Does Tribune Make Merit Management Obsolete?

June 03, 2019

Merit Management

In March 2018, the U.S. Supreme Court handed down its opinion in Merit Management Group, LP v. FTI Consulting, Inc., unanimously affirming the Seventh Circuit, holding that transfers are not protected from avoidance under the § 546(e) safe harbor when a “financial institution” or other statutorily-protected entity merely acts as a conduit for the transfers and is not either the debtor or the real party in interest that ultimately received the payment from the financial institution conduit. In affirming the judgment, the Supreme Court concluded that when “determining whether the §546(e) safe harbor saves [a] transfer from avoidance liability, the Court must look to th[e] overarching transfer…[,]” rather than the transfer’s specific components, “to evaluate whether it meets the safe-harbor criteria….” To the extent the overarching transfer was not between (or for the benefit of) one or more statutorily-protected entities, but instead was made between two parties not otherwise shielded by the provisions of the statute, the safe harbor does not apply.

Merit conceded, however, that it was not a protected party, a concession that proved costly. As the Supreme Court noted in footnote 2 to the opinion, the term “financial institution” is defined to include the customer of the financial institution when the financial institution acts for the customer in the transaction. But Merit did not argue that either it, or the debtor qualified as financial institutions by virtue of either or both of them being the customer of the financial institutions that acted as an intermediary. When discussing the Merit opinion, we predicted that since the term “customer” included in the definition of financial institution is not defined, it will be the new frontier in section 546(e) fraudulent transfer litigation. Then came Tribune.

The Customer as a Financial Institution

In In re Tribune Fraudulent Conveyance Litig., 2019 U.S. Dist. Lexis 69081 (S.D.N.Y. Apr. 23, 2019), the court refused to allow the plaintiff to assert fraudulent transfer actions against selling shareholders into an LBO, finding that they received payment from a financial institution that acted for the debtor-transferor as its customer, thus making the debtor itself a financial institution.

In Tribune, the company purchased its stock via a tender offer for which it engaged Computershare Trust Company, N.A. (“CTC”). CTC and Tribune entered into agreement pursuant to which CTC acted as a depositary or exchange agent. Tribune transferred to CTC the funds required to be paid to the selling shareholders and upon tender, accepted the tendered stock, held the tendered shares on Tribune’s behalf and paid the tendering shareholders. Claims based on actual fraud (which are carved-out from section 546(e)), were brought against the selling shareholders. After Merit, the plaintiff sought to amend the complaint to add claims for constructive fraudulent transfer that would have been barred pre-Merit under Second Circuit precedent. The district court denied leave, inter alia, because the amendment would be futile.

It was undisputed that CTC is both a bank and a trust company, and therefore qualified as a financial institution under the bankruptcy code. It was also undisputed that transfers sought to be avoided qualified as “settlement payments” and were made “in connection with a securities contract.” Thus, the remaining issues were whether Tribune was CTC’s customer, whether CTC acted as Tribune’s agent or custodian and whether CTC acted in connection with a securities contract. The court answered these questions in the affirmative.

First, since the bankruptcy code does not define the term “customer” (except for broker-dealer and commodity broker purposes), the court looked to dictionary definitions, including a purchaser of services and “in banking, any person having an account with a bank or for whom a bank agreed to collect items.” Since Tribune engaged CTC for a fee, it was purchaser of CTC’s services and thus, its customer.

Second, CTC acted as Tribune’s agent as it “was entrusted with billions of dollars of Tribune’s cash and was tasked with making payments on Tribune’s behalf …. This is a paradigmatic principal-agent relationship.”

Finally, CTC clearly acted in connection with a securities contract, defined as “a contract for the purchase, sale, or loan of a security … including any repurchase transaction on any such security.”

Other Observations

The court did not address an argument that CTC was acting as the selling shareholders’ agent or custodian, nor that CTC acted as Tribune’s custodian. Black’s legal dictionary defines the term as “describe[ing] anyone who has charge or custody of property, papers, etc.” Thus, it is quite possible that the selling shareholders themselves qualified as financial institutions by virtue of granting CTC custody over their shares pending payment.

The court rejected the selling shareholders’ argument that Tribune also qualified as a financial participant, holding that the entity that is the financial participant cannot be the debtor-transferor.

The court rejected the plaintiff’s argument that the term “customer” in section 101(22)(A) should be given the meaning ascribed to it in sections 741 (in connection with stockbroker liquidation) and 761 (in connection with commodity broker liquidation).

Final Thoughts

Many believed that Merit Management would not be the final word in light of Merit’s failure to raise the “customer” argument. Tribune seems to support that view.

Read the opinion >>