Securities Contract Safe Harbor Defeats Attack on Global Restructuring

April 07, 2020

Section 546(e) of the Bankruptcy Code excepts certain transfers made to certain protected parties, under or in respect of securities contracts, from avoidance as preferences or constructively fraudulent transfers. A recent decision in the DSI Renal case addressed some interesting aspects of section 546(e).


The underlying transfers were made in January 2010 pursuant to a Global Restructuring Agreement (the “GRA”). In a nutshell, the GRA was designed to separate the portion of the business relating to the kidney dialysis clinics throughout the U.S. (the “Renal Business”) from the other businesses of the enterprise, and transfer ownership of the Renal Business to newly created entity that became the owner of the Renal Business (“NewCo”) and which was owned by (i) existing creditors through debt-for-equity exchange (by exchanging existing debt for equity in NewCo), (ii) existing equityholders and creditors by issuing to them new equity in NewCo in exchange of new investment, and (iii) existing equityholders through the issuance of a portion of NewCo’s new equity.

About a year later, an unrelated third-party purchased NewCo for $689 million, resulting in the defendants receiving $440 million on account of their loans to and equity in NewCo. In June 2011, about a year and a half after the GRA, the entities that held that remaining businesses, filed chapter 7 bankruptcy petitions.

The Complaint

The bankruptcy trustee brought an action against various participants in the GRA for avoidance and recovery of actual and constructive fraudulent transfers as well for breaches of fiduciary duties against the directors and officers. In essence, the complaint asserts that the defendants effectuated a fraudulent scheme through which the debtors were stripped of their most valuable assets (the Renal Business) for little or no consideration, while a short time later the defendants turned around and sold that same business for hundreds of millions of dollars.

The Safe Harbor Motion and Decision

One of the equityholders, Northwestern Mutual Life Insurance Company (“NML”), which participated in the debt-for-equity exchange, made a new investment in NewCo and received a pro rata share of NewCo’s stock, moved for summary judgement under section 546(e) safe harbor.

Securities Contract. NML argued that the GRA is a securities contract and that the transfers made to it were either settlement payments – new stock received in exchange for the old debt, and to complete a securities transaction, or made in connection with a securities contract – the GRA. While the trustee did not dispute that the GRA was a securities contract and that the payments to NML qualified, the court nevertheless noted that it agreed with NML and cited numerous cases for the propositions that settlement payment generally means a transfer of securities against cash to complete a securities transaction and that transactions in private securities qualify.

Financial Participant. While not specifying the Rule of Evidence it relied on, absent opposition from the trustee the court accepted NML’s audited financial statements to establish that it qualified as a financial participant. Yet the trustee argued that NML should not be deemed a financial participant in this case because it acted for its own account as an investor of its own funds. The court rejected the argument noting that the trustee offered no factual or legal theory in support of the argument and that existing precedents counsel against it as they require the application of the statute as written.

Unfair/One sided Transaction. The court agreed with NML that there is no carve-out from the scope of section 546(e) for transactions that are alleged to be unfair, or one sided. Either the elements of section 546(e) are satisfied, or they are not.

Integrated Transaction. The complaint collapsed the various transactions that took place under the GRA, and sued the defendants for the transfer of NewCo’s stock to them. There is some confusion in the case-law as to whether section 546(e) applies to a collapsed transaction. While a Delaware bankruptcy court in Mervyn’s held that as a general rule section 546(e) does not apply to collapsed transactions, the same court later explained in HH Liquidation that collapsing transactions does not modify the elements necessary to establish liability. Further, in Crescent the bankruptcy court for the Western District of Texas applied section 546(e) to a collapsed transaction. As the DSI Renal court noted, the trustee could have sued NewCo for the transfer of the Renal Business to it, but it did not. As the Supreme Court in Merit instructs, courts must focus on the transfer that the complaint seeks to avoid; here that transfer was the receipt of the NewCo stock.


DSI Renal continues the trend of applying section 546(e) literally and refusing to create carve outs nowhere found in the statute: Financial participants will get the protections as long as they meet the definition contained in the bankruptcy code, securities contracts will be interpreted consistent with the commonly understood meaning of the term and general allegations of unfairness, unless plausibly allege actual fraud, will not defeat its application. After Merit, though, some uncertainty remains as to how to apply section 546(e) to collapsed transactions.

Read the opinion >>

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