Financial Disequilibrium
by | posted in: Bankruptcy, Bankruptcy Reform, Distressed Debt Markets, Fiduciary Duties, fraudulent transfer, Reorganization | 0

By Samir Parikh (Lewis & Clark Law School)

Samir Parikh

Corporate bankruptcy cases have recently undergone a shift. After decades where creditors exercised outsized control, equity sponsors have now ascended the throne. This new group exploits contractual loopholes and employs coercive tactics to initiate creditor-on-creditor violence. The result is the ability to dictate outcomes in distress situations where equity sponsors would normally be idle passengers. The unwritten rules have been rewritten.

This new disequilibrium has the potential to fundamentally harm the financial ecosystem. Scholars have successfully chronicled the new tactics, but formulating the means to mitigate market distortion has been elusive. Most scholars have appealed to the judiciary to intervene. Unfortunately, the judiciary has rejected this call, arguing that sophisticated parties should address coercion through contracts. What if that is not possible? An efficient public debt market relies on some sort of check on outright exploitation. The inability to manage bad actors renders these markets more volatile and amplifies contagion risk for national and global economies. Further, coercive measures allow a company that should have sought bankruptcy protection or some other substantive restructuring to artificially limp along. There is a significant risk that this iniquitousness destroys value and there is little left to salvage by the time the company actually lands in bankruptcy.

This Article argues that a significant movement towards equilibrium is attainable by adjusting two aspects of this ecosystem. Primarily, I advocate for amendment of section 546(e) of the Bankruptcy Code to exclude leveraged buyouts from the fraudulent transfer safe harbors. My proposal aligns the section with its historical underpinnings and acts as a natural check on debt levels in overly aggressive acquisitions. This proposal reduces the need for coercive restructuring measures when a corporation experiences financial distress. On the backend, Delaware courts have limited creditors to derivative breach-of-fiduciary-duty actions, even when a corporation is insolvent and directors are actively attacking certain stakeholders. Delaware case law protects the mechanism by which equity sponsors implement coercion. I argue that when a corporation is insolvent, directors and officers who undertake hostile actions against specific creditors to whom they owe fiduciary duties should be subject to direct claims by those creditors. Unable to act with impunity, directors would be forced to properly consider all key stakeholders in formulating rehabilitation measures.

The full 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).

Another Court of Appeals Broadly Reads Settlement Payment Safe Harbor
by | posted in: Financial Firms and Safe Harbors | 0

By Michael L. Cook, Schulte Roth & Zabel LLP

The Courts of Appeals, with few exceptions, have broadly read the safe harbor defense contained in Bankruptcy Code §546(e) over the past 24 years.  It insulates a “settlement payment” or “margin payment” on a “securities contract,” “commodity contract” or “forward contract” from a trustee’s fraudulent transfer or preference claims unless the debtor makes the payment with “actual intent to hinder, delay or defraud creditors.”  Despite policy arguments by lower courts, trustees, creditors and commentators, the appellate courts have claimed to rely on the Code’s “plain language” to deny recovery.  In this Article, we discuss a recent Seventh Circuit decision that (a) reversed a district court’s “policy” decision purporting to divine Congress’s intent as to the proper application of the safe harbor provision; (b) rejected decisions by the Fifth and Ninth Circuits that refused to apply the safe harbor in the context of a Ponzi scheme; and (c) followed recent decisions of the Second and Fourth Circuits.

We discuss the Seventh Circuit’s close reading and application of the statutory language, “clearly and predictably using well established principles of statutory construction.”  Citing Supreme Court precedent, the court refused to rely on legislative history that was “neither passed by a majority of either House nor signed into law.”  Instead, the court explained why the safe harbor in the case before it yielded a sensible result, avoiding instability and uncertainty in the securities business.

We also review recent conflicting decisions in the lower courts that have resulted from imaginative attempts by lawyers to avoid application of the safe harbor defense.  Finally, we discuss another case pending in the Second Circuit that pushes the safe harbor defense to its outer limits.  That case asks (a) whether an intermediary is required in a safe harbor case, and (b) whether the defendant must show an adverse effect on financial markets.

Schulte Roth & Zabel Client Alert, April 3, 2014:  http://www.srz.com/Seventh_Circuit_Reads_Bankruptcy_Safe_Harbor_Broadly_to_Insulate_Preferential_Settlement_Payment_to_Commodity_Broker/