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) often hinges on what qualifies as a “financial institution,” which the Bankruptcy Code defines in a way that includes many entities not ordinary considered financial institutions. See 11 U.S.C. § 101(22)(A). But section 546(e) sometimes also raises the question of whether a transfer is made “in connection with a securities contract.” That is the question the Seventh Circuit recently addressed in Petr v. BMO Harris Bank, No. 23-1931 (7th Cir. Mar. 15, 2024).

BWGS, LLC (“BWGS”) was a wholesale distributor of garden products. In December 2016, it was acquired by Sun Capital Partners VI, L.P. (“Sun Capital”), pursuant to a stock purchase agreement (“SPA”). Sun Capital formed a subsidiary, BWGS Intermediate Holding, LLC (“Intermediate Holding”), to acquire BWGS’s stock, and to finance the acquisition Intermediate Holding borrowed $25.8 million (the “Bridge Loan”) from BMO Harris Bank, N.A. (“BMO Harris”), pursuant to a loan authorization agreement (the “Bridge Loan Authorization Agreement”). Sun Capital guaranteed the loan (the “Sun Capital Guaranty”).

In January 2017, Sun Capital caused BWGS and Intermediate Holding to borrow an additional $24.5 million, which, together with about $400,000 of BWGS’s cash on hand, was transferred to BMO as full payment of the Bridge Loan (the “Transfer”). BWGS received no value from this transaction.

BWGS repeatedly defaulted between 2017 and 2019, and BWGS’s creditors ultimately filed an involuntary bankruptcy petition against it under chapter 7. The bankruptcy court issued an order for relief under chapter 7, and a trustee was appointed (the “Trustee”). The Trustee filed an adversary proceeding against Sun Capital and BMO seeking to avoid the Transfer. BMO and Sun Capital (“Defendants”) sought dismissal based on the section 546(e) safe harbor. The bankruptcy court denied dismissal, concluding that the only securities contract involved was the SPA, and that the Transfer lacked a sufficient nexus to the SPA to be “in connection with” it. The bankruptcy court additionally held that the Trustee’s section 544 claim based on Indiana state fraudulent transfer law could go forward because section 546(e) only shields transfers from avoidance and, in the bankruptcy court’s view, Indiana law permitted recovery against Sun Capital without actually avoiding the transfer. Sun Capital and BMO appealed to the district court, which reversed on both grounds, finding that the SPA, the agreement relating to the Bridge Loan, and Sun Capital’s guaranty agreement all qualified as securities contracts, and holding that the Trustee had waived his section 544 argument. The Trustee appealed to the Seventh Circuit.

The Seventh Circuit affirmed. First, the Seventh Circuit rejected the Trustee’s argument that, based on the legislative history of section 546(e), it does not apply to private securities transactions that do not involve the national securities clearance system. The Seventh Circuit noted that legislative history is only relevant where the statutory text is ambiguous, and here, nothing in the statutory text definition of “securities contract” limited the term to contracts involving the national securities clearance system. The Seventh Circuit instead noted that the Bankruptcy Code defines “securities contract” very broadly, including eleven sub-definitions.

Second, again emphasizing the statutory definition’s “extraordinary breath,” the Seventh Circuit concluded that each of the SPA, the Bridge Loan agreement, and the Sun Capital Guaranty were securities contracts. The SPA was a securities contract because the statutory definition includes a “contract for the purchase . . . of a security.” See 11 U.S.C. § 741(7)(A)(i). The Bridge Loan Authorization Agreement was likewise a securities contract because the Code’s definition of “securities contract” also includes “any extension of credit for the clearance or settlement of securities transactions.” See 11 U.S.C. § 741(7)(A)(v). And the Sun Capital Guaranty was a securities contract because it was a “credit enhancement related to” the Bridge Loan Authorization Agreement. See 11 U.S.C. § 741(7)(A)(xi).

Third, the Seventh Circuit concluded that the Transfer was “in connection with” the securities contracts. The Transfer satisfied the Bridge Loan and extinguished Sun Capital’s guaranty, each of which involved a securities contract, and those securities contracts effectuated the SPA, another securities contract. Because no party disputed that the Transfer was made to a financial institution (BMO), the Seventh Circuit found that the safe harbor applied to the Transfer.

Lastly, the Seventh Circuit rejected the argument that the Trustee’s section 544 claim was not barred by section 546(e). Section 544 enables a bankruptcy trustee to make use of state-law remedies that would be available to a creditor of the debtor. Here, the Trustee argued that under Indiana law, a creditor could recover “judgment for the value of the asset transferred” to the extent a transfer is “avoidable” from “the person for whose benefit the transfer was made,” here Sun Capital. See Indiana Uniform Voidable Transactions Act (“IUVTA”) § 18(b)(1). According to the Trustee, section 546(e) would not apply to bar such a claim because recovery is not dependent on avoiding the underlying transfer. The Seventh Circuit held that the Trustee’s state law claim was nonetheless precluded as a matter of obstacle preemption, since it would effectively permit the use of a state-law claim to circumvent the safe harbor. The Seventh Circuit understood the Trustee’s sought remedy as functionally the same as the avoidance remedy that the safe harbor bars, and therefore held that it was unavailable.