Delaware Bankruptcy Court Finds that Section 546(e) Does Not Protect Fraudulent Transfers Following Supreme Court’s Ruling in Merit Management

The Bottom Line

In one of the first applications of the Supreme Court’s ruling on the scope of section 546(e) in Merit Management, Delaware Bankruptcy Court Judge Carey found that section 546(e)’s safe harbor did not apply to fraudulent transfers between two parties that were not financial institutions, even if the transaction passed through financial intermediaries.

What Happened

In FTI Consulting, Inc. v. Sweeney, Adv. Proc. No. 12-50423, 2018 WL 6841469 (Bankr. D. Del. Dec. 27, 2018), Judge Kevin J. Carey of the Delaware Bankruptcy Court addressed the scope of section 546(e)’s safe harbor as a defense to fraudulent transfers following the Supreme Court’s ruling in Merit Management Group v. FTI Consulting, 138 S. Ct. 883 (2018).

FTI Consulting, as trustee (the “Trustee”) for a litigation trust formed as part of Centaur LLC’s (“Centaur”) plan of reorganization, initiated an adversary proceeding against Joseph Sweeney and Linda Porr Sweeney (the “Sweeneys”). The adversary proceeding sought to recover alleged fraudulent transfers from one of the Centaur debtors to the Sweeneys. Consideration of the adversary proceeding was suspended while the Supreme Court considered and ruled on the issues raised in Merit Management. Following the Supreme Court’s decision, Judge Carey asked the parties to submit supplemental briefing on the impact of the Supreme Court’s ruling.

Factually, in 2004, the Sweeneys acquired an 8 percent interest in Debtor Valley View Downs LP (“VVD”). 2018 WL 6841469, at *1. VVD was to construct a casino and horse racing track, for which it needed both a racing and a gaming license. VVD was then awarded the last racing license in Pennsylvania in 2007. Id. VVD, Centaur and other related entities then entered into an agreement to purchase the Sweeneys’ 8 percent interest for $11.19 million (partially paid in cash and partially in a promissory note). Centaur took out certain revolving credit facilities and term loans to finance various casino and racing facilities, and advanced a portion of the proceeds to VVD in exchange for an intercompany note (obligating VVD to Centaur for the transferred amount). VVD then transferred the cash purchase price to the Sweeneys, and later transferred the amount of the promissory note to the Sweeneys. 2018 WL 6841469, at *1-2. VVD was eventually unable to obtain its separate gaming license and filed for bankruptcy. The Trustee filed suit against Merit Management for a related constructive fraudulent transfer and was successful.

The Trustee also initiated an adversary proceeding to avoid the transfers of $11.19 million as constructive fraudulent transfers under sections 548(a)(i)(B) and 544 and Pennsylvania Uniform Fraudulent Transfer Act section 5105. The Trustee then moved for summary judgment, and the Sweeneys asserted that they were entitled to the protections of section 546(e)’s safe harbor. 2018 WL 6841469, at *2.

The court found that, following the Supreme Court’s decision on similar facts in Merit Management, the section 546(e) defense did not apply. First, the court provided a detailed summary of the relevant provisions of the Supreme Court’s decision in Merit Management, noting that the Supreme Court took a narrow view of section 546(e), following the Seventh Circuit’s approach and not the Third Circuit’s broader approach. 2018 WL 6841469, at *4-5. Judge Carey noted that “the Court relied on a plain text interpretation of the statute and concluded that the relevant transfer in a safe harbor analysis is the overarching transfer the trustee seeks to avoid, not any component part of that transfer.” 2018 WL 6841469, at *6. Concluding that the two transfers at issue in this case took place during the applicable two-year window, were undertaken while VVD was insolvent and that VVD did not receive reasonably equivalent value for the $11.19 million transfer, the court found the two transfers to be constructive fraudulent transfers. 2018 WL 6841469, at *8-9.

Turning to the application of Merit Management, the court disagreed with the Sweeneys’ assertion that the Third Circuit’s previously broad interpretation of what constituted a  “settlement payment made by a financial institution” allowed them to invoke section 546(e) as a defense. 2018 WL 6841469, at *9. While certain intermediaries to the transaction may have been financial institutions, the overarching transaction was between VVD and the Sweeneys, neither of which were financial participants.

Why the Case Is Interesting

Judge Carey’s decision in FTI Consulting v. Sweeney marks one of the first applications of the Supreme Court’s decision in Merit Management to fraudulent transfers. Bankruptcy courts applying Merit Management will likely take a similarly narrow view of what constitutes a “settlement payment made by a financial institution,” and parties should be aware that, under this decision and others that follow it, fraudulent transfers and constructive fraudulent transfers will not be insulated from liability merely for passing through a financial intermediary if the transferor itself is not a financial participant.