High Court Won’t Limit Asset Recovery in Bankruptcy Cases

(CN) – Resolving a circuit split and handing a win to creditors, the U.S. Supreme Court ruled Tuesday that certain financial transfers completed before a company went bankrupt can be undone by bankruptcy trustees.

In 2003, Valley View Downs, owner of a Pennsylvania racetrack, acquired Bedford Downs, another racetrack, for $55 million in an effort to consolidate their chances of winning a license to run a combination horse track and casino.

Valley View borrowed money to pay for the acquisition but failed to secure a gambling license, and eventually filed for Chapter 11 bankruptcy.

One of its creditors, FTI Consulting, sued Merit Management Group, a 30 percent shareholder in Bedford Downs, alleging that Bedford’s transfer to Valley View can be voided under the bankruptcy code, and the $55 million is part of Valley View’s bankruptcy estate.

The Seventh Circuit ruled for FTI in July 2016, finding that the bankruptcy code does not provide a safe harbor to prevent the transaction from being undone by the bankruptcy trustee.

“We are not troubled by any potential ripple effect through the financial markets from returning the funds to FTI,” U.S. Circuit Judge Diane Wood said, writing for a three-judge panel. “Valley View’s bankruptcy will not trigger bankruptcies of any commodity or securities firms… Nor are we persuaded that the repercussions of undoing a deal like this one outweigh the necessity of the bankruptcy code’s protections for creditors.”

The Seventh Circuit’s ruling conflicts with five other circuit court decisions. Only the 11th Circuit has taken a similar position regarding bankruptcy transfers.

Merit Management noted the circuit split in its petition for a writ of certiorari to the U.S. Supreme Court, which was granted last May.

“Consistency of interpretation is fundamentally important in matters of bankruptcy. Business bankruptcies in particular often involve debtors and creditors from throughout the United States,” the petition states. “Inconsistent interpretations of the bankruptcy code in different circuits distort the incentives and expectations of debtors, trustees, creditors, and shareholders. In addition, uncertainty about the application of a safe harbor may alter investment decisions and may cause individuals and companies to refuse to deal with a distressed business because of concerns about potential liability.”

On Tuesday, the Supreme Court affirmed the Seventh Circuit and ruled unanimously that the safe harbor provision of section 546(e) of the bankruptcy code does not prevent trustees like FTI from clawing back money even when the transaction involved a financial intermediary.

Justice Sonia Sotomayor, who penned the court’s 19-page opinion, illustrated an example using the statutory term “avoid” to refer to financial clawbacks.

“This Court is asked to determine how the safe harbor operates in the context of a transfer that was executed via one or more transactions, e.g., a transfer from A → D that was executed via B and C as intermediaries, such that the component parts of the transfer include A → B → C → D,” Sotomayor wrote. “If a trustee seeks to avoid the A → D transfer, and the §546(e) safe harbor is invoked as a defense, the question becomes: When determining whether the §546(e) securities safe harbor saves the transfer from avoidance, should courts look to the transfer that the trustee seeks to avoid (i.e., A → D) to determine whether that transfer meets the safe-harbor criteria, or should courts look also to any component parts of the overarching transfer (i.e., A → B → C → D)?”

“The Court concludes that the plain meaning of §546(e) dictates that the only relevant transfer for purposes of the safe harbor is the transfer that the trustee seeks to avoid,” she added.

Sotomayor wrote that applying that interpretation of the law to the case “yields a straightforward result.”

“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…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,” she concluded.

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