Supreme Court Bankruptcy Thoughts: Scope of Safe Harbor and Appellate Review

by Mintz Levin - Distressing Matters
Contact

Mintz Levin - Distressing Matters

[author: Sarah Ramuta]

The Supreme Court recently addressed two bankruptcy issues.  In its Merit Management opinion, the Court resolved a circuit split regarding the breadth of the safe harbor provision which protects certain transfers by financial institutions in connection with a securities contract.  In Village at Lakeridge, the Court weighed in on the scope of appellate review and whether a bankruptcy court’s factual determination should be reviewed for clear error or de novo.  These decisions are notable because they provide guidance on previously murky issues of bankruptcy law.

Merit Management Group, LP v. FTI Consulting, Inc.

In Merit Management, the Supreme Court held that Section 546(e) of the Bankruptcy Code does not protect transfers by financial institutions in connection with a securities contract if the financial institution is only a conduit for the transfer.

Merit Management concerned a Chapter 11 bankruptcy case filed by Valley View Downs, LP (“Valley View”).  Prior to filing, Valley View agreed to purchase the stock of Bedford Downs Management Corp. (“Bedford”), a company it had competed against for the last available harness-racing license in Pennsylvania.  The exchange took place through an escrow agent, and Valley View borrowed money from another bank and other lenders to pay for the shares.  Valley View filed for bankruptcy when it failed to secure the requisite gaming license.

After plan confirmation, the trustee sued Merit Management Group, LP (“Merit”), a former shareholder of Bedford, seeking to recover $16.5 million that Merit received in exchange for its shares as a constructive fraudulent transfer. Merit sought dismissal, arguing that the transfers were made by or to the type of financial institutions covered by the safe harbor provision of Section 546(e).  The safe harbor provision provides an exception to the bankruptcy trustee’s power to avoid certain transfers, specifically those made “by or to (or for the benefit of)” certain entities, including financial institutions “in connection with a securities contract.”  While it is undisputed that the escrow agent and bank were enumerated entities within this provision, the Court analyzed whether the language “made by or to” pertained to institutions that act as “mere conduits” in a transaction, such as here.

In making its determination, the Court considered approaches taken by the different circuits.  The Seventh and Eleventh Circuits have interpreted the safe harbor provision to not provide protection to transfers that pass through a covered entity, where the entity only acts as a conduit and has no beneficial interest in the property transferred.  The Second, Third, Sixth, Eighth, and Tenth Circuits have historically held to the contrary.

The Court analyzed the specific language of the safe harbor exception, as well as the entire statutory structure.  It concluded that the relevant transfer for purposes of the safe harbor is the same transfer that the trustee seeks to avoid.  In this case, the trustee sought to avoid the transfer between Valley View and Merit, not the transfers of the escrow agent and bank.  Because neither Valley View nor Merit were covered by the safe harbor provision, the provision did not apply to the transfer.  Therefore, the safe harbor provision does not apply when an entity covered by the exception is only a “conduit” for the transfer at issue.

This holding resolves a circuit split by favoring a narrow view of the safe harbor provision.

 U.S. Bank, N.A. v. Village at Lakeridge, LLC

In Village at Lakeridge, the Supreme Court addressed whether a bankruptcy court’s determination that a set of facts demonstrated an arms-length transaction should be reviewed for clear error or de novo.

In 2011, The Village at Lakeridge, LLC (“Lakeridge”) attempted to reorganize under Chapter 11 of the Bankruptcy Code.    Lakeridge’s proposed plan of reorganization purported to impair the interests of two of its substantial creditors: U.S. Bank, N.A. (“U.S. Bank”) and MBP Equity Partners (“MBP”), which owned Lakeridge.  U.S. Bank refused the proposal, which consequently blocked Lakeridge’s option to reorganize through a fully consensual plan.  See 11 U.S.C. § 1129(a)(8).

Lakeridge then opted to use a “cramdown” plan, which impairs the interests of a non-consenting class of creditors. For the court to approve a “cramdown” plan, another impaired class of creditors must consent to the plan.  However, if a creditor is an “insider” of the debtor, the Bankruptcy Code does not factor that creditor’s consent in this determination.  While the Bankruptcy Code defines “insider” as any director, officer, or “person in control” of the entity, courts (including the Ninth Circuit) have devised tests to identify “non-statutory” insiders.  The crux of these tests is whether an individual’s transaction with the debtor was at arm’s length.

Because of its “insider” status, MBP could not provide the consent required for a cramdown plan.  It instead sold its claim for $5,000 to a retired surgeon who was romantically involved with an MBP board member/Lakeridge officer. Thereafter, the surgeon consented to Lakeridge’s proposed reorganization.  U.S. Bank objected, arguing that the surgeon was a “non-statutory” insider because the transaction was not at arm’s length.  Based on the facts provided, the Bankruptcy Court rejected U.S. Bank’s argument and found that the transaction was conducted at arm’s length. The Ninth Circuit affirmed, holding that the finding was entitled to clear-error review.

The Supreme Court affirmed the Ninth Circuit’s holding.  It stated that at the case involved a “mixed question” of law and fact.  When a case requires appellate courts to expound on the law, the case should be reviewed de novo.  However, when a case immerses the courts in case-specific factual issues, the case should be reviewed with deference.  In this case, the Court boiled the mixed question down, asking: Given all the basic facts found, was the surgeon’s purchase of MBP’s claim conducted as if the two were strangers to each other?  The Court stated that “this is as factual sounding as any mixed question gets” and reasoned that the Bankruptcy Court had presided over presentation of evidence, heard all the witnesses, and had the deepest understanding of the record.  It further stated that very little legal work was required to apply the arm’s-length test.  For these reasons, the Court determined that the issue primarily rests with the Bankruptcy Court, subject only to appellate review for clear error.

Village at Lakeridge clarifies the correct standard of review – clearly erroneous –  in the narrow circumstances it addresses.  However, in reaching this decision, the Court expressly declined to review questions related to “insider” status and whether the Ninth Circuit test is appropriate to make this determination.

[View source.]

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.

© Mintz Levin - Distressing Matters | Attorney Advertising

Written by:

Mintz Levin - Distressing Matters
Contact
more
less

Mintz Levin - Distressing Matters on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.