We have previously blogged about the section 546(e) defense to a trustee’s avoidance powers under the Bankruptcy Code. A trustee has broad powers to set aside certain transfers made by debtors before bankruptcy. See 11 U.S.C. §§ 544, 547, 548. Section 546(e), however, bars avoiding certain transfers, including a “settlement payment . . . made by or to (or for the benefit of) . . . a financial institution [or] a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract.” 11 U.S.C. § 546(e). The applicability of section 546(e) can thus hinge on what qualifies as a “financial institution.” The Bankruptcy Code’s definition of “financial institution” is counterintuitive: it includes not only certain institutions that fall within the colloquial understanding of “financial institution” (“a Federal reserve bank, or an entity that is a commercial or savings bank, industrial savings bank, savings and loan association, trust company, federally-insured credit union, or receiver, liquidating agent, or conservator for such entity”), but also a customer of such institutions “when” such institutions are “acting as agent or custodian for [such] customer . . . in connection with a securities contract.” 11 U.S.C. § 101(22)(A).
In In re Tribune Co. Fraudulent Conveyance Litigation, 946 F.3d 66 (2d Cir. 2019) (“Tribune”), the Second Circuit held that this definition extended to Tribune Co. with respect to Tribune’s payments to shareholders in connection with a merger, because Tribune was a “customer” of a financial institution, and that institution served as Tribune’s agent for the payments. As such, the Second Circuit held that the payments were protected from avoidance by the safe harbor.
The precise scope of Tribune remains in question. For purposes of section 546(e), what does it mean for a financial institution to be “acting as agent” for a customer? And when a financial institution is acting as an agent for a customer, rendering the customer itself a financial institution for section 546(e) purposes, how broadly does that classification extend? These issues are addressed in a recent Second Circuit decision on section 546(e), In re Nine West Holdings Inc., __ F.4th __, 2023 U.S. App. LEXIS 31258 (2d Cir. Nov. 27, 2023).
The case arose from a leveraged buyout of the apparel company Jones Group, Inc. (“Jones Group”) by the private equity firm Sycamore Partners (“Sycamore”), and the subsequent bankruptcy of the surviving company Nine West Holdings, Inc. (“Nine West”). Because the court’s decision turned on the facts of the merger, we provide a summary of the key facts as the court described them. To effectuate the merger, Sycamore created Jasper Parent LLC (“Jasper Parent”) and Jasper Merger Sub, Inc. (“Jasper Merger Sub”), a wholly owned subsidiary of Jasper Parent. On December 19, 2013, Jasper Parent, Jasper Merger Sub, and Jones Group entered into the Merger Agreement, under which Jones Group merged with Jasper Merger Sub, leaving Jones Group (later Nine West) as the survivor. The Merger Agreement provided for a “paying agent” to be hired to make payments to the public shareholders, and also provided that Jasper Parent would deposit the merger consideration with the paying agent. Jasper Parent and Jones Group hired Wells Fargo to act as the paying agent and entered into the Paying Agent Agreement (“PAA”) with it. The PAA specified that the paying agent would act as Jones Group’s “special agent” for distributing the merger consideration and outlined the payment mechanics in detail. The Merger Agreement also provided for payments to Jones Group’s former directors, officers, and employees for their restricted shares, share-equivalent units, and accumulated dividends, which were to be made through payroll and other means.
In April 2018, Nine West filed for bankruptcy. A plan was confirmed in February 2019. In February 2020, the Litigation Trustee for the Nine West Litigation Trust and the Indenture Trustee for certain notes issued by Nine West brought 17 actions against Jones Group’s former directors and officers for unjust enrichment, and against its former public shareholders for fraudulent conveyance. The public shareholders and the directors and officers moved to dismiss on the basis that the transfers to them were shielded by the section 546(e) safe harbor. The district court granted both motions and Plaintiffs appealed.
The Second Circuit affirmed in part and reversed in part. First, the Second Circuit held that whether Nine West qualified as a “financial institution” for purposes of section 546(e) was properly analyzed on a transfer-by-transfer basis rather than a contract-by-contract basis. For an entity to qualify as a financial institution by virtue of a financial institution serving as its agent, the Second Circuit held that agency relationship must pertain to the transaction at issue. To justify that requirement, the Second Circuit pointed to the statutory text, which provides that customers qualify as financial institutions “when” a bank is acting as its agent, and to the principle that courts should interpret statutes to avoid absurd results, reasoning that a contrary interpretation would mean that every transfer in connection with an LBO would be shielded as long as at least one such transfer involved a bank serving as agent. The Second Circuit also reasoned that a more expansive interpretation of the safe harbor would undermine the avoidance powers critical to the Bankruptcy Code and would shield transfers unrelated to Congress’s purpose of protecting the stability of the financial system.
Second, based on this framework, the Second Circuit held that Nine West qualified as a financial institution as to the transfers to the public shareholders, but not as to the transfers to the directors and officers. As to the transfers to the public shareholders, the Second Circuit held that Wells Fargo acted as Nine West’s agent, rendering Nine West a financial institution for 546(e) purposes. As to the transfers to the directors and officers, however, the Second Circuit rejected certain defendants’ arguments that Wells Fargo had a role in cancelling certain restricted shares and, as such, was Nine West’s “agent” as to those transfers as well. The Second Circuit noted that the factual record was unclear, but even if Wells Fargo had a ministerial role in cancelling the shares, the court held that this was insufficient for Wells Fargo to be an agent, since Nine West did not exercise control over Wells Fargo for this role. In reaching this conclusion, the Second Circuit emphasized that a further expansion of section 546(e)’s scope would not fulfill Congress’s purpose.
Third, the Second Circuit briefly rejected Plaintiffs’ argument that the safe harbor did not apply because the Merger Agreement was not a “securities contract,” relying on the expansive statutory definition of “securities contract” and noting that the payments were also “settlement payments.”
Judge Sullivan dissented. He argued that, based on the “connection with a securities contract” language in section 546(e) and in the statutory definition of “financial institution,” the contract-by-contract approach was the appropriate one, and all the transfers at issue were safe harbored.
