Creditors of an insolvent debtor may avoid certain transfers as fraudulent conveyances under state or federal law. A fraudulent conveyance is a transfer made without the transferor receiving adequate consideration and which satisfies one of three insolvency conditions: 1) the transferor was insolvent when the transfer was made; 2) the transferor was rendered insolvent by the transfer; or 3) the transferor was left with unreasonably small capital to carry on his/her or its business.
In bankruptcy cases, however, creditors cannot avoid transfers that are “safe harbored” under section 546(e) of the Bankruptcy Code. These safe harbored transactions include (i) a “settlement payment” or transfer “in connection with a securities contract” (ii) made by, to, or for the benefit of a “financial institution.”
A recent Southern District of New York Bankruptcy Court decision in the Boston Generatingcase demonstrated the breadth of section 546(e), finding that two debtors, as customers of a “financial institution” acting as their agent in connection with a securities contract, were “financial institutions” for (i) an intercompany transfer of lent funds between the debtors (ii) that ultimately funded a sizable distribution and unit/warrant redemption to investors. The case makes new law on the issue of who qualifies as a “financial institution” for purposes of the section 546(e) safe harbor and provides a new avenue of defense against fraudulent conveyance claims.
At the end of 2006, EBG Holdings LLC (EBG) and its main subsidiary, Boston Generating LLC (BosGen), underwent a leveraged recapitalization in which it (a) paid a $35 million distribution to EBG’s equity investors and (b) funded a $925 million tender offer to redeem certain EBG units/warrants. The distribution and the tender offer were funded by new loans totaling $2.1 billion.
The leveraged recapitalization proceeded as follows: in the tender offer, EBG units/warrants were tendered to a depository (the Bank of New York), which held them until BosGen and EBG instructed it to accept the tendered securities and pay investors.
BosGen entered into two new credit facilities, and EBG, one. BosGen transferred the funds from its new facilities to EBG’s Bank of America account. The funds from the EBG Bank of America account were transferred to another EBG bank account (with the Bank of New York), and then combined with the other facility funds to pay the distribution and unit/warrant redemptions.
On October 18, 2010, roughly four years after the leveraged recapitalization was completed, EBG and BosGen filed petitions under Chapter 11 of the Bankruptcy Code and subsequently confirmed a liquidating plan of reorganization, under which a trustee was appointed to pursue claims for the debtors’ unsecured creditors (including the leveraged recapitalization lenders). Utilizing section 544(b) of the Bankruptcy Code, the trustee brought New York fraudulent transfer claims to avoid and recover the leveraged recap’s (i) intercompany transfer (of $708 million of lent money from BosGen to EBG) and (ii) the $35 million distribution and $925 million unit/warrant redemptions (to EBG investors). The defendants included EBG investors who had received funds in the unit/warrant redemptions.
The Bankruptcy Court’s ruling dismissed the trustee’s complaint in its entirety. Herrick, Feinstein LLP represented a number of investors who were sued because they had received funds in the leveraged recap. We participated in the briefing before the Bankruptcy Court that led to the dismissal of the complaint.
Section 546(e), Tribune, and Merit
Under section 546(e), a trustee or debtor-in-possession cannot avoid (i) a “settlement payment” or transfer “in connection with a securities contract” (ii) made by, to, or for the benefit of a “financial institution.” “Financial institution” includes a bank, receiver, liquidating agent, conservator, or an entity that acts as agent or custodian for a customer “in connection with a securities contract.” Thus, a customer of a “financial institution” itself is a “financial institution” when (i) the financial institution acts as the customer’s agent (ii) in connection with a securities contract.
Two important cases have applied section 546(e)’s safe harbor for financial institutions: Tribune and Merit. Merit was a 2018 decision from the Supreme Court which held that the relevant transfer under section 546(e) is the overarching transfer sought to be avoided, not any component transfers to or between financial institutions. Merit held that the ultimate recipient of a fraudulent conveyance could be liable to the return the fraudulent conveyance even if the transfer to it had been made by a financial institution. Previously most courts had held that transfers effected through “financial institutions” were safe harbored under section 546(e). Tribune was a Second Circuit decision that applied Merit, holding that a repurchase and redemption of shares during a leveraged buyout was safe harbored under section 546(e) as a transfer by, to, or for the benefit of a financial institution. The debtor itself was a “financial institution” because it was a customer of a financial institution (a bank) that acted as its agent in connection with a securities contract (the leveraged buyout).
The Boston Generating Decision
The BosGen liquidating trustee sought to avoid two sets of transfers as fraudulent under New York law: (i) the two-step intercompany transfer (of lent money from BosGen to one EBG bank account, and then between EBG bank accounts) and (ii) the distribution and unit/warrant redemptions (to EBG investors). The defendants moved to dismiss the claims, asserting that the challenged transfers were exempt from avoidance as safe harbored settlement payments/transfers in connection with a securities contract made by, to, or for the benefit of a financial institution under section 546(e). The trustee argued that the component transfers in the leveraged recap (particularly, the first transfer from BosGen to EBG’s Bank of America account) were not safe harbored and that the depositories did not act as the debtors’ agents in connection with a securities contract when they made the transfer.
The BosGen court disagreed with the trustee, finding that all challenged transfers were safe harbored. It held that BosGen was a financial institution under section 546(e) because it was a customer of a financial institution (US Bank, the depository), which acted as BosGen’s agent when it transferred the credit facility funds from BosGen to EBG, which ultimately were used to pay the distribution and unit/warrant redemptions to EBG investors. It also held that BosGen was a financial institution because it transferred the funds it had borrowed under its new credit facilities to a financial institution (the Bank of New York), as agent for its customers (BosGen and EBG) in connection with the distribution and unit/warrant redemptions. Finally, both BosGen and EBG were financial institutions as customers of a financial institution (the Bank of New York), who acted as their agent and depository in connection with the unit/warrant redemption.
The court examined the documentary evidence regarding the leveraged recap and the flow of funds to US Bank and the Bank of New York and found that an agency relationship existed between the debtors and the depositories. The court’s opinion also emphasized the importance of assessing the overall transaction (the leveraged recap) when determining whether transfers are safe harbored under section 546(e).
- When determining whether a transfer is a safe harbored “settlement payment” or transfer “in connection with a securities contract” by, to, or for the benefit of a financial institution under section 546(e), the overarching transaction controls.
- “Financial institution” under section 546(e) is broadly defined to include customers of financial institutions when the financial institution makes a transfer in connection with a securities contract as the customer’s agent.
- To safe harbor a transfer section 546(e), parties should be clear in transaction documents about (i) customer and agency relationships with financial institutions, (ii) a transfer’s role in a transaction, and (iii) the purpose of a transfer.
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 Fraudulent conveyances can be avoided under section 548 of the Bankruptcy Code or under state law; every state has a form of fraudulent conveyance law. Moreover, while the lookback period under section 548 of the Bankruptcy Code is two years, under section 544 of the Bankruptcy Code, the trustee may utilize a longer state statute, such as New York’s six-year statute of limitations.
 11 U.S.C. § 546(e).
 In Re Boston Generating LLC et al., Case No. 10-14419 (SCC) (S.D.N.Y. Bankruptcy Court): Mark Holliday, as Liquidating Trustee of the BosGen Liquidating Trust v. K Road Power Management, LLC et al., Adversary Proceeding No. 12-01879 (RG), Mem. Op. Resolving Mot. to Dismiss Third Am. Compl. (June 18, 2020) (Mem. Op.).
 11 U.S.C. § 101(22)(A) (emphasis added).
 In re Tribune Co. Fraudulent Conveyance Litigation, 946 F.3d 66 (2d Cir. 2019).
 Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 138 S. Ct. 883, 892-93 (2018).
 In re Tribune Co. Fraudulent Conveyance Litigation, 946 F.3d 66, 78 (2d Cir. 2019).
 Herrick represented a group of the defendants.