The case before the U.S. Supreme Court is Merit Management Group, LP v. FTI Consulting, Inc., Case No. 16-784. The bankruptcy question is whether the § 546(e) safe harbor prohibits avoidance of a transfer made through a financial institution as escrow agent.
Oral arguments occurred on November 6, 2017 [Footnote 1].
Justice Breyer Interrupts
Justice Breyer jumps in, during oral arguments, with a couple points.
The first point is a concern about unexpected results. Here’s his hypothetical:
JUSTICE BREYER: . . . I have two shares of company X in . . . an account somewhere . . . So knowing I’m about to go bankrupt, I take my share, and I tell them go transfer it to my wife. Right?
MR. WALSH: Yes.
JUSTICE BREYER: Now, you’ll say they can’t attack that as a fraudulent conveyance . . . [even though its] the paradigm case of a fraudulent conveyance.
MR. WALSH: Well, actually, Your Honor, that — that very well might be a case that wouldn’t fall within the safe harbor.
JUSTICE BREYER: Why not?
MR. WALSH: Because if you transfer your stock to your wife –¬
JUSTICE BREYER: No, no, no. I told you it’s being held in a — in a bank, and I tell the bank to do it.
MR. WALSH: It’s being held in the indirect system, and you — you sell it to your wife. Then in — then in that case, there’s safe harbor.
JUSTICE BREYER: It does. So . . . this is going to cover all kinds of things.
There’s nothing surprising in that exchange.
The surprise is in Justice Breyer’s second point on the definition of a “financial institution” under 11 U.S.C. § 101(22)(A) [Footnote 2].
Justice Breyer raises this definition issue as something the parties have failed to discuss and suggests that the definition is dispositive of the entire case.
Here’s how the surprise happens.
“JUSTICE BREYER:” VVD “wants to give $55 million to a group of people that include” Merit. “Neither of them is” a financial institution. But “Credit Suisse which [has] the line of credit, [says] you send it to the Citizens Bank, which is the escrow.”
“And so the argument here is, because they used these two agents, now, suddenly,” it falls into “the bank exception.”
“MR. WALSH: Correct, right.”
“JUSTICE BREYER: . . . And so why are we hearing this case?”
“when I look up the definition of financial institution, it says that not only is it Credit Suisse and not only is it Citizens Bank, but it is also the customers of each of those financial institutions in an instance where the bank is acting as agent or custodian for a customer.”
JUSTICE BREYER: “Now, it seems to me that Citizens Bank is acting for agent or custodian of a customer, namely VVD, and it seems to me that Credit Suisse is acting as . . . an agent or custodian for VVD. So why doesn’t that cover it?
MR. WALSH: I think that is a fair way to look at it, Your Honor.
Some Frustration and a Scolding
JUSTICE BREYER: Well, why doesn’t that cover it? Why are we . . . deciding all kinds of things about banks and my wife,” when “this is absolutely dealt with in a statute, . . . under another provision.”
“nobody refers us to that provision, and I can’t understand why they didn’t — what’s going on?”
“MR. WALSH: Your Honor, we did — we did refer to that provision in — in both of our briefs, if I remember correctly.
JUSTICE BREYER: You may have put it in your briefs, but, I mean, why in the lower courts wasn’t this just said . . . Judge, this involves a customer of a financial institution, namely VVD, and, therefore, it’s in the exempt area?”
“And I want to know why that didn’t happen.
MR. WALSH: That I don’t —
JUSTICE BREYER: It’s your case. You can do it.” Yet, instead, “we’re asked to decide a question that I think is fraught with difficulty.”
“I would like to know the answer.
MR. WALSH: I’m afraid I don’t have a good answer for why that did not come up earlier.”
A Failed Attempt at Explanation
“JUSTICE ALITO: Oh, I thought you conceded it. Didn’t both parties . . . concede that . . . Valley View is not a financial institution?”
“JUSTICE GINSBURG: You just did in answer to my [prior] question.
MR. WALSH: No, I’m sorry.
JUSTICE GINSBURG: . . . I asked you specifically, do you agree that neither Valley View nor Merit is an entity enumerated under 546(e)?
MR. WALSH: I may have . . . misunderstood the difference between the two questions, Your Honor.
JUSTICE BREYER: I think it’s the same.”
“MR. WALSH: . . . Justice Ginsburg, in response to your question, neither of the parties to this case is a . . . financial institution, as that term is . . . generally understood. In trying to —
JUSTICE BREYER: But not as the statute understands it, which uses it to include a customer of a financial institution in circumstances which are present here.”
“JUSTICE GINSBURG: If . . . this was such a standout issue, you must have thought about it, and yet, you relegated it to a footnote in your reply brief.
MR. WALSH: And I — and I don’t know whether it’s a standout issue or not, Your Honor, but that is a quirk in the definition of financial institution, that is true. That is true.”
The Opposition Tries to Pile On
“MR. CLEMENT: Mr. Chief Justice, and may it please the Court:
I think it would be helpful if I could start with the elephant in the room, which is Justice Breyer’s question about the definition of financial institution and then address the question presented.
So, Justice Breyer, a couple of points about that. First of all, I think it could not be clearer that that’s never been at issue in this case, and . . . the Petitioner, when they were trying to get this Court to take the case, emphasized the fact that this wasn’t in dispute as a sort of a positive feature of this petition.”
A Rebuff and a Question
“JUSTICE BREYER: I have no doubt that neither party wanted it resolved on that basis. And so what’s nagging at the back of my head is” this:
“can two parties who would just love it, if we could decide an issue that really isn’t at issue before [the Court] and can they stipulate away all of the actual [rules] . . . in order to get us to decide a question?”
“MR. CLEMENT: . . . what you would do is dismiss the case as improvidently granted, which would serve my client’s interest just fine.”
“But I think there are two very good reasons why that issue was not put front and center by my friends here.”
“The first is that it’s completely inconsistent with their overall theory of the case. . . . So it’s more than a little bit of an embarrassment for them to come across a definition that says that customers . . . are also covered.”
The “second point . . . it doesn’t apply here anyways, which is, as I read that provision, it is very narrow, and it protects the customer only when the bank is acting . . . as an agent or custodian.”
Knowledgeable prognosticators seem to generally agree that the U.S. Supreme Court will resolve the Merit Management question presented to it in a clear and direct manner, and that the § 546(e) avoidance defense will be construed narrowly so that a bank, as escrow agent, does not shield the transaction from avoidance.
It will be interesting, however, to see if-or-how Justice Breyer’s concern about the “financial institution” definition will, (i) affect the ultimate ruling in this case, and/or (ii) affect future cases with the same definition issue.
Footnote 1: A transcript of oral arguments in this case is published here.
Footnote 2: 11 U.S.C. § 101(22)(A) defines “financial institution” as including a bank and, when “any such” bank “is acting as agent or custodian for a customer ( . . . ) in connection with a securities contract ( . . . ) such customer.” [Editorial note: This language seems awkward at the end — shouldn’t there be a comma before “such customer”?]
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Follow-up: Here is a link to a follow-up article on the Supreme Court’s February 27, 2018, ruling in the Merit Management case.