No Quorum on U.S. Supreme Court?! And § 546(e) Issues Heading Back to Courts Below? (Deutsche Bank v. McCormick)

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Statement by Justices Kennedy and Thomas in Deutsche Bank v. McCormick

By: Donald L. Swanson

On April 3, 2018, Justices Kennedy and Thomas issue this Statement for the U.S. Supreme Court in Deutsche Bank v. McCormick, Case No. 16-317 [photo of entire Statement is above]:

“consideration of the petition for certiorari will be deferred . . . given the possibility that there might not be a quorum in this Court.”

Lack of Quorum

Wow: lack of a quorum for a case in the U.S. Supreme Court! Who ever heard of such a thing? But it happens.

Here’s what 28 U.S.C. § 2109 says about handling a lack of quorum on the Supreme Court:

When a “a majority of the qualified justices” believe that a case “cannot be heard and determined at the next ensuing term” due to “the absence of a quorum of qualified justices,” the court shall “enter its order affirming the judgment” on appeal “with the same effect as upon affirmance by an equally divided court.”

Speculation is that quorum problems in this case arise from ownership, by Supreme Court Justices, of corporate stock related to the case. Presumably, Justices Kennedy and Thomas issued the Statement because they do not have such problems and are, therefore, “qualified justices.”

Deferral Remedy and Motion

Instead of affirming the judgment, as authorized by § 2109, the Supreme Court defers ruling on the case for this specific purpose:

–to “allow the Court of Appeals or the District Court to consider whether to recall the mandate” in light of the Supreme Court’s recent “Merit Management” decision.

Accordingly, on April 10, 2018, creditors in Deutsche Bank v. McCormick file their Motion with the Second Circuit Court of Appeals requesting this relief:

“That the Court recall its mandate, vacate its March 29, 2016, decision in its entirety, and remand to district court for further proceedings in light of Merit Management
Group LP v. FTI Consulting, Inc., 138 S. Ct. 883 (2018).”

Merit Management Decision

The Merit Management decision resolved a question on how the § 546(e) defense applies to fraudulent transfer claims, which question had also been raised in Deutsche Bank v. McCormick.

The Supreme Court’s Merit Management decision rejects a § 546(e) “mere conduit” theory, involving intermediaries, as putting “the proverbial cart before the horse.” The proper horse-first analysis, the Supreme Court says, is this:

First, ignore intermediaries and identify the “overarching” transfer being challenged; and

Then, determine whether the parties to such transfer qualify in their own right as entities protected by § 546(e): if either qualifies, the defense applies; if not, it doesn’t.

The Role of Intermediaries

Intermediaries can be important in evaluating whether parties to a transfer qualify for protection by § 546(e). Here’s how:

A “financial institution” is protected under § 546(e); and

The Bankruptcy Code’s definition of “financial institution” (in § 101(22)) includes these entities:

(i) obvious ones like a bank; and

(ii) a bank’s “customer,” when the bank acts as customer’s “agent or custodian” in the challenged transfer.

–Justice Breyer’s View

So . . . one view, under the horse-then-cart approach, is this:

–once the “overarching” transfer is identified, a bank-as-intermediary can create a § 546(e) defense for the transferee, when the bank acts as agent or custodian in the challenged transfer.

This view applies, even when:

neither the transferor nor transferee qualifies as a “financial institution” without the bank’s involvement; and

the bank’s role in the challenged transfer is as nothing more than a “mere conduit.”

This view is explained by Justice Breyer at oral arguments on the Merit Management case and is preserved in Footnote 2 of the Merit Management opinion. See this article.

–Footnote 2 Issue

No one raised the Footnote 2 issue in Merit Management or in Deutsche Bank v. McCormick. And Justice Breyer suggested, in Merit Management oral arguments, that such issue might have altered the outcome of that case, if it had been raised.

A Possible Result: Same as Before

So . . . here’s guessing that, if and when the Deutsche Bank v. McCormick case goes back to the Circuit Court or District Court, Footnote 2 issues will take center stage.

And it’s possible that the result, after it goes back, will be the same as before: dismissal of the fraudulent transfer claims. Here’s how:

–“financial institutions” did act as agents for the parties, in the challenged LBO transfers, by handling the exchange of $8 billion cash for shares of stock.

This is precisely the type of agency relationship identified by Justice Breyer as grafting a bank’s “customer” into the “financial institution” definition and, thereby, generating a § 546(e) defense.

What Won’t Be Decided–A Second Question

The Petition for a Writ of Certiorari in Deutsche Bank v. McCormick raises a second and important circuit-split question under § 546(e). However, this second question will not be answered in this case, as things stand now, because of the quorum problem.  The second question is this:

–Did the Second Circuit properly dismiss the claims on preemption grounds?

The resolution of such second question will, presumably, have to await the grant of certiorari in another case.

Deutsche Bank v. McCormick – Tribune Company LBO

Here are Deutsche Bank v. McCormick facts.

–Transaction History

Tribune Company was a multimedia corporation that, in 2007, faced financial stress.

Samuel Zell, a billionaire investor, acquired Tribune Company through a leveraged buyout (“LBO”). To consummate the LBO, Tribune Company borrowed $11 billion, secured by a lien on all its assets, to which Zell added a $315 million equity contribution.

Such amounts were used to, (i) refinance some of Tribune’s pre-existing debt, and (ii) cash out Tribune’s shareholders for $8 billion, a premium price, using financial institutions as intermediaries for the transaction.

–Failure, Bankruptcy, and Fraudulent Transfer Claims

Tribune Company promptly failed, after the LBO.  And it filed bankruptcy on December 8, 2008.

In November 2010, the bankruptcy estate brought actual fraud claims, under the Bankruptcy Code’s fraudulent transfer statute (§ 548(a)(1)(A)), to recover the $8 billion LBO payments from shareholders.

[Note: actual fraud claims are an explicit exception to the § 546(e) defense.]

After expiration of the two-year statute of limitations of § 546(a)(1), creditors brought constructive fraud claims, under state law, against Tribune’s former shareholders to recover the same LBO payments. Creditors argued that constructive fraud claims under state law reverted back to them, upon expiration of the two-year statute of limitations, and that the § 546(e) defense does not apply to such claims outside bankruptcy.

[Note: constructive fraud claims are subject to the § 564(e) defense in bankruptcy.]

Thereafter, the Tribune Company’s reorganization plan is confirmed, under which, (i) responsibility for prosecuting actions on behalf of the bankruptcy estate is transferred to a Litigation Trust, and (ii) creditors could continue pursuing their constructive fraud claims.

–District Court Dismissal

In District Court, the shareholder defendants moved to dismiss the creditors’ state law claims because, (i) § 546(e) preempts all state law fraudulent transfer claims, and (ii) creditors lack standing, since the bankruptcy estate is already pursuing avoidance of the same transfers.

District Court rejected shareholders’ preemption argument. But it accepted shareholders’ lack-of-standing argument and dismissed the creditors’ claims.

–Second Circuit Affirms, on Opposite Grounds

The Second Circuit affirms the District Court’s dismissal . . . but it does so on opposite grounds:

–“we affirm the dismissal of the complaint, on preemption rather than standing grounds.”

Conclusion

The Deutsche Bank v. McCormick case is unusual – if not unique. Where else do we see this combination of developments in the U.S. Supreme Court:

Absence of quorum;

Deferring action, instead of affirming under § 2109;

Inability to address an important, circuit-split issue; and

Opportunity for lower courts to sync up their rulings with the latest Supreme Court decision?

This will be interesting to watch as the case develops further.

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