Payments to Investors in a Securitization Structure Protected from Avoidance

May 04, 2015

In what appears to be a matter of first impression, the U.S. Bankruptcy Court for the Northern District of Illinois recently held that payments made to investors in a two tiered securitization structure commonly employed in commercial mortgage-backed securitization (“CMBS”) transactions are largely protected from fraudulent or preferential transfer claims by the securities contract safe harbor set forth in Bankruptcy Code section 546(e). Specifically, in Krol v. Key Bank National Association (In re MCK Millenium Centre Parking, LLC),1 the court held that payments by a debtor to a commercial bank on account of a loan, where the promissory note evidencing the loan was held by a real estate mortgage conduit (“REMIC”) trust, could be integrated with the trust’s distribution of the loan payments to its investors under a pooling and servicing agreement such that the payments constituted transfers in connection with a securities contract and thus, were not avoidable. 


The court’s decision arose in the context of an adversary proceeding instituted by the chapter 7 trustee for debtor MCK Millennium Centre Parking, LLC (“Debtor”). The trustee sought to recover payments made by Debtor to defendant Key Bank (“Key”) since the payments were made for no consideration as they were applied to repay a loan made to MCK Millennium Centre Retail (“Retail”), a subsidiary and insider of Debtor. Over the last four years, Debtor had paid over US$5 million on account of an US$11.2 million loan made to Retail. The payments to Key were only held by it temporarily, as after making the loan to Retail, Key transferred the promissory note to a REMIC trust with Wells Fargo Bank, N.A. serving as trustee (the “Trust”) to be held as part of a pool of mortgages. 

Key’s transfer of the promissory note to the Trust was the first step in a two-step CMBS transaction: promissory notes in respect commercial mortgages were sold to the Trust, which then pooled the mortgages together and issued certificates representing ownership in the Trust to investors. As is standard for CMBS transactions, this transaction was governed by a pooling and servicing agreement (the “PSA”) among Key, Wells Fargo Bank, N.A., as trustee, and other financial institutions. The PSA designated Key as master servicer, and in that capacity, it continued to handle administration of the loans, including by receiving the payments on account of the loans, including from the Debtor to be applied to the loan to Retail. In response to the trustee’s complaint, Key argued that the payments were non-avoidable transfers under Bankruptcy Code section 546(e) as being in connection with a securities contract. 

Bankruptcy Code Section 546(e)

Bankruptcy Code section 546(e) provides, in relevant part, that “[t]he trustee may not avoid a payment… that is a transfer made by or to (or for the benefit of) a… financial institution… in connection with a securities contract, as defined in section 741 (7)… (emphasis supplied).” This section shields from avoidance prepetition payments made by or to certain financial market participants and in connection with a securities contract (unless the transfer was done with actual fraudulent intent). The legislative history of section 546(e) indicates Congressional concern for the stability in the financial markets in the event that a major financial institution was to file for bankruptcy.2 If prepetition transactions with financial institutions were subject to attack as avoidable transfers, the result could chill activity with any institution that was rumored to be in trouble, resulting in a loss of confidence in the markets.3 Congress thus enacted section 546(e) to provide a defense for such transfers in order to aid the stability of securities markets. 

The availability of section 546(e) as a defense often depends on whether the transfer was done in connection with a securities contract as that term is defined under the Bankruptcy Code. Bankruptcy Code section 741(7) broadly defines “securities contract”, to include, among other things, “a contract for the purchase, sale, or loan of a security… a mortgage loan, any interest in a mortgage loan, [or] a group or index of securities… or mortgage loans or interests therein (including an interest therein or based on the value thereof)[.]” Furthermore, there is a catchall provision in section 741(7) which states that a securities contract may be “any other agreement or transaction that is similar to an agreement or transaction” referred to in section 741(7). 

The Krol Decision 

It was not disputed by any party that Key, as a commercial bank, fell within the Bankruptcy Code’s definition of financial institution.4 Although the trustee initially argued that the transfers to Key should not be protected because Key neither used nor benefited from the payments by Debtor, the court dismissed that argument based on the plain language of section 546(e), which only requires that the transfer be “by or to” a financial institution and does not impose requirements as to how the payment is used. Therefore, the chief issue was whether the payments from Retail to Key were “in connection with a securities contract”. The court recognized that the PSA governing the Trust was a securities contract and focused on the question of whether Debtor’s payments under the loan were sufficiently “in connection with” the PSA. 

Key argued that the loan to Retail should be integrated with the PSA and thus qualifies as a securities contract. The trustee argued that the Debtor’s payments were made on account of the loan agreement between Key to Retail which was plainly not a securities contract. 

The court sided with Key and recommended dismissal of the trustee’s claims. In its opinion, the court emphasized that the promissory note evidencing the loan was owned by the Trust and therefore was governed by the PSA; for example, the PSA dictated how payments made on the loan to Retail would be distributed to certificate holders. The court believed that it made sense to “properly consider two separate transactions as a single transaction when doing so would align with the economic realities” and held that the payments by Debtor bore a significant enough relationship to the PSA to constitute a securities contract. 

In further support of its decision, the court focused on the broad language of sections 546(e) and 741(7). It reasoned that the phrase “in connection with” has historically been interpreted very broadly to mean “related to.” The court believed that the statutory language, coupled with the expansive definition of securities contract in section 741, reflected Congress’ desire to afford broad protection to securities contracts. Therefore, the payments made on the loan were at a minimum related to the PSA, which in and of itself, constituted a securities contract. 


Even though CMBS transactions are common, Krol appears to be the first reported decision addressing whether payments made in respect of mortgages pooled together and held by a REMIC trust are entitled to protection under section 546(e). Following trend of recent circuit court decisions applying section 546(e) as written, the court did not consider the policy goals of section 546(e). The court’s decision, if followed by others, would ensure that the bankruptcy of an individual mortgagor would not upset investors’ expectations in securitization vehicles. 


1) Adv. No. 14-00392 (Bankr. C.D. Ill. April 24, 2015).
2) See Shmuel Vasser, Derivatives in Bankruptcy, 60 Bus. Law. 1507, 1510 (2005).
3) See 5 Collier on Bankruptcy ¶ 546.LH[5] (16th ed. 2010).
4) See 11 U.S.C. § 101(22) (The term “financial institution means… an entity that is a commercial or savings bank”).

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