Court's Broad Interpretation of Definition of "Securities Contracts" Promotes Expansive Scope of Bankruptcy Code "Safe Harbor"

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Section 546(e) of the Bankruptcy Code's "safe harbor" preventing avoidance in bankruptcy of certain securities, commodity, or forward-contract payments has long been a magnet for controversy. Several noteworthy court rulings have been issued in bankruptcy cases addressing the application of the provision, including application to financial institutions, its preemptive scope, and its application to non-publicly traded securities.

One of the latest chapters in the ongoing debate was written by the U.S. District Court for the Southern District of Indiana in Petr v. BMO Harris Bank N.A., 2023 WL 3203113 (S.D. Ind. May 2, 2023), appeal filed, No. 23-1931 (7th Cir. May 17, 2023). The district court broadly construed the section 546(e) safe harbor to bar a chapter 7 trustee from suing under state law and section 544(b) of the Bankruptcy Code to avoid an alleged constructive fraudulent transfer made by the debtor shortly after it had been acquired in a leveraged buy-out ("LBO"). According to the district court: (i) all of the agreements related to the LBO acquisition "were securities contracts" for purposes of the section 546(e) safe harbor, which insulated from avoidance a transfer made by the debtor one month after the LBO to refinance a loan incurred as part of the transaction; (ii) the safe harbor is not limited to transfers involving publicly traded securities; and (iii) section 546(e) preempted the trustee's state law constructive fraudulent transfer claims.

The Section 546(e) Safe Harbor

Section 546 of the Bankruptcy Code imposes a number of limitations on a bankruptcy trustee's avoidance powers, which include the power to avoid certain preferential and fraudulent transfers. Section 546(e) provides that the trustee may not avoid, among other things, a pre-bankruptcy transfer that is a settlement payment "made by or to (or for the benefit of) a … financial institution [or a] financial participant …, or that is a transfer made by or to (or for the benefit of)" any such entity in connection with a securities contract, "except under section 548(a)(1)(A) of the [Bankruptcy Code]." Thus, the section 546(e) "safe harbor" bars avoidance claims challenging a transfer falling under the subsection's terms unless the transfer was made with actual intent to hinder, delay, or defraud creditors under section 548(a)(1)(A), as distinguished from constructively fraudulent transfers under section 548(A)(1)(B), where the debtor is insolvent at the time of the transfer (or becomes insolvent as a consequence) and receives less than reasonably equivalent value in exchange.

Section 101(22) of the Bankruptcy Code defines the term "financial institution" to include, in relevant part:

[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 and, when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer (whether or not a "customer", as defined in section 741) in connection with a securities contract (as defined in section 741) such customer ….

11 U.S.C. § 101(22). "Customer" and "securities contract" are defined broadly in sections 741(2) and 741(7) of the Bankruptcy Code, respectively. Sections 101(51A) and 741(8) define the term "settlement payment."

According to the legislative history of section 546(e), the purpose of the safe harbor is to prevent "the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market." H.R. Rep. No. 97-420, at 1 (1982). The provision was "intended to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries." Id.

Notable Court Rulings

Many notable court rulings have addressed: (i) whether section 546(e) preempts fraudulent transfer claims that can be asserted by or on behalf of creditors by a bankruptcy trustee under state law; (ii) whether the section 546(e) safe harbor insulates from avoidance only transactions involving publicly traded securities; and (iii) whether a "financial institution" must be the transferor or ultimate transferee, as distinguished from an intermediary or conduit, for a transaction to be insulated from avoidance under the safe harbor.

Preemption. In Deutsche Bank Trust Co. Ams. v. Large Private Beneficial Owners (In re Tribune Co. Fraudulent Conveyance Litig.), 818 F.3d 98 (2d Cir. 2016) ("Tribune 1"), the U.S. Court of Appeals for the Second Circuit affirmed lower court decisions dismissing creditors' state law constructive fraudulent transfer claims arising from the 2007 LBO of Tribune Co. ("Tribune"). According to the Second Circuit, even though section 546(e) expressly provides that "the trustee" may not avoid certain payments under securities contracts unless such payments were made with the actual intent to defraud, section 546(e)'s language, its history, its purposes, and the policies embedded in the securities laws and elsewhere lead to the conclusion that the safe harbor was intended to preempt constructive fraudulent transfer claims asserted by creditors under state law.

Other courts have applied this rationale in finding preemption of state intentional and constructive fraudulent transfer laws by the safe harbor. See, e.g., Holliday, Liquidating Trustee of the BosGen Liq. Trust v. Credit Suisse Secs. (USA) LLC, 2021 WL 4150523 (S.D.N.Y. Sept. 13, 2021) ("Boston Generating") (section 546(e) preempts intentional fraudulent transfer claims under state law because the intentional fraud exception expressly included in the provision applies only to intentional fraudulent transfer claims under federal law), appeals filed, Nos. 21-2543 et al. (2d Cir. Oct. 8, 2021) (argued on Sept. 28, 2022); In re Nine West LBO Sec. Litig., 482 F. Supp. 3d 187 (S.D.N.Y. 2020) (the safe harbor preempts state law fraudulent transfer claims), appeal filed, No. 20-3290 (2d Cir. Sept. 25, 2020) (argued on Nov. 23, 2020).

Transactions Involving Publicly and Privately Traded Securities. Because section 546(e) is silent as to whether it applies to transactions involving publicly or privately traded securities, some courts, finding the language of the provision to be ambiguous and looking to its legislative history for guidance, have concluded that the safe harbor is limited to transactions involving publicly traded securities. See, e.g., Kipperman v. Circle Trust F.B.O. (In re Grafton Partners, L.P.), 321 B.R. 527, 539 (B.A.P. 9th Cir. 2005) (finding that section 546(e) places a "line between public transactions that involve the clearance and settlement process and nonpublic transactions that do not involve that process"); Kapila v. Espirito Santo Bank (In re Bankest Capital Corp.), 374 B.R. 333, 346 (Bankr. S.D. Fla. 2007) (section 546(e) is inapplicable where the "case did not involve the utilization of public markets or publicly traded securities").

Other courts have disagreed, concluding that section 546(e) is not on its face limited to transactions involving publicly traded securities, and that resort to the provision's legislative history is therefore unwarranted. See, e.g., Brandt v. B.A. Capital Co. L.P. (In re Plassein Int'l Corp.), 590 F.3d 252 (3d Cir. 2009) (finding that the plain meaning of section 546(e) is clear and holding that the provision is not limited to publicly traded securities but also extends to transactions involving privately held securities), cert. denied, 559 U.S. 1093 (2010); In re QSI Holdings, Inc., 571 F.3d 545, 550 (6th Cir. 2009) ("[W]e hold that nothing in the text of § 546(e) precludes its application to settlement payments involving privately-held securities."), abrogated in part on other grounds by Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009) (section 546(e) is not limited to publicly traded securities transactions and protects from avoidance a debtor's payments deposited in a national bank in exchange for its shareholders' privately held stock during an LBO); Quebecor, 719 F.3d at 98-99 (ruling that the safe harbor applied to insulate from avoidance a repurchase transaction for private-placement notes that involved payments to a noteholder trustee that was a "financial institution"); In re Taylor, Bean & Whitaker Mortgage Corp., 2017 WL 4736682, *9 (M.D. Fla. Mar. 14, 2017) ("[I]f Congress wanted § 546(e) to apply to only non-private transactions, it has the constitutional authority to rewrite the statute. The judiciary, however, does not."); In re Lancelot Investors Fund, L.P., 467 B.R. 643, 655 (N.D. Ill. 2012) (section 546(e) "does not limit its protection to transactions made on public exchanges").

Financial Institution as Transferor or Transferee. Prior to the Supreme Court's 2018 ruling in Merit, there was a split among the circuit courts concerning whether the section 546(e) safe harbor barred state-law constructive-fraud claims to avoid transactions in which the "financial institution" involved was merely a "conduit" for the transfer of funds from the debtor to the ultimate transferee. See generally Collier on Bankruptcy ¶ 546.06[2] n.16 (16th ed. 2023) (listing cases). For example, the Second Circuit ruled that the safe harbor applied under those circumstances in In re Quebecor World (USA) Inc., 719 F.3d 94 (2d Cir. 2013). The Supreme Court resolved the circuit split in Merit.

In Merit, a unanimous Supreme Court held that section 546(e) did not protect a transfer made as part of a non-public stock sale transaction through a "financial institution," regardless of whether the financial institution had a beneficial interest in the transferred property. Instead, the relevant inquiry is whether the transferor or the transferee in the transaction sought to be avoided overall is itself a financial institution. Because the selling shareholder in the LBO transaction that was challenged in Merit was not a financial institution (even though the conduit banks through which the payments were made met that definition), the Court ruled that the payments fell outside of the safe harbor.

In a footnote, the Court acknowledged that the Bankruptcy Code defines "financial institution" broadly to include not only entities traditionally viewed as financial institutions but also the "customers" of those entities, when financial institutions act as agents or custodians in connection with a securities contract. Merit, 138 S.Ct at 890 n.2. The selling shareholder in Merit was a customer of one of the conduit banks, yet never raised the argument that it therefore also qualified as a financial institution for purposes of section 546(e). For this reason, the Court did not address the possible impact of the selling shareholder's customer status on the scope of the safe harbor.

The Second Circuit quickly filled that void. In In re Tribune Co. Fraudulent Conveyance Litig., 946 F.3d 66 (2d Cir. 2019), dismissing cert. in part, 141 S. Ct. 728 (2020), cert. denied, 141 S. Ct. 2552 (2021) ("Tribune 2"), the Second Circuit explained that, under Merit, the payments to Tribune's shareholders were shielded from avoidance under section 546(e) only if either Tribune, which made the payments, or the shareholders who received them, were "covered entities." It then concluded that Tribune was a "financial institution," as defined by section 101(22) of the Bankruptcy Code, and "therefore a covered entity."

According to the Second Circuit, the entity Tribune retained to act as depository in connection with the LBO was a "financial institution" for purposes of section 546(e) because it was a trust company and a bank. Therefore, the court reasoned, Tribune was likewise a financial institution because, under the ordinary meaning of the term as defined by section 101(22), Tribune was the bank's "customer" with respect to the LBO payments, and the bank was Tribune's agent according to the common-law definition of "agency." Tribune 2, 946 F.3d at 91; see also Kelley as Tr. of PCI Liquidating Tr. v. Safe Harbor Managed Acct. 101, Ltd., 31 F.4th 1058, 1065 (8th Cir. 2022) (noting that "we do not disagree" with Tribune 2's "basic assumption" that the customer of a financial institution may itself qualify as a financial institution for purposes of the section 546(e) safe harbor if it meets the definition of "financial institution" set forth in section 101(22)(A) of the Bankruptcy Code).

Several bankruptcy and district courts in the Second Circuit picked up where the Second Circuit left off in Tribune 2, ruling that pre-bankruptcy recapitalization or LBO transactions were safe-harbored from avoidance as fraudulent transfers because they were effected through a bank or other qualifying "financial institution." See, e.g., Boston Generating, 2021 WL 4150523, at *6 (payments made to the members of LLC debtors as part of a pre-bankruptcy recapitalization transaction were protected from avoidance under section 546(e) because the debtors were "financial institutions," as customers of banks that acted as their depositories and agents in connection with the transaction); Nine West, 482 F. Supp. 3d at 206 (dismissing fraudulent transfer and unjust enrichment claims brought by a chapter 11 plan litigation trustee and an indenture trustee seeking to avoid payments made as part of an LBO, and ruling that the payments were protected by the safe harbor because they were made by a bank acting as the debtor's agent); SunEdison Litigation Trust v. Seller Note, LLC (In re SunEdison, Inc.), 620 B.R. 505, 515 (Bankr. S.D.N.Y. 2020) (noting that, under Merit, the "relevant transfer" was "the overarching transfer," and ruling that, because one step of an "integrated transaction" was effected through a qualified financial institution, section 546(e) shielded the "component steps" from avoidance as a constructive fraudulent transfer); see also In re Tops Holding II Corp., 646 B.R. 617 (Bankr. S.D.N.Y. 2022) (the safe harbor did not insulate a transaction whereby, after encumbering the assets of a privately held chapter 11 debtor with privately issued debt, certain private equity investors took massive dividends, because, although the proceeds of the private notes were intended to be deposited into the bank accounts of the debtors and the private equity investors, the parties' banks were not agents or custodians (as was the case in Tribune 2), and therefore were not qualifying recipients for purposes of section 546(e)), leave to appeal denied, 2023 WL 119445 (S.D.N.Y. Jan. 6, 2023).

However, at least one court has criticized the Tribune 2 "workaround" approach. See In re Greektown Holdings, LLC, 621 B.R. 797, 827 (Bankr. E.D. Mich. 2020) (ruling that a pre-bankruptcy recapitalization transaction fell outside the scope of the safe harbor where neither the transferor nor the transferees were financial institutions and the underwriter did not act as the transferor's agent in connection with the transaction, and noting that, under Tribune 2, "any intermediary hired to effectuate a transaction would qualify as its customer's agent [, which] … would result in a complete workaround of [Merit]"), reh'g denied, 2020 WL 6701347 (Bankr. E.D. Mich. Nov. 13, 2020).

BMO Harris

In March 2019, creditors filed an involuntary chapter 7 petition against BWGS, LLC (the "debtor"), a distributor of agricultural equipment and supplies, in the Southern District of Indiana. After the bankruptcy court entered an order for relief, the chapter 7 trustee filed an adversary proceeding against BMO Harris Bank, N.A. ("BMO") and Sun Capital Partners, VI, L.P. ("Sun Capital" and collectively, the "defendants"). In his complaint, the trustee sought to avoid as constructively fraudulent under Indiana law and section 544(b) of the Bankruptcy Code approximately $25 million transferred by the debtor in January 2017 to BMO to repay a bridge loan made to a Sun Capital affiliate created in 2016 to acquire the debtor's non-publicly traded stock from an employee stock ownership plan trust (the "ESOP Trust") for $37.75 million.

Although the debtor was not liable on the bridge loan, which was guaranteed by Sun Capital, the debtor borrowed funds from another bank one month after the acquisition was completed to pay off the bridge loan. The debtor pledged its assets as security for repayment of the second loan.

Because the transfer occurred more than two years before the bankruptcy filing, the chapter 7 trustee could not seek avoidance under section 548 of the Bankruptcy Code. Instead, the trustee invoked section 544(b) to step into the shoes of an actual creditor for the purpose of suing BMO and Sun Capital to avoid the constructively fraudulent transfer under Indiana law. The trustee alleged that the $25 million transfer to pay off the bridge loan was made "to or for the benefit" of Sun Capital and BMO and that the debtor received no consideration for encumbering its property.

The defendants moved to dismiss the trustee's complaint. They argued that the litigation was barred by the section 546(e) safe harbor because the bridge loan repayment was made in connection with several securities contracts, including the stock purchase agreement between the Sun Capital affiliate and the ESOP Trust, the bridge loan from BMO (a "financial institution"), and the Sun Capital guarantee. The trustee countered that section 546(e) applies only to transactions "that implicate systemic risks in the national clearance and settlement system for trades of publicly-held securities," not private LBO transactions.

The bankruptcy court denied the defendants' motion to dismiss. See Petr v. BMO Harris Bank N.A. (In re BWGS LLC), 643 B.R. 576 (Bankr. S.D. Ind. 2022), rev'd and remanded, 2023 WL 3203113 (S.D. Ind. May 2, 2023). According to the bankruptcy court, the section 546(e) safe harbor did not apply because the trustee's complaint sought avoidance of the constructively fraudulent transfer under section 544(b), rather than section 548. The court also found that the safe harbor did not apply because the stock sold by the ESOP Trust was not publicly traded, so that avoiding the transfer would not pose any systemic risk to the financial markets. In addition, because there was a one-month gap between the closing of the LBO and the bridge loan repayment, the bankruptcy court concluded that the two transactions were separate for purposes of section 546(e).

The bankruptcy court authorized the defendants' interlocutory appeal to the district court.

The District Court's Ruling

The district court reversed and remanded the case to the bankruptcy court.

According to U.S. District Court Judge Jane Magnus-Stinson, the bankruptcy court erred by: (i) limiting its analysis to whether the stock purchase agreement, as distinguished from all of the related agreements, was a "securities contract" for purposes of the safe harbor; and (ii) concluding that the safe harbor was not implicated because the debtor's stock was not publicly traded. Instead, she explained, the court should have examined whether all of the related agreements were securities contracts, as defined in section 741(7), in determining whether the relevant transactions were within the scope of section 546(e).

"Based on the plain and unambiguous language in Section 546(e)," Judge Magnus-Stinson concluded that the stock-purchase agreement, the bridge loan, and the Sun Capital guarantee were all covered by the safe harbor because they were entered into "in connection with a securities contract." BMO Harris, 2023 WL 3203113, at *5. She explained that all three agreements fell within the definition of a "securities contract" because: (i) the stock purchase agreement was the transaction by which the Sun Capital affiliate acquired the debtor's stock from the ESOP trust, and the agreement constituted "a contract for the purchase … of a security," as specified in section 741(7); (ii) the bridge loan was made by BMO to the Sun Capital affiliate to provide part of the $37.75 million stock purchase price, and the loan was an "extension of credit for the clearance or settlement of [a] securities transaction[ ]," or an "agreement … that is similar to an agreement or transaction" referred to in section 741(7); and (iii) by the Sun Capital guarantee, Sun Capital provided a credit enhancement to BMO with respect to the bridge loan, and the guarantee was accordingly an "arrangement or other credit enhancement related to any agreement or transaction referred to in [§ 741(7)], including any guarantee … to a … financial institution … in connection with any agreement or transaction referred to in [§ 741(7)]." Id.

The district court also faulted the bankruptcy court's determination that the safe harbor was inapplicable because the bridge loan was repaid one month after the LBO. According to Judge Magnus-Stinson, although the Seventh Circuit has not addressed the issue, the phrase "in connection with a securities contract" in section 546(e) should be read broadly to mean "related to" a securities contract. She wrote that "the Transfer was made in connection with the Stock Purchase Agreement because it was made to pay off the Bridge Loan that was used to close the Stock Purchase Agreement." Id. at *7.

The district court then ruled that the bankruptcy court erroneously concluded, based on the legislative history of section 546(e), that the safe harbor applies only to transactions involving publicly traded securities. According to Judge Magnus-Stinson:

Nowhere in § 546(e) is a distinction drawn between a transaction that implicates publicly traded securities versus one that implicates privately held securities. Instead, as discussed above, § 546(e) refers to the definition of "securities contract" in § 741(7), which similarly does not distinguish between publicly or privately held securities. The fact that the definition of "securities contract" appears in another section of the Bankruptcy Code is of no moment—indeed statutes frequently refer to other statutes in order to define included terms.

Id. at *9. She also noted that her conclusion is consistent with the rulings of "numerous" courts, including the Sixth and Eighth Circuits in QSI Holdings and Contemporary Industries, respectively. Id.

Finally, citing Tribune 1, the district court ruled that the trustee's state constructive fraudulent transfer claims under section 544(b) and Indiana law were preempted by section 546(e).

The district court accordingly reversed the bankruptcy court's ruling and remanded the case below with instructions to dismiss the suit.


The section 546(e) safe harbor has produced a wealth of notable court rulings in recent years, and BMO Harris adds to that body of case law. Moreover, further developments on this issue are likely. Even though the U.S. Supreme Court declined to review Tribune 2 in 2021, BMO Harris has been appealed to the Seventh Circuit, which has another opportunity (after the affirmance of its ruling in Merit) to weigh in on how broadly or narrowly the safe harbor should be construed. Briefing in the case was completed in September 2023. In addition, appeals of the decisions in Boston Generating and Nine West have been pending for years before the Second Circuit.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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