Supreme Court’s Bankruptcy Opinion on § 546(e): Merit Management v. FTI Consulting, and an Important Footnote 2

A safe harbor (photo by Marilyn Swanson)

By Donald L. Swanson

On February 27, 2018, the U.S. Supreme Court issued an eagerly awaited bankruptcy opinion on the § 546(e) safe harbor defense against trustee avoidance actions. The new opinion is Merit Management Group, LP v. PTI Consulting, Inc., Case No. 16-784.

The opinion, at first read, appears to dramatically narrow the reach and effect of the § 546(e) safe harbor defense.  But an issue identified in Footnote 2 of the opinion may change that to an expansive reach and effect.

I’ll try to explain.

Legal Question and Conclusion

A bankruptcy Trustee (PTI Consulting) is pursuing a constructively fraudulent transfer claim against Merit Management under § 548(a)(1)(B) of the Bankruptcy Code, and Merit Management is asserting the § 546(e) safe harbor defense.

The question the Supreme Court addresses in Merit Management is this:

How does the § 546(e) “safe harbor” exception to a bankruptcy trustee’s avoiding powers work when a transfer is “executed via one or more transactions?”

The Court provides this example of  being “executed via one or more transactions”: “a transfer from A → D that was executed via B and C as intermediaries” so that “the component parts of the transfer include A → B → C → D”?

The Supreme Court explains the question, further, like this:

“If a trustee seeks to avoid the A → D transfer” and the §546(e) safe harbor defense “is invoked,” the question then becomes,

–“should courts look to the transfer that the trustee seeks to avoid (i.e., A → D)”; or

–“should courts look also to any component parts of the overarching transfer (i.e., A → B → C → D)?”

The Supreme Court reaches this conclusion:

“the plain meaning of §546(e) dictates that the only relevant transfer for purposes of the safe harbor is the transfer that the trustee seeks to avoid.”

Simplified Facts

Actual names and roles, in the Merit Management case, corresponding with the letters in the Court’s question and example, are:

A = Merit Management Group, LP, (transferor of its stock interests in Bedford Downs Management Corp. to Valley View Downs and payee of the purchase price)

B = Credit Suisse (lender of the purchase price money to Valley View Downs)

C = Citizens Bank of Pennsylvania (escrow agent for exchanging the purchase money and stock certificates)

D = Valley View Downs (transferee of Merit Management’s stock interests and payor of the purchase price), now represented by its bankruptcy Trustee, PTI Consulting, Inc.

Here’s a simplified summary of what happened:

Merit Management sold its stockholder interests in Bedford Downs to Valley View for a purchase price of $16.5 million. Credit Suisse loaned the purchase price to Valley View. Citizens Bank processed the closing, as escrow agent, by (i) receiving Valley View’s purchase money from Credit Suisse and sending it to Merit Management, and (ii) receiving Merit Management’s stock certificates and sending them to Valley View.

“Safe Harbor” Defense

Section 546(e) language applicable to the Merit Management case is as follows:

“(e) Notwithstanding sections . . . 548(a)(1)(B) . . . of this title, the trustee may not avoid a transfer that is a . . . settlement payment . . . made by or to (or for the benefit of) a . . . financial institution . . . that is made before the commencement of the case.”

–The Wrong Approach

In presenting the case, the parties and lower courts spent a lot of their time and attention on:

–the § 546(e) words, “by or to (or for the benefit of)”; and

–whether the “covered entity” must have “a beneficial interest in or dominion and control over the transferred property” to qualify for the § 546(e) safe harbor defense.

The Supreme Court, however, rejects such time and attention as putting “the proverbial cart before the horse.”

–The Correct Approach

The correct approach, the Supreme Court says, is to “first identify the relevant transfer,” because “(a)t bottom, that is the issue the parties dispute in this case.” The Court explains the positions of the parties under this correct approach:

“On one side, Merit posits that the Court should look not only to” the end-to-end transfers between Merit Management and Valley View, “but also to all its component parts,” which “include transactions by and to financial institutions” (i.e., Credit Suisse and Citizens Bank) so that § 546(e) bars recovery by the Trustee against Merit Management.

“FTI, by contrast,” asserts that “the only relevant transfer” for the §546(e) safe-harbor inquiry “is the overarching transfer between Valley View and Merit” of millions of dollars “for purchase of the stock,” which is “the transfer that the trustee seeks to avoid under §548(a)(1)(B).” FTI contends that, because the stock transfer “was not made by, to, or for the benefit of a financial institution,” the § 546(e) safe harbor defense “has no application.”

Then, the Supreme Court declares that, in these two contrasting positions, it “agrees with FTI.” Such agreement is based on three separate items of authority:

–“the language of §546(e),”
–“the specific context in which that language is used,” and
–“the broader statutory structure.”

All three of these items “support the conclusion that the relevant transfer for purposes of the §546(e) safe harbor inquiry” is the “overarching transfer that the trustee seeks to avoid.”

–Here’s How it Works

In discussing “the broader statutory structure” item, the Supreme Court provides this illustration of how the § 546(e) defense works in practice:

–“after a trustee files an avoidance action identifying the transfer it seeks to set aside, a defendant” can then raise the § 546(e) safe harbor defense; and

–if the plaintiff trustee “properly identifies an avoidable transfer,” the court “has no reason to examine the relevance of component parts” of the transfer under § 546(e).

In the Merit Management case, the Trustee identified the purchase of stock “by Valley View from Merit as the transfer that it sought to avoid.” Accordingly, “the Credit Suisse and Citizens Bank component parts” of the transaction “are simply irrelevant” to the § 546(e) analysis.

And finally, since the parties “do not contend that either Valley View or Merit is a ‘financial institution’ or other covered entity, the transfer falls outside of the §546(e) safe harbor” defense.

Simplified Translation and Analysis

Here’s a simplified translation of what I think the Supreme Court is saying in this case.

1. When a trustee brings an avoidance lawsuit, and the defendant raises a § 564(e) defense, the defendant must prove that either the defendant or the other party to the overarching transfer is a covered party under § 546(e) in their own right – and not on the basis of an intermediary’s § 546(e) status; and

2. If the defendant proves that one of those two parties is a covered entity, then the § 546(e) defense applies; but, if the defendant can’t, the § 546(e) defense does not apply.

This result provides a “clean” position that should be relatively easy to apply.  [Note: a “clean” position is mentioned numerous times at oral argument as a value to be achieved.]  The Merit Management result is certainly cleaner than requiring bankruptcy and appellate courts to distinguish between a “mere conduit” and something else.

This result appears, at first read, to narrow the reach and effect of the § 546(e) defense by requiring an avoidance defendant to prove that one of the parties to the overarching transfer qualifies as a covered entity in its own right and not on the basis of an intermediary’s status.  However, the issue raised in Footnote 2 (discussed below) seems to change that to an expansive reach and effect.

Departure from the Approach of Circuit Courts and Parties

The Supreme Court’s Merit Management opinion ends up affirming the Seventh Circuit’s ruling. But it does so on grounds slightly different from what the parties and circuit courts had argued.

Prior circuit court opinions, and the parties’ arguments to the Supreme Court, focused on whether any of the component parts of a stock transfer were a covered entity under § 546(e).

–Five circuit courts had declared that, if one entity in the component parts of a transfer is a covered entity under § 546(e), then all parties to the transaction are protected by § 546(e), even if they aren’t covered entities.

–The Seventh Circuit in the Merit Management case (FTI Consulting, Inc. v. Merit Management Group, LP, 830 F.3d 690 (7th Cir. 2016)), varied from the position of the five other circuits only in a situation where the covered entity in the component parts of a transaction is a “mere conduit.” Here’s what the Seventh Circuit said in Merit Management (830 F.3d at 691):

“Ultimately, we find it necessary to answer only one question: whether the section 546(e) safe harbor protects transfers . . . conducted through financial institutions (or the other entities named in section 546(e)), where the entity is” merely a “conduit”; and

“We hold that it does not.”

The Supreme Court’s Merit Management opinion departs from all of this, declaring that the role of component-part parties in an overarching transaction is irrelevant under § 546(e), whether they are mere conduits or not.

What’s Left Out — Footnote 2

One of the most interesting parts of the Supreme Court’s Merit Management opinion is what’s left out. Here’s what I mean.

–The Footnote

Footnote 2 in the Supreme Court’s opinion says:

“The term ‘financial institution’ is defined” in 11 U.S.C. § 101(22).  Footnote 2 then quotes the lengthy definition.  Here is the § 101(22)(A) language applicable to the facts of Merit Management:

“(22) The term ‘financial institution’ means—(A) a . . . bank . . . and, when any such . . . bank . . . is acting as agent or custodian for a customer . . . such customer.”

Then footnote 2 declares:

“The parties here do not contend that either the debtor or petitioner in this case qualified as a ‘financial institution’ by virtue of its status as a ‘customer’ under §101(22)(A)”;

Merit Management “discussed this definition only in footnotes and did not argue that it somehow dictates the outcome in this case”; and

We therefore do not address what impact, if any, §101(22)(A) would have in the application of the §546(e) safe harbor” (italics added for emphasis).

–Some Context from Oral Argument

Here’s some context for Footnote 2.

Back in oral argument on the Merit Management case (here’s a link to the transcript), Justice Breyer goes slightly-ballistic on this definition of “financial institution” issue, as follows:

“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?”

“JUSTICE BREYER: Well, why doesn’t that cover it? Why are we . . . deciding all kinds of things” when “this is absolutely dealt with in a statute, . . . under another provision” and “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.”

–Summary of Justice Breyer’s Position

What Justice Breyer is saying in oral argument is that Merit Management should have won—at every stage of the proceeding—if it had simply raised the “financial institution” definition as part of its § 546(e) defense. He’s irritated that Merit Management failed to do so. And he vents frustration in this rhetorical question during oral argument:

JUSTICE BREYER: “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?”

–Ultimate Result

The ultimate result of the “financial institution” definition issue is, apparently, Footnote 2 in the Supreme Court’s Merit Management opinion.

The bankruptcy courts and appellate courts will now need to figure out exactly how the “financial institution” definition issue fits into the Merit Management result.  And it looks like the inclusions of “customer” in the § 101(22) definition of “financial institution” will enable many avoidance action defendants to utilize the § 546(e) defense.  [See Notes on Footnote 2 below.]


This is an interesting opinion. The outcome affirming the Seventh Circuit’s decision is not a surprise, but the Supreme Court’s rationale is unexpected. And the rationale is incomplete, until the full effect of the Footnote 2 issue is worked out.

The opinion seems to provide a good approach to the § 546(e) defense. Kudos to them.

And they did it in a unanimous opinion!

Notes on Footnote 2:

A.  A similar issue is raised in Footnote 5 of the Supreme Court’s opinion about the definition of “settlement payment” in § 546(e), which Justice Breyer also raised in oral argument.

B.  See a prior article on oral argument in the Merit Management case, titled: A Surprise Development at U.S. Supreme Court in Oral Arguments on Merit Management v. FTI Consulting.]

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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