Section 546(e) of the Bankruptcy Code provides a “safe harbor” for certain transfers involving the purchase and sale of securities and protects those transfers from avoidance in bankruptcy proceedings as preferences or constructively fraudulent conveyances. Specifically, section 546(e) insulates transfers that are “settlement payments” used in the securities trade, as well as other transfers made to or from certain parties, including financial institutions, financial participants and stockbrokers, in connection with a securities contract. Section 741(8) of the Bankruptcy Code defines “settlement payment” somewhat cryptically, as a “preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment or any other similar payment commonly used in the securities trade.”
Some courts have interpreted this safe harbor expansively, and have applied section 546(e) to shield a wide array of otherwise recoverable transfers from the avoidance provisions of the Bankruptcy Code. As we have noted in previous editions of Absolute Priority, courts have increasingly applied the section 546(e) safe harbor to shield virtually all transactions that concern a purported transfer of securities, both public and private, from avoidance. In light of recent admonitions like that made by the Court of Appeals for the Second Circuit in Enron Creditors Recovery Corp. v. Alfa, S.A.B. de CV, 651 F.3d 329, 334 (2d Cir. 2011) that section 546(e) should be interpreted “extremely broadly”, commentators and practitioners alike have struggled to define the outer limit of the types of transactions that may come under the protection of section 546(e). The Second Circuit returned to this debate again this past summer, and issued a ruling that reinforces the broad application of section 546(e) announced in Enron.
In Official Comm. Of Unsecured Creditors of Quebecor World (USA) Inc. v Am. United Life Ins. Co. (in re Quebecor World (USA) Inc.), 719 F.3d 94 (2d Cir. 2013) (“Quebecor”), the Second Circuit held that section 546(e) precluded the bankruptcy estate of Quebecor World (USA) Inc. (“QWUSA”) from avoiding and recovering as preferences certain transfers made by the debtor within 90 days of bankruptcy to purchase notes issued by one of its affiliates. Before the QWUSA bankruptcy, Quebecor World Capital Corp. “QWCC“), raised $371 million by issuing notes pursuant to note purchase agreements (the “NPAs“). Facing financial difficulty and the prospect of default, QWCC sought to prepay the notes, which was permissible under the NPAs. For tax purposes, the note repurchase was structured such that QWUSA (rather than QWCC) would purchase the notes from the noteholders. To complete the transaction, QWUSA transferred $376 million to CIBC Mellon Trust Co. (“CIBC“), the trustee for the noteholders, who then distributed those funds to the individual noteholders. The noteholders subsequently surrendered their notes directly to Quebecor World, Inc., the corporate parent of QWUSA and QWCC. All of this occurred within 90 days of QWUSA’s bankruptcy filing.
The QWUSA creditors’ committee sued the noteholders, seeking to avoid and recover, as preferential transfers, the payments they received from the note repurchase. The noteholders moved for summary judgment, contending that the transfers were protected from avoidance under the section 546(e) safe harbor as either “settlement payments” or transfers made “in connection with a securities contract.” Relying on the Second Circuit’s ruling in Enron, which held that redemptions of commercial paper by a debtor were protected “settlement payments,” the bankruptcy court granted summary judgment to the noteholders, finding that the transfers from QWUSA were both “settlement payments” and transfers made “in connection with a securities contract” under 546(e). The district court affirmed on both points and the QWUSA creditors’ committee appealed to the Second Circuit.
The Second Circuit concluded that the payments made by QWUSA to the noteholders were protected from avoidance under section 546(e) as transfers made to a financial institution in connection with a securities contract. The Second Circuit found that (i) CIBC was a “financial institution” for purposes of section 546(e), (ii) the NPAs met the definition of a “securities contract” because they provided for both the original purchase and repurchase of the notes, and (iii) the payments were “in connection with” the NPAs. In so ruling, the Second Circuit also expressly embraced prior holdings of the Third, Sixth, and Eighth Circuits which have held that transfers are protected by section 546(e) even if the “financial institution” present in the transaction (in this case, CIBC) is only involved as a conduit through which the payments are made to beneficial holders who are not financial institutions. The court based its ruling in part on the legislative purpose of section 546(e), which was to “minimiz[e] the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.” Quebecor, 719. F3d at 100 (quoting Enron, 651 F.3d at 334).
When considered in conjunction with the Second Circuit’s decision in Enron, the ruling in Quebecor unequivocally affirms the Second Circuit’s exceedingly expansive view of section 546(e), as it joins the growing chorus of appellate courts to insulate a broad swath of transfers, including both public and private debt and equity transactions, from avoidance in the event of a bankruptcy based only on the mere fact that the payments at issue were passed through a financial institution on their way to the ultimate beneficiary. This growing body of jurisprudence continues to stymie trustees, creditors committees and their constituencies as challenges to questionable prepetition conduct are increasingly defeated by broad applications of the safe harbor.