringing: 1) preference actions; 2) fraudulent conveyance actions based on state law; or 3) federal law constructive intent fraudulent conveyance actions. The most frequently invoked has been section 546(e), which provides:
the trustee may not avoid a transfer that is a margin payment … or settlement payment … made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, or that is a transfer made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract … commodity contract … or forward contract, that is made before the commencement of the case, except under section 548(a)(1)(A) ….
The Merit Management Decision
In Merit Management, the Supreme Court addressed one aspect of the qualifying institution requirement: the conduit rule, adopted in several circuits, and held that the qualifying institution rule could be satisfied even if the only qualifying institution was involved in the transaction merely as a conduit. The case arose from efforts by a trustee to avoid as a constructive intent fraudulent conveyance prepetition payments that had been made to acquire stock of a competitor of the debtor. The purchase price had been escrowed, and was subsequently paid to the shareholder/sellers by the escrow agent. The complaint alleged that the debtor had been insolvent when the transaction took place, and that it had “significantly overpaid” for the stock such that the payment was for less than reasonably equivalent value.
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