The United States Court of Appeals for the Second Circuit held, on June 10, 2013, that payments made by a company to purchase notes issued by an affiliate were transfers made in connection with a “securities contract,” and therefore, pursuant to Section 546(e) of the Bankruptcy Code, could not be avoided as preferential transfers. In re Quebecor World (USA) Inc., No. 12-4270-bk.
The dispute related to notes issued by Quebecor World Capital Corp. pursuant to two note purchase agreements. Quebecor World (USA) Inc. (the “Debtor”) guaranteed the notes. Some years later, the Debtor purchased the notes from the noteholders and paid for that purchase by transferring funds to the trustee for the notes, who then distributed the funds to the noteholders. Within 90 days of the purchase, the Debtor filed for bankruptcy. The unsecured creditors committee then sought to avoid the payment of the purchase price as a preferential transfer.
The Second Circuit first concluded that the two note purchase agreements were “securities contracts” within the meaning of Section 741(7) of the Bankruptcy Code, because they provided for the original purchase of the notes by the noteholders and because the purchase of the notes by the Debtor was made in accordance with the terms of the note purchase agreements.
Under Section 546(e) of the Bankruptcy Code, a transfer in connection with a securities contract is exempt from avoidance if the transfer is “made by or to (or for the benefit of)” a financial institution. The trustee who received the funds from the Debtor was a financial institution, but certain of the noteholders were not. The Second Circuit held that a transfer was “to” a financial institution if the financial institution received the funds, even if the financial institution did not have title to the funds. Thus, the transfer of funds by the Debtor was “to” the trustee, which was a financial institution.
Accordingly, the Second Circuit held that the payment by the Debtor of the purchase price of the notes was a transfer to a financial institution in connection with a securities contract, and therefore could not be avoided as a preferential transfer under Section 546(e) of the Bankruptcy Code.
The Second Circuit expressly declined to decide two questions: (i) whether the payments by the Debtor were “settlement payments” that are also protected from avoidance by Section 546(e) of the Bankruptcy Code, and (ii) whether the outcome would have been different had the Debtor repurchased its own securities. The Second Circuit emphasized that the Debtor had purchased the securities of an affiliate.
The Second Circuit’s decision offers some useful insights on how to structure a commercial loan transaction so that it will qualify as a securities contract and loan repayments will not be avoidable as preferential transfers. But the decision is also unsatisfying in certain respects.
While the purchase of the notes by the Debtor was made in compliance with the note purchase agreements, it does not appear to have been made pursuant to the note purchase agreements. Nonetheless, the Second Circuit ruled that the transfers were “in connection with” a securities contract. Under such circumstances, “in connection with” seems to be a rather elastic term.
In addition, financial institutions have avoided liability under Section 550 of the Bankruptcy Code by arguing that they were mere conduits and thus that they were not the “initial transferee” within the meaning of Section 550. If, as the Second Circuit ruled, a transfer is “to” a financial institution under Section 546(e) even if the financial institution does not have title to the funds, then why wouldn’t such a financial institution also be an “initial transferee” under Section 550? The Second Circuit’s decision may have the unintended effect of exposing financial institutions to expanded preference liability.