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Merit Management Group v. FTI Consulting

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Supreme Court of the United States
Merit Management Group v. FTI Consulting
Term: 2017
Important Dates
Argument: November 6, 2017
Decided: February 27, 2018
Outcome
United States Court of Appeals for the 7th Circuit affirmed
Vote
9 - 0 to affirm
Majority
Sonia Sotomayor • Chief Justice John G. Roberts • Anthony Kennedy • Clarence Thomas • Ruth Bader Ginsburg • Stephen Breyer • Samuel Alito • Elena Kagan • Neil Gorsuch


Merit Management Group v. FTI Consulting is a case argued during the October 2017 term of the U.S. Supreme Court. Argument in the case was held on November 6, 2017. The case came on a writ of certiorari to the United States Court of Appeals for the 7th Circuit.

The case addressed a split among federal circuit courts on the how broadly to interpret the safe harbor provisions of the federal bankruptcy code. Writing in Law360, a legal affairs website, Brian Koosed and Robert Honeywell wrote, "The stakes for the Supreme Court’s Merit decision are extremely high, not just for the bankruptcy bar but also for investors and financial institutions generally."[1]

HIGHLIGHTS
  • The case: Bankruptcy trustees have authority to undo previously completed transactions in order to facilitate the distribution of assets in a bankruptcy case. Some transactions benefiting financial institutions, however, are protected against a trustee's actions under the safe harbor provision of the federal bankruptcy code. In this case, the question was whether safe harbor only protected transactions made by, made to, or for the benefit of financial institutions, or whether the protection also included transactions in which financial institutions served as conduits only. Two federal circuit courts, including the Seventh Circuit in this case, excluded facilitated transactions from safe harbor protection, while five other circuit courts permitted safe harbor protection for such transactions.
  • The issue: Does the safe harbor provision of the federal bankruptcy code extend to transactions in which financial institutions serve as conduits only?
  • The outcome: The United States Supreme Court affirmed the Seventh Circuit's ruling, 9 - 0.


    • In brief: In bankruptcy cases, a bankruptcy trustee is appointed to distribute any residual assets from a bankrupt entity to any of the bankrupt entity's creditors with a legitimate claim. Bankruptcy trustees can undo previously completed transactions in order to facilitate payments to creditors, but the federal bankruptcy code prevents a trustee from doing so in certain circumstances. This protection is known as the safe harbor provision in the bankruptcy code. The safe harbor provision generally protects legitimate transactions made by, made to, or for the benefit of financial institutions, but there was a question as to whether the safe harbor provision also protects transactions where the financial institution merely served as a conduit, but was not a beneficiary. In this case, the Seventh Circuit held that the safe harbor provision did not extend to transactions in which a financial institution merely served as a conduit, agreeing with a prior holding of the Eleventh Circuit. Five other federal circuit courts, however, had read the safe harbor provision to include transactions in which financial institutions serve as conduits only. Argument in the case was held on November 6, 2017. The United States Supreme Court affirmed the Seventh Circuit's ruling on February 27, 2018.[2]

    You can review the lower court's opinion here.[3]

    Background

    Legal background

    In a bankruptcy, a bankruptcy trustee is appointed to distribute any residual assets from a bankrupt entity to any of the bankrupt entity's creditors with a legitimate claim. Sometimes, a bankruptcy trustee has the authority to unwind certain financial pre-bankruptcy transfers made by or to the bankrupt entity for the purpose of redistributing assets to the creditors. These are commonly referred to as clawbacks, a term that refers the recovery of money or assets that have been already disbursed. A portion of the federal bankruptcy code, 11 U.S.C. §546(e), protects some of these transfers from a bankruptcy trustee's power to unwind or, in bankruptcy terms, to avoid the transfers.[4] By virtue of protecting these transfers from a trustee's authority to unwind them, §546(e) is known as the safe harbor provision.

    The issue in this case, however, was exactly which creditors' transactions were protected by the safe harbor provision. At the time of this case, the relevant portion of §546(e) read,[5][6]

    “

    The trustee may not avoid a transfer that is ... a settlement payment ... made by or to (or for the benefit of) a ... financial institution ... or that is a transfer made by or to (or for the benefit of) a ... financial institution ... in connection with a securities contract ... that is made prior before the commencement of the case, except under section 548(a)(1)(A) of this title.[7]

    		”

    Federal circuit courts "have divided on whether the safe harbor is available only for settlement payments that are for the benefit of the entities listed in § 546(e) or whether that safe harbor is also available for any settlement payments that pass through these types of entities to others (i.e., ultimate beneficiaries who may not be specifically listed in § 546(e))."[1]

    Case background

    In 2007, Valley View Downs, LP, owner of a Pennsylvania racetrack, agreed to purchase Bedford Downs, a competing racetrack. In a merger, Valley View agreed to acquire all of Bedford Downs' shares for $55 million dollars. Valley View borrowed money from a financial institution, Credit Suisse, to help finance the merger and the payments were made in escrow to Citizens Bank, a financial institution serving as Bedford Downs' escrow agent. It was undisputed that both Credit Suisse and Citizens Bank were financial institutions. Merit Management Group, the petitioner here, was a 30% shareholder in Bedford Downs and received approximately $16.5 million dollars as a result of the merger.

    Valley View later declared bankruptcy. The bankruptcy trustee, FTI Consulting, the respondent here, sought to unwind (i.e. to avoid) the $16.5 million dollar payment to Merit Management, arguing that the payment was a fraudulent transfer under 548(a)(1)(A) and was, therefore, subject to clawback in order to facilitate payments to Valley View's creditors. Specifically, FTI argued "that Valley View did not receive reasonably equivalent value for the Bedford Downs purchase price, and Valley View was insolvent at the time of the purchase."[8] Merit Management argued that, because its payment was a transfer made by a financial institution in connection with a securities contract, §546(e)'s safe harbor provision applied to them and the bankruptcy trustee (FTI) could not avoid the $16.5 million dollar transfer.

    A federal district court agreed with Merit Management. The court held that the safe harbor provision applied not only to transfers benefiting institutions listed in §546(e) but also for transactions in which §546(e) institutions served as conduits for the transfers. Put simply, even though Merit Management was not a §546(e) institution, because §546(e) institutions (Citizens Bank and Credit Suisse) served as conduits for the $16.5 million dollar transfer, the court held that the transfer was protected under the safe harbor provision and was not subject to clawback (i.e. the transfer could not be avoided by the bankruptcy trustee).[3][9]

    FTI appealed to the Seventh Circuit Court of Appeals. There, a three-judge panel composed of Chief Judge Diane Wood and Circuit Judges Richard Posner and Ilana Rovner heard the appeal. Judge Wood wrote the opinion for a unanimous panel. In this case, the panel reversed the lower court and held that the safe harbor provision did not protect transfers in which §546(e) institutions did not themselves benefit, but merely served as conduits. Judge Wood wrote, "Although we have said that section 546(e) is to be understood broadly ... that does not mean that there are no limits. ... We will not interpret the safe harbor so expansively that it covers any transaction involving securities that uses a financial institution or other named entity as a conduit for funds."[3]

    Circuit split

    In her opinion for the panel, Judge Wood acknowledged that the opinion would create a split among federal appeals courts as to how the safe harbor provision was interpreted. She wrote,[3]

    “

    We recognize that we are taking a different position from the one adopted by five of our sister circuits, which have interpreted section 546(e) to include the conduit situation. ... One circuit, however—the Eleventh—agrees with us. In Matter of Munford, Inc., the Eleventh Circuit found section 546(e) inapplicable to payments made by Munford to shareholders because financial institutions were involved only as conduits. ... Merit contends that Congress disapproved Munford by passing the 2006 Amendment adding '(or for the benefit of),' and that Congress was responding to the Eleventh Circuit’s language in Munford that '[t]he bank never acquired a beneficial interest in either the funds or the shares.' ... We do not believe that Congress would have jettisoned Munford’s rule by such a subtle and circuitous route. Its addition of an alternate way to meet the safe harbor criteria says nothing about the method already in the statute. If Congress had wanted to say that acting as a conduit for a transaction between non-named entities is enough to qualify for the safe harbor, it would have been easy to do that. But it did not.[7]

    		”

    Petitioner's challenge

    Merit Management Group, the petitioner, challenged the holding of the Seventh Circuit. Merit Management Group argued that the Seventh and Eleventh Circuit's interpretations of the safe harbor provisions in the federal bankruptcy code were too narrowly interpreted, and that the interpretation of the Second, Third, Sixth, Eighth, and Tenth Circuits was the correct interpretation.

    Certiorari granted

    On December 16, 2016, Merit Management Group, the petitioner, initiated proceedings in the Supreme Court of the United States in filing a petition for a writ of certiorari to the Seventh Circuit.[8] The U.S. Supreme Court granted Merit Management's certiorari request on May 1, 2017. Argument in the case was held on November 6, 2017.[10]

    Question presented

    Question presented:

    "Whether the safe harbor of 11 U.S.C. § 546(e) prohibits avoidance of a transfer made by or to a financial institution, without regard to whether the institution has a beneficial interest in the property transferred, consistent with decisions from the Second, Third, Sixth, Eighth, and Tenth Circuits, but contrary to decisions from the Eleventh Circuit and now the Seventh Circuit."[10]

    Audio

    • Audio of oral argument:[11]



    Transcript

    • Transcript of oral argument:[12]

    Outcome

    Decision

    The Supreme Court affirmed the Seventh Circuit's ruling, 9 - 0.

    Opinion

    Justice Sonia Sotomayor wrote the opinion for a unanimous court. The court first clarified what it saw as the key issue in the case:

    “ The parties and the lower courts dedicate much of their attention to the definition of the words 'by or to (or for the benefit of)'...In our view, those inquiries put the proverbial cart before the horse. Before a court can determine whether a transfer was made by or to or for the benefit of a covered entity, the court must first identify the relevant transfer to test in that inquiry. At bottom, that is the issue the parties dispute in this case...


    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... the statutory language and the context in which it is used all point to the transfer that the trustee seeks to avoid as the relevant transfer for consideration of the §546(e) safe-harbor criteria.[2][7]

    		”

    Having identified the transaction at issue, the court turned to the facts of the case to apply its reasoning:

    “ FTI, the trustee, sought to avoid the $16.5 million Valley View-to-Merit transfer. FTI did not seek to avoid the component transactions by which that overarching transfer was executed. As such, when determining whether the §546(e) safe harbor saves the transfer from avoidance liability, i.e., whether it was 'made by or to (or for the benefit of) a . . . financial institution,' the Court must look to the overarching transfer from Valley View to Merit to evaluate whether it meets the safe-harbor criteria. Because 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.[2][7] ”


    The court affirmed the ruling of the Seventh Circuit.[2]

    Text of the opinion

    See also

    Footnotes

    1. ↑ 1.0 1.1 Law360, "The Stakes Are High In FTI Consulting V. Merit Management," May 18, 2017
    2. ↑ 2.0 2.1 2.2 2.3 United States Supreme Court, Merit Management Group v. FTI Consulting Opinion, February 27, 2018
    3. ↑ 3.0 3.1 3.2 3.3 U.S. Court of Appeals for the Seventh Circuit, FTI Consulting Inc. v. Merit Management Group, LP, July 28, 2016
    4. ↑ Avoidance is a power given to a bankruptcy trustee to recover property, such as fraudulent transfers, in advance of a bankruptcy case.
    5. ↑ Cornell University's Legal Information Institute, "11 U.S. Code § 546 - Limitations on avoiding powers," accessed September 29, 2017
    6. ↑ Section 548(a)(1)(A) refers to lawsuits involving transfers that were intentionally fraudulent. Thus, an intentionally fraudulent transfer would not be protected by the safe harbor provision.
    7. ↑ 7.0 7.1 7.2 7.3 Note: This text is quoted verbatim from the original source. Any inconsistencies are attributable to the original source.
    8. ↑ 8.0 8.1 Supreme Court of the United States, Merit Management Group, LP, v. FTI Consulting - Petition for a writ of certiorari, December 16, 2016
    9. ↑ Cite error: Invalid <ref> tag; no text was provided for refs named petitioner
    10. ↑ 10.0 10.1 Supreme Court of the United States, Merit Management Group v. FTI Consulting, May 1, 2017
    11. ↑ Supreme Court of the United States, Merit Management Group v. FTI Consulting, argued November 6, 2017
    12. ↑ Supreme Court of the United States, Merit Management Group v. FTI Consulting, argued November 6, 2017
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