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SCOTUS Merit Case: The Clawback Carwash Is Closed…

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On February 27, 2018, the United States Supreme Court issued a unanimous opinion in the Merit Management Group, LP v. FTI Consulting, Inc. case, holding that funds that are merely transferred through a financial institution are not afforded the Bankruptcy Code “safe harbor” protections of 11 U.S.C. § 546(e), which precludes the avoidance or “clawback” of certain transfers; rather, whether the safe harbor applies in a given case will depend on the whether the parties to the overarching transfer are listed as protected parties in the statute.

Summary of Key Takeaways:

  • The relevant transfer for purposes of the § 546(e) safe harbor is the transfer the trustee seeks to avoid pursuant to its avoidance powers under the Bankruptcy Code.
  • Involvement of a financial institution in the intermediate steps of an overarching transaction, where a financial institution acts as a mere conduit to effectuate a transfer between parties, is irrelevant to the § 546(e) safe harbor, and the safe harbor does not apply to prevent avoidance of the transfer between the originating transferor and ultimate transferee who are not parties listed in the safe harbor.
  • Industry participants listed in the safe harbor of § 546(e) in addition to financial institutions that could also be affected by this ruling are commodity brokers, forward contract merchants, stockbrokers, financial participants, and securities clearing agencies.
  • The net result of this opinion is clarification of the potential liability of ultimate transferees in securities or other financial transactions that in some jurisdictions previously would have been shielded under the § 546(e) safe harbor.
  • Safe harbor should still apply to “overarching” transfers  to or for the benefit of a financial institution, commodity broker, forward contract merchant, stockbroker, financial participant, or securities clearing agency.


The Merit case involved a sale of stock between two competing harness racing (a form of horse racing) businesses.  Specifically, Valley View Downs, LP (“Valley View”) and Bedford Downs Management Corporation (“Bedford”) were in competition for the last of a limited number of harness racing licenses issued by the State of Pennsylvania to open a “racino” (a clever moniker for a combination racetrack casino facility).  After both had been turned down for a license, Valley View and Bedford entered into an agreement pursuant to which Bedford withdrew its request for a harness racing license, and Valley View agreed to purchase all of the stock of Bedford for $55 million after Valley View obtained the license.

Valley View was awarded the license, and, in turn, Valley View arranged for the Cayman Islands branch of Credit Suisse to finance the $55 million purchase.  Credit Suisse transferred the funds to the escrow agent, Citizens Bank of Pennsylvania (“Citizens”).  The shareholders of Bedford (including Merit) transferred their stock shares to Citizens as escrow agent.  Ultimately, Valley View received the Bedford stock certificates, and the Bedford shareholders received their pro rata shares of the $55 million (with Merit receiving $16.5 million) from Citizens.  Despite being awarded the license for its racino, Valley View failed to timely secure a separate gaming license, which caused its business to fail, and Valley View and its parent company, Centaur, LLC, filed a chapter 11 bankruptcy.

Under the confirmed plan in the bankruptcy case, FTI Consulting, Inc. (“FTI”) was appointed to serve as trustee for the litigation trust.  FTI filed suit against Merit in the Northern District of Illinois seeking to avoid the $16.5 million transfer it received in the transaction, asserting that it was a constructively fraudulent transfer under 11 U.S.C. § 548(a)(1)(B) because Valley View was insolvent and Valley View received less than reasonably equivalent value for its $16.5 million transfer to Merit.  Merit contended that the transfer was exempt from avoidance under 11 U.S.C. § 546(c) as a “settlement payment . . . made by or to (or for the benefit of) a . . . financial institution . . . or . . . a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract.”  The District Court agreed with Merit, finding that the safe harbor under § 546(e) applied because the financial institutions involved in the transaction transferred or received funds in connection with “a settlement payment” or a “securities contract.”  The Seventh Circuit reversed, finding that the § 546(e) safe harbor did not protect transfers in which financial institutions served as mere conduits.

The Parties’ Arguments Regarding Applicability of the § 546(e) Safe Harbor

The issue before the Supreme Court in Merit was “whether the transfer between Valley View and Merit implicated the safe harbor exception because the transfer was ‘made by or to (or for the benefit of) a . . . financial institution’” for purposes of 11 U.S.C. § 546(e).  Merit argued that the Court must consider not only the end-to-end $16.5 million transfer between Valley View and Merit for purposes of the § 546(e) analysis, but also should look at all of its component parts, e.g., the transfer by Credit Suisse (financing the transaction for Valley View) to Citizens, and the transfers from Citizens to Merit (in two installment payments), which are transfers by and to “financial institutions.”  On the other side, FTI maintained that the only relevant transfer for purposes of § 546(e) is the “overarching” $16.5 million transfer between Valley View and Merit (neither of which is a “financial institution”), which is the transfer FTI sought to avoid as constructively fraudulent.

The Supreme Court’s Interpretation

The Supreme Court agreed with FTI’s position stating:

The language of §546(e), the specific context in which that language is used, and the broader statutory structure all 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 under one of the substantive avoidance provisions.

Statutory Text

First, the Court looked to the text of § 546(e).  The Court explained that the opening clause of § 546(e) indicates that § 546(e) operates as an exception to the avoiding powers a trustee otherwise has under the substantive avoidance provisions in the Bankruptcy Code.  Thus, the starting point for interpreting § 546(e) is the substantive avoiding powers, and accordingly, the transfer that the trustee seeks to avoid by exercise of those powers.  The Court further observed that the last clause of § 546(e) creates an exception to the exception for actual fraudulent transfers under § 548(a)(1)(A).  The Court interpreted this exception to the safe harbor, with its reference back to a specific excluded statutory basis for avoidance, as Congress signaling that the safe harbor applies to the “overarching transfer that the trustee seeks to avoid, not any component parts” thereof.  The Court further explained that the section heading for § 546, which is “Limitations on avoiding powers,” demonstrates the close connection between the transfer sought to be avoided and the exemption from that avoiding power pursuant to the safe harbor.  The Court then pointed to the language in § 546(e) that “the trustee may not avoid” a “transfer that is” either a “settlement payment” or “made in connection with a securities contract,” as opposed to a transfer that merely “involves” or “comprises.”  In other words, for a transfer to qualify for protection under the safe harbor, the transfer must be an otherwise avoidable transfer that itself meets the safe harbor criteria.

Statutory Structure

Second, the Court looked to the specific context in which § 546(e) exists in the Bankruptcy Code.  The Court observed that the Bankruptcy Code creates both a system for avoiding transfers and a safe harbor from that avoidance, which are logically “two sides of the same coin.”  First, a trustee must identify an avoidable transfer that satisfies the statutory avoidance requirements; here, FTI identified the transfer from Valley View to Merit.  Next, a defendant may argue the trustee failed to identify a properly avoidable transfer (e.g., may argue the component parts of the overarching transfer should be examined).  Here, however, Merit did not argue that FTI improperly identified the avoidable transfer; rather, it argued that the component parts of the transfer could not be ignored.  However, the Court found this argument unpersuasive, reasoning that the component parts “are simply irrelevant to the analysis under § 546(e).”

Other Arguments

Merit additionally contended that the “or for the benefit of” language in § 546(e) was added to the statute in 2006 in order to overrule a prior decision of the Eleventh Circuit Court of Appeals in In re Munford, Inc., 98 F.3d 604, 610 (1996); however, the Court explained that Merit failed to point to anything in the text or legislative history corroborating the theory that Congress intended to abrogate Munford by its 2006 amendment.  Indeed, the Court observed that the addition of the “to or for the benefit of” amended language appropriately mirrors language in other avoidance power statutes (e.g., § 547(b)(1) and 548(a)(1)).  Merit’s further argument that the addition of “securities clearing agencies” as covered entities along with “financial institutions” in § 546(e) must mean that all intermediaries are protected was also rejected by the Court.  Instead, the Court reiterated that the transfer upon which courts must focus is the one sought to be avoided by the trustee.  Only after identifying that transfer should the court consider whether the party receiving the transfer is one listed in and protected by the safe harbor.  Last, Merit argued that Congress was concerned with advancing the interest of the parties in the “finality of transactions,” and, accordingly, it would be incongruous with that Congressional intent to focus on the nature of the transaction generally as opposed to the identities of the parties intended to be protected by the safe harbor.  The Court was not inclined to consider legislative purpose in light of its textual analysis but added in dicta that the Court has “good reason to believe” that Congress was concerned with transfers by certain industry participants, though the statute says nothing about transfers that are merely through those participants.  Thus, the Court determined that it need not deviate from the plain meaning of the text of § 546(e).

This update presents a high-level summary of several key takeaways from the Supreme Court’s opinion in Merit Management Group, LP v. FTI Consulting, Inc., 583 U.S. __ (2018) issued on February 27, 2018.

Visit our website to learn more about V&E’s Bankruptcy Litigation practice. For more information, please contact V&E Partner/Restructuring and Reorganization Practice Group Leader Bill Wallander (Dallas) or Partner David Meyer (New York).

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.