Tribune II: Law Firm Perspectives
by | posted in: Avoidance, Financial Firms and Safe Harbors, fraudulent transfer, Statutory Interpretation | 0

By Xiao Ma (Harvard Law School)

Xiao Ma

On December 19, 2019, the Second Circuit issued its amended opinion in In re Tribune Company Fraudulent Conveyance Litigation, 2019 WL 6971499 (2d Cir. Dec. 19, 2019), which held the “safe harbor” provision in section 546(e) of the Bankruptcy Code covers Tribune Company’s payments made to public shareholders as Tribune constitutes a “financial institution” in pursuance with the Bankruptcy Code definition, and such definition includes the “customer” of a financial institution when the financial institution acts as the customer’s “agent or custodian…in connection with a securities contract”.

The Second Circuit’s opinion was controversial in light of the Supreme Court’s recent ruling in Merit Management Group, LP v. FTI Consulting, Inc., 138 S.Ct. 883 (2018) on the scope of safe harbor, with law firms perceiving it as moving away from the position of Merit by opening new room for application of safe harbor protection. Jones Day suggests that the Tribune’s reasoning “avoided the strictures of Merit”, while Nelson Mullins finds it “shifting the focus from the financial institution as a ‘mere conduit’ to an ‘agent’.” Kramer Levin comments that the decision represents a “dramatic, and perhaps unexpected, extension of the safe harbor from the position it occupied in the immediate aftermath of Merit.” Weil calls it throwing the 546(e) safe harbor a lifeline.

Firms also find the case paving a way to protect LBO payments from subsequent attacks. King & Spalding notes that the Second Circuit’s opinion provides protection for recipients involved in LBO transaction where the debtor is the “customer” of the intermediary financial institutions. Cadwalader believes that the decision may “narrow the impact” of Merit, as market participants could structure their transaction to involve a financial institution thereby bypassing the “mere conduit” carve-out. Skadden agrees on the likely trend of structured LBOs, highlights that the customer defense is “likely to continue gaining momentum” after the Second Circuit’s decision. Parties would ensure they meet the “financial institution” and “customer” criteria methodically articulated in Tribune. “An appropriately structured principal/agent relationship could continue to shelter transfers or distributions within the ambit of section 546(e) safe harbors,” says Weil, adding that the operative facts will be key to strengthen the position.

Finally, Gibson Dunn notes that Tribune is not binding on other circuits. It remains to be seen whether such holding will be extended to different circumstances by other courts. “Some courts may find (in contrast to the Second Circuit) that the Supreme Court in Merit could not possibly have intended that its narrowing of the section 546(e) safe harbor be so easily vitiated by an argument that the Court itself acknowledged in a footnote,” says Kramer Levin.

In a prior Roundtable post, Professor Bussel noted that a plain meaning interpretation of the term “financial institution” should not include the customers of commercial banks, thus precluding a sharp change from Merit.

For Roundtable’s other posts on Tribune, see Bankruptcy Court Disagrees with Second Circuit’s Holding in Tribune, Tribune Fraudulent Conveyance Litigation Roundup. For Roundtable discussions relating to the 546(e) safe harbor, please refer to the tag #Safe Harbors.

Recent Developments in Bankruptcy Law, April 2018
by | posted in: Bankruptcy Administration and Jurisdiction, Derivatives, Financial Firms and Safe Harbors | 0

By Richard Levin (Jenner & Block LLP)

The bankruptcy courts and their appellate courts continue to explore issues of interest to practitioners and academics. This quarterly summary of recent developments in bankruptcy law covers cases reported during the first quarter of 2018.

Most notable were two Supreme Court decisions. Merit Mgmt. Group, LP. v. FTI Consulting, Inc. substantially reduced the scope of the financial contracts avoiding power safe harbor by directing courts to focus on the ultimate recipient of the transfer, rather than on the intermediate financial institutions who participated in the transfer. Village at Lakeridge ducked the substantive bankruptcy law issue of the standard for determining who is a non-statutory insider (although the dissent tackled it) and instead ruled only on the appellate standard of review of such determinations. 

Moving in the opposite direction from the Supreme Court’s reduction of safe harbor protections, the New York district court, on an appeal from the bankruptcy court’s decision, gave a broad reading to the ability of swap counter-parties under section 560 to close out and distribute collateral upon a default. (Lehman Bros.).

The Ninth Circuit took a strong position on the open question in the application of section 1129(a)(10), requiring an impaired consenting class for confirmation, adopting the “per-plan” approach. (Transwest) And the Fourth Circuit gave another boost to reorganizing real estate debtors by permitting a bankruptcy court to value collateral in a partial “dirt-for-debt” plan. (Bates Land).

In a case largely of first impression, the Texas bankruptcy court proposed rules to apply the “single satisfaction” rule of section 550(d) when the trustee settles with some but not all defendants. (Provident Royalties).

During the first quarter, the bankruptcy courts also expanded the reach of chapter 15 and its effectiveness. (Manley Toys, B.C.I. Finances Pty Ltd., Energy Coal S.P.A., Avanti, and Platinum Partners).

The full memo, discussing these and other cases, is available here, and the full (900-page) compilation of all prior editions is available here.

The Year in Bankruptcy: 2017
by | posted in: Avoidance, Bankruptcy Administration and Jurisdiction, Bankruptcy Roundtable Updates, Cramdown and Priority, Legislation, Supreme Court, Valuation, Workouts and Pre-Packs | 0

by Charles M. Oellermann and Mark G. Douglas (Jones Day).

In their annual chronicle of business bankruptcy, financial, economic, and related developments in the U.S., Charles M. Oellermann and Mark G. Douglas of Jones Day review the most significant events of 2017, including business bankruptcy filing statistics and industry trends; newsworthy developments regarding sovereign and commonwealth debt; the top 10 public-company bankruptcies of the year; notable private and cross-border bankruptcy cases; significant business bankruptcy and U.S. Supreme Court bankruptcy rulings; bankruptcy-related legislative and regulatory developments; noteworthy chapter 11 plan confirmations and exits from bankruptcy; and more.

The article is available here.

Merit Management v. FTI: Law Firm Perspectives
by | posted in: Avoidance, Financial Firms and Safe Harbors, fraudulent transfer, Statutory Interpretation, Supreme Court | 0

On February 27, the Supreme Court decided Merit Management Group, LP v. FTI Consulting, Inc., holding unanimously that the § 546(e) safe harbor does not protect allegedly fraudulent transfers “in which financial institutions served as mere conduits.” The Court’s decision resolves a circuit split on the reach of § 546(e). In reaching its conclusion, the Court focused on the “end-to-end transfer” that the trustee seeks to avoid, rather than any “component parts of the overarching transfer.” In FTI, because the overarching transfer was made between two parties not otherwise shielded by the safe harbor, the transfer will now fall outside the safe harbor.

As many law firms recognize, this decision will have wide-ranging implications on the finality of securities transactions effected through financial institutions, especially leveraged buyouts. Mayer Brown notes that as the decision enhances a trustee’s ability to recover fraudulent transfers, it also increases the bankruptcy estate’s leverage against recipients of pre-petition transfers. Cleary observes that “debtors or trustees may strategically frame avoidance actions in order to limit the scope of the safe harbor.” Mayer Brown concludes that the decision may also expose investors, investment funds and similar entities to fraudulent transfer litigation risks.

The bottom line, as Davis Polk notes, is that the § 546(e) safe harbor is no longer a blanket safe harbor for the recipients of transactions that pass through financial institutions. But the safe harbor will still shield financial institutions operating as escrow agents or clearinghouses, as the Court expressly stated that a financial institution under § 546(e) is protected whether the institution acts as a principal or as an intermediary.

Firms have noted that the decision also left open some ambiguities. First, Schulte Roth & Zabel writes that the Court leaves open possible arguments that any “customer” of a “financial institution” is also itself a “financial institution” under § 546(e). Second, Mayer Brown points out that the Court did not address whether the transaction at issue actually qualified as a transfer that is a “settlement payment” or made in connection with a “securities contract” under § 546(e). These ambiguities will draw the attention of defendants in future fraudulent transfer litigation.

Finally, Weil notes that the decision raises the question of how the preemption of state-law creditor remedies under § 546(e) will be applied in light of the Supreme Court’s now-narrow construction of the safe harbor.

By Jianjian Ye, Harvard Law School, J.D. 2018.

The roundtable has posted on FTI before. Some of those posts are: an analysis of the FTI oral argument, the Amici Curiae Brief of Bankruptcy Law Professors, an article by Ralph Brubaker on the meaning of § 546(e), and a roundup of law firm perspectives on the Seventh Circuit’s decision in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016).

Mandatory Contractual Stay Requirements for Qualified Financial Contracts
by | posted in: Derivatives, Financial Firms and Safe Harbors | 0

By Erika D. White and Donald S. Bernstein of Davis Polk & Wardwell LLP.

The U.S. banking agencies have issued rules that require U.S. G-SIBs and the U.S. operations of foreign G-SIBs to amend their swaps, repurchase agreements and other qualified financial contracts (QFCs) to include certain provisions designed to mitigate the risk of destabilizing close-outs of QFCs in the event the G-SIB enters resolution. The rules are part of a package of reforms implemented by the industry, Congress and the U.S. banking agencies since the financial crisis in an attempt to ensure that the largest financial institutions can be resolved in an orderly manner. Specifically, the rules seek to (1) mitigate the risk that the FDIC’s stay-and-transfer powers with respect to QFCs under Title II of the Dodd-Frank Act and the Federal Deposit Insurance Act may not be recognized and given effect outside of the United States and (2) improve the likelihood of success of a single-point-of entry resolution strategy under the Bankruptcy Code by limiting the ability of counterparties to terminate their QFCs with a solvent and performing operating entity based on cross-defaults triggered by the bankruptcy of the operating entity’s parent or other affiliate. The QFC Stay Rules do not, however, affect the rights of counterparties to terminate QFCs under the safe harbor provisions of the Bankruptcy Code in the event the operating subsidiary itself were to enter bankruptcy proceedings.

 

The full visual memo is available here.

FTI Argument Analysis: Justices Dubious About Limiting Bankruptcy Court’s Right to Recover Fraudulently Transferred Assets
by | posted in: Financial Firms and Safe Harbors | 0

By Ronald Mann. Published by SCOTUSblog and re-posted with permission.

Perhaps a week with only two cases on the argument calendar gave the justices more time to prepare than normal. They certainly seemed to come to the argument in Merit Management Group v FTI Consulting with a strong predisposition about how to decide the case.

As I explained in more detail in my preview, the case involves the “avoidance” powers of the bankruptcy court, which generally permit the court to recover (“avoid”) dubious payments that bankrupts make before their bankruptcy filings. The provisions are intricately drafted, with numerous detailed exceptions – excellent terrain for law-school exam questions! This case involves a “safe harbor” exception that protects transactions in the securities industry; that provision bars recovery of any “settlement payment” made under a “securities contract” if the payment is made “by or to” a financial institution. The transaction here involved a transfer of assets between parties that were not themselves financial institutions; to make the transfer, the assets had to pass through a financial institution. The U.S. Court of Appeals for the 2nd Circuit has held for many years that those “conduit” payments are protected from avoidance; the U.S. Court of Appeals for the 7th Circuit in this case disagreed.

From the earliest moments of the argument, it seemed clear that the justices were skeptical of the 2nd Circuit’s position. (…)

The remainder of the post can be found here.

Oral argument took place on November 6, 2017. The transcript is available here. The roundtable previously posted the Amici Curiae Brief of Bankruptcy Law Professors, an article by Ralph Brubaker on the meaning of § 546(e), and a roundup of law firm perspectives on the Seventh Circuit’s decision in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016). The Supreme Court granted certiorari to review the Seventh Circuit’s decision on May 1, 2017. Petitioner Merit Management Group, LP’s opening brief was subsequently filed, along with the Respondent’s brief, and Petitioner’s reply. Additional amicus curiae briefs were filed by Opportunity Partners, L.P., Various Former Tribune and Lyondell Shareholders, Tribune Company Retirees and Noteholders, and the National Association of Bankruptcy Trustees.

Amicus Brief on the Scope of the Bankruptcy Safe Harbor for Securities Settlement Payments Filed in Merit Mgmt. v. FTI Consulting
by | posted in: Avoidance, Bankruptcy Roundtable Updates, Financial Firms and Safe Harbors | 0

By Ralph Brubaker (University of Illinois College of Law), Bruce A. Markell (Northwestern University Pritzker School of Law), Charles W. Mooney, Jr. (University of Pennsylvania Law School), and Mark Roe (Harvard Law School).

Bankruptcy Code § 546(e) contains a safe harbor that prevents avoidance of a securities settlement payment, e.g. as a preferential or constructively fraudulent transfer. This amicus brief was filed in Merit Management Group, LP v. FTI Consulting, Inc., No. 16-784 (U.S.). The brief explains how § 546(e) rationally constrains its scope via the statutory specification that the safe harbor only applies (because it need only apply) if the “transfer” sought to be avoided was allegedly “made by or to (or for the benefit of)” a protected securities market intermediary, such as a stockbroker or a financial institution.

Ascertaining the meaning and function of that determinative scope language requires an understanding of (1) the concept of a “transfer” as the fundamental analytical transaction unit throughout the Code’s avoidance provisions, and (2) the relationship between that avoidable “transfer” concept and the inextricably interrelated concepts of who that “transfer” is “made by or to (or for the benefit of).” By its express terms, § 546(e) only shields a challenged “transfer” from avoidance if (1) that transfer was “made by” a debtor-transferor who was a qualifying intermediary, “or” (2) a party with potential liability—because the challenged transfer allegedly was made “to or for the benefit of” that party—was a protected intermediary. Thus, the transfer of cash to a stock seller and of the stock back to the buyer is not safe-harbored. The delivery of the cash (and the stock) through financial intermediaries, however, is.

The full amicus brief may be found here.

Oral argument took place on November 6, 2017. The transcript is available here. The roundtable previously posted an article by Ralph Brubaker on the meaning of § 546(e) and a roundup of law firm perspectives on the Seventh Circuit’s decision in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016). The Supreme Court granted certiorari to review the decision on May 1, 2017. Petitioner Merit Management Group, LP’s opening brief was subsequently filed, along with the Respondent’s brief, and Petitioner’s reply. Additional amicus curiae briefs were filed by Opportunity Partners, L.P., Various Former Tribune and Lyondell Shareholders, Tribune Company Retirees and Noteholders, and the National Association of Bankruptcy Trustees.

Understanding the Scope of the § 546(e) Securities Safe Harbor Through the Concept of the “Transfer” Sought to Be Avoided
by | posted in: Bankruptcy Roundtable Updates, Financial Firms and Safe Harbors | 0

By Ralph Brubaker (University of Illinois College of Law)

Bankruptcy Code § 546(e) contains a safe harbor that prevents avoidance of a securities settlement payment. To date, pleas for sane limits on the scope of the § 546(e) safe harbor have focused upon what kinds of transactions should be considered a “settlement payment.” That language, however, is not the primary means by which § 546(e) both reveals its manifest object and correspondingly limits its reach thereto. Section 546(e) rationally constrains its scope via the statutory specification (the meaning of which the Supreme Court will consider in the pending case of Merit Management Group v. FTI Consulting) that the safe harbor only applies (because it need only apply) if the “transfer” sought to be avoided was allegedly “made by or to (or for the benefit of)” a protected securities market intermediary, such as a stockbroker or a financial institution.

Ascertaining the meaning and function of that determinative scope language requires an understanding of (1) the concept of a “transfer” as the fundamental analytical transaction unit throughout the Code’s avoidance provisions, and (2) the relationship between that avoidable “transfer” concept and the inextricably interrelated concepts of who that “transfer” is “made by or to (or for the benefit of).” By its express terms, § 546(e) only shields a challenged “transfer” from avoidance if (1) that transfer was “made by” a debtor-transferor who was a qualifying intermediary, “or” (2) a party with potential liability—because the challenged transfer allegedly was made “to or for the benefit of” that party—was a protected intermediary.

The full article is available for download here.

The roundtable previously posted a roundup of law perspectives on the Seventh Circuit’s decision in FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016). The Supreme Court granted certiorari to review that decision on May 1, 2017. Petitioner Merit Management Group, LP has filed its opening brief, and amicus curiae briefs have been filed by Opportunity Partners, L.P. and Various Former Tribune and Lyondell Shareholders. Argument has been scheduled for November 6, 2017.

Repo Regret?
by | posted in: Financial Firms and Safe Harbors | 0

By Rohan Ganduri (Goizueta Business School, Emory University)

In April 2005 Congress expanded the range of bankruptcy safe-harbored repurchase agreements (repos) to include mortgage-related securities with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The rationale behind this provision was to prevent a chain of failures among financial institutions by granting derivative counterparties an exemption to the automatic stay, thereby allowing them to close out their positions.

In “Repo Regret?” I show that there were unanticipated adverse consequences of BAPCPA, which exacerbated the growth of risky mortgage credit in the U.S. economy. BAPCPA affected the funding of non-bank mortgage originators, which fund their mortgage origination business primarily through short-term revolving lines of credit, typically secured by the originated mortgages. However, after BAPCPA, short-term secured loans were cloaked in repurchase agreement (repo) terms consistent with the bankruptcy code. This was because a repo lender has greater protection in bankruptcy, although a secured loan and a repo are economically equivalent.

Furthermore, safe harboring eliminated any long-term risk associated with a drop in the collateral’s value at liquidation. Lower exposure to the collateral’s risk drove down funding costs for non-bank originators and also reduced the incentives of short-term funding intermediaries to screen the mortgages that the non-banks placed as collateral to obtain funding. This increase in funding and lax screening led to the growth of risky mortgage credit.

Conferring seniority on derivative counterparties does not eliminate risk, however; it transfers the risk to other investors. In the case of BAPCPA and the mortgage market, the seniority accorded to repo lenders transferred the long-term credit risk associated with the holding of mortgage-related collateral entirely to the end mortgage-backed security (MBS) investors.

To the extent that greater defaults, due to increased origination of riskier mortgages, have externalities and spillover effects that cannot be internalized by the MBS investors by demanding higher yields, the cost of awarding seniority to derivative counterparties may outweigh its expected benefits.

The full article is available here.

For previous Roundtable posts on the safe harbors, see Morrison, Roe & Sontchi, “Rolling Back the Repo Safe Harbors“; Janger & Pottow, “Implementing Symmetric Treatment of Financial Contracts in Bankruptcy and Bank Resolution“; and Lubben, “Lehman’s Derivatives Portfolio.”

We at the Bankruptcy Roundtable will take a break from posting this August and hope that you too will be able to get away from your desk at work. We’ll be back on September 5th.

Do the Financial Institution Bankruptcy Act and the CHOICE Act Undermine an Effective Restructuring of a Failing Financial Institution?
by | posted in: Bankruptcy Roundtable Updates, Financial Firms and Safe Harbors | 0

By Bruce Grohsgal (Delaware Law School, Widener University)

The House recently passed the Financial Institution Bankruptcy Act of 2017 (FIBA). FIBA’s provisions are incorporated into the Financial CHOICE Act of 2017, passed by the House last week, which would repeal Dodd-Frank’s receiverships for failing financial institutions that pose risk to the financial system. The Senate may soon consider both bills.

FIBA creates a subchapter V of chapter 11 for financial institutions. Only the holding company will file. In the first 48 hours of the case, it will transfer certain assets—consisting primarily of its equity in its subsidiaries and its derivatives—to a newly-formed bridge company. It will leave behind pre-designated “bail-in debt,” mostly unsecured term obligations owed to 401ks and pensions and shorter term unsecured trade debt.

In my view, however, FIBA is unlikely to result in an effective restructuring. First, because of FIBA’s 48-hour deadline, individual determinations likely will not be made with respect to the hundreds of thousands, if not millions of repo, derivatives, and other qualified financial contracts. Instead, the entire book of financial contracts—the “bad” along with the “good”—likely will be transferred to the bridge company. The bankruptcy court’s jurisdiction over the bridge company and its property—and the restructuring—ends on the transfers.

Second, the bridge company must assume 100% of the debt secured by any property transferred—without any write down, even if the property is worth less than the claim—and all liabilities owed on the derivatives and repo transferred. These statutory provisions may weaken the bridge company’s balance sheet and imperil its ability to obtain financing.

Though the Federal Reserve’s total loss-absorbing capacity (TLAC) rule includes “clean holding company” requirements to facilitate restructuring, the rule does not adequately address these balance sheet ills that FIBA creates. The clean holding company requirements apply only to eight U.S. global systemically important banks, and do not reach dozens of $50+ billion banks or nearly 5,000 other FIBA-eligible financial institutions. Moreover, TLAC does not prohibit secured borrowing even by those eight bank holding companies, though undersecured borrowings by those eight banks may be limited by TLAC’s regulatory capital requirements. But at a time of declining asset values and a ramp-up to a subchapter V filing, it is likely that many previously fully secured loans will have become undersecured. FIBA will require the bridge bank to either assume the unsecured portion of the debt or lose the collateral to the lender.

FIBA’s bankruptcy proceeding makes a run by the bridge company’s derivatives and repo counterparties more likely. If the bridge company’s balance sheet is weakened by the wholesale assumption of qualified financial contracts and by the assumption of debt above asset value, then the bridge company’s ability to obtain new financing may be diminished. Actions against the bridge company and its assets are not stayed under FIBA. As a result, when repo lenders and other counterparties require post-transfer haircuts and margin payments, and the bridge company is unable to obtain new funding, the run on repo and derivatives will continue.

The text of FIBA is available here. My testimony on FIBA before the House Judiciary’s subcommittee is available here. The text of The Financial CHOICE Act of 2017 is available here. The “clean holding company” requirements of TLAC are at 12 CFR § 252.64, and the TLAC final rule release is available here.

1 2 3