At the end of February, the United States Supreme Court decided Merit Management Group, LP v. FTI Consulting, Inc., a decision with perhaps far-reaching implications affecting a broad range of business transactions, especially leveraged stock deals. The Court’s decision in affirming a 2016 decision by the Seventh Circuit Court of Appeals, effectively overruled conflicting decisions from the Second, Third, Sixth, Eighth and Tenth Circuits.
The Merit Management decision involved a $55 million purchase by Valley View Downs of all of the outstanding stock of BDMC, owned in part (30%) by Merit Management. Later, Valley View filed for bankruptcy relief. Title 11 – the Bankruptcy Code – grants bankruptcy trustees certain avoidance powers, allowing them to set aside and recover certain transfers for the benefit of the bankruptcy estate, including certain fraudulent transfers “of an interest of the debtor in property.”
Section 546(e) of Title 11 places various limits on the exercise of these avoidance powers, including a “safe harbor” which provides that a “trustee may not avoid a transfer that is a … settlement payment … made by or to (or for the benefit of) a … financial institution .. or that is a transfer made by or to (or for the benefit of) a … financial institution … in connection with a securities contract.”
In an exercise of these avoidance powers, Valley View’s bankruptcy estate sued Merit Management, alleging that Valley View had “substantially overpaid” for the BDMC stock and attempting to claw back Merit Management’s share of the purchase price. Bankruptcy trustees and debtors can increase the amount of money available to creditors in a bankruptcy case by “clawing back” funds transferred by the debtor to another party. Several sections of Title 11, §§ 547, 548(a)(1), and 544, grant the debtor or trustee powers to effectuate the clawback of transfers. Section 546(e), known as the “safe-harbor” provision, limits most of these claw back powers by barring the avoidance of certain transfers.
Here, the purchase was financed by Credit Suisse, and Citizens Bank served as escrow agent. At Valley View’s direction, Credit Suisse wired its loan proceeds directly to Citizens Bank which, upon receiving selling shareholders’ stock, closed the transaction and distributed 30% of the total purchase price to Merit Management. Merit Management argued that the payment could not be avoided because the transfers from Credit Suisse to Citizens Bank and from Citizens Bank to Merit Management were transfers “by or to” a financial institution.
The Supreme Court unanimously held that the relevant transfer for the purposes of determining any “safe harbor” is the transfer that the trustee seeks to avoid, in this case, from Valley View to Merit Management, not any of the intermediate transfers that comprised such transfer. Therefore, the payment by Valley View to Merit Management was not protected, and the facilitating transfers by Credit Suisse and Citizens Bank were irrelevant. For now, the Merit Management decision seems to substantially narrow the 546(e) safe harbor for bankruptcy debtors.
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