bankruptcy 546(e) safe harbor exemptions for swaps,...

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Presenting a live 90-minute webinar with interactive Q&A

Bankruptcy 546(e) Safe Harbor Exemptions

for Swaps, Securitized Loan Payments,

LBO Shareholder Payments and More Latest Developments in the Application of 546(e) to Financial Transactions and Securities Contracts

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, MARCH 1, 2016

Mark D. Sherrill, Partner, Sutherland Asbill & Brennan, Washington, D.C.

Jason T. Rodriguez, Shareholder, Higier Allen & Lautin, Dallas

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BANKRUPTCY 546(e) SAFE HARBOR

EXCEPTIONS

Al Rights Reserved. This presentation is for general informational purposes. This is not to be considered legal advise, a recommendation of legal action, nor a offer for legal representation. This should not be relied upon for legal guidance. Each legal issue is different. Obtaining legal counsel is advised if you believe you have a legal claim. No engagement or representation should be presumed by this presentation.

Presented by:

Jason T. Rodriguez, Esq.

Higier Allen & Lautin, PC

[email protected]

Overview of Section 546(e) Safe Harbor

6

Bankruptcy Avoidance

Federal Fraudulent Transfers for Actual Fraud

11 U.S.C.. § 548(a)(1)(A)

Federal Fraudulent Transfers for Constructive Fraud

11 U.S.C.. § 548(a)(1)(B)

State Fraudulent Transfers for Actual Fraud

11 U.S.C.. § 544(b) / State law

State Fraudulent Transfers for Constructive Fraud

11 U.S.C.. § 544(b) / State law

Preferences

11 U.S.C. § 547 / State law

7

Limitations on Avoidance 8

11 U.S.C.. § 546 sets limits on avoidance by

bankruptcy trustee

11 U.S.C.. § 546(e) provides a “Safe Harbor” for

certain transfers

Text of the statute 9 (e) Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title,

the trustee may not avoid a transfer that is a margin payment, as defined in section

101, 741, or 761 of this title, or settlement payment, as defined in section 101 or

741 of this title, made by or to (or for the benefit of) a commodity broker, forward

contract merchant, stockbroker, financial institution, financial participant, or

securities clearing agency, or that is a transfer made by or to (or for the benefit of)

a commodity broker, forward contract merchant, stockbroker, financial institution,

financial participant, or securities clearing agency, in connection with a securities

contract, as defined in section 741(7), commodity contract, as defined in section

761(4), or forward contract, that is made before the commencement of the case,

except under section 548(a)(1)(A) of this title.

11 U.S.C. § 546(e)

Summery Overview 10

Only deals with preferences and constructive fraud

Actual fraud is not subject to the safe harbor provisions

If a pre-petition transfer was received by a

qualified recipient or was from a qualified

recipient, it cannot be recovered by a bankruptcy

trustee if was on account of the one of the types of

agreements.

Two Parts to the Statute (1) 11

The trustee may not avoid a transfer that is a

margin payment or settlement payment made by or

to (or for the benefit of) a commodity broker,

forward contract merchant, stockbroker, financial

institution, financial participant, or securities clearing

agency,

[that is made before commencement of the

bankruptcy case]

Two Parts to the Statute (2) 12

the trustee may not avoid a transfer that is a

transfer made by or to (or for the benefit of) a

commodity broker, forward contract merchant,

stockbroker, financial institution, financial

participant, or securities clearing agency, in

connection with a securities contract, commodity

contract, or forward contract, that is made before

the commencement of the case,

A Broad Statute for a Policy Purpose 13

Legislative history: “Congress’s purpose was to

minimize the displacement caused in the

commodities and securities markets in the event of a

major bankruptcy affecting those industries.” H.R.

Rep. No. 420, 97th Cong., 2d Sess. (1982).

Types of Qualified Recipients 14

Commodity broker

Forward contract merchant

Stockbroker

Financial institution

Financial participant

Securities clearing agency

These would all be the potential defendants

Commodity Broker 15

An entity which is a futures commission merchant,

clearing organization, leverage transaction

merchant or commodity operation dealer

11 U.S.C. § 101(6)

Forward Contract Merchant 16

A bank or entity which enters into forward contracts

for commodities or similar goods, articles, services,

rights or interests

11 U.S.C. § 101(26)

Stockbroker 17

Person who trades stocks as a profession (ie, for a

client)

11 U.S.C. § 101(53A)

Financial Institution 18

Basically any type of lending institution or a

receiver for such entity as well as an registered

investment company.

11 U.S.C. § 101(22)

Financial Participant 19

An entity with at least one security agreement,

commodity contract, repurchase agreement, swap

agreement or master netting agreement with a non-

affiliate with a total gross dollar value of not less

than $1B outstanding in the prior 15 months or has

gross mark-to-market positions of not less than

$100MM in the same time frame

11 U.S.C. § 101(22A)

Securities Clearing Agency 20

A person who is registered as a clearing agency

under section 17A of the ‘34 act, or an exempt

person who acts solely as a securities clearing

agency

11 U.S.C. § 101(48)

546(e) Further Distilled 21

The trustee may not avoid a transfer that is a margin payment or settlement payment made by or to (or for the benefit of) a Qualified Recipient,

The trustee may not avoid a transfer that is a transfer made by or to (or for the benefit of) a Qualified Recipient, in connection with a securities contract, commodity contract, or forward contract, that is made before the commencement of the case

Except for actual fraud

The Devil is in the Definitions 22

Who falls into each Qualified Recipient is a matter

of statute and court interpretation

Mere conduit?

What types of transfers are also defined and

subject to statute and court review

Types of Qualified Transfers 23

Margin Payment

Settlement Payment

Transfers made “in connection with”:

Securities Contracts

Commodity Contract

Forward Contract

Margin Payment 24

Defined in Three Separate Sections

The term “margin payment” means, for purposes of the forward contract provisions of this title, payment or deposit of cash, a security or other property, that is commonly known in the forward contract trade as original margin, initial margin, maintenance margin, or variation margin, including mark-to-market payments, or variation payments.

11 U.S.C. § 101(38)

“margin payment” means payment or deposit of cash, a security, or other property, that is commonly known to the securities trade as original margin, initial margin, maintenance margin, or variation margin, or as a mark-to-market payment, or that secures an obligation of a participant in a securities clearing agency;

11 U.S.C. § 741(5)

“margin payment” means payment or deposit of cash, a security, or other property, that is commonly known to the commodities trade as original margin, initial margin, maintenance margin, or variation margin, including mark-to-market payments, settlement payments, variation payments, daily settlement payments, and final settlement payments made as adjustments to settlement prices;

11 U.S.C. § 761(15)

Margin Payment 25

“Margin payment is a broadly construed term and

includes any payment by a debtor to pay for the

purchase of securities or to reduce a deficiency in a

margin account.”

In re Stewart Fin. Co., 367 B.R. 909, 917 (Bankr. M.D.

Ga. 2007)

Settlement Payments 26

"A number of courts which have examined the

meaning and legislative history of § 546(e) have

concluded that the definition of settlement payment

defies plain meaning; to the contrary...it is circular

and cryptic. [T]he statutory definition of the term is

as opaque as it is circular. As one court put it, §

546(e) essentially provides that a settlement

payment is a settlement payment....”

In re Adler, Coleman Clearing Corp., 263 B.R. 406, 475

(S.D.N.Y. 2001) (internal cites omitted)


Defined 11 U.S.C. § 101(51A) or 741

(51A) The term “settlement payment” means, for purposes of the forward contract provisions of this title, a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, a net settlement payment, or any other similar payment commonly used in the forward contract trade.

Section 741 is similar without reference to forward contract provisions


“…Cases have extended or adapted the term to embrace various forms of payment that further the settlement process in different types of securities transactions.

payment for shares during a leveraged buyout

reverse repurchase agreement between stockbroker and debtor

debtor's return to another party, upon cancellation of the transaction, of government securities serving as additional margin in a repurchase agreement

payments to shareholders for their stock in connection with a leveraged buyout

transfers of federal government securities in connection with repurchase agreements by participant securities dealer to purchasers qualify as settlement payments under § 546(f)”

In re Adler, Coleman Clearing Corp., 263 B.R. 406, 476-77 (S.D.N.Y. 2001)

"a settlement payment, quite simply, is a transfer of cash to a financial institution ... made to complete a securities transaction.”

In re Quebecor World (USA) Inc., 480 B.R. 468, 475 (S.D.N.Y. 2012) (internal citation omitted)

Securities Contract 29

Defined in 11 U.S.C. § 741(A)(7)

“The plain language of section 741(7) is very broad in its application and encompasses virtually any contract for the purchase or sale of securities, any extension of credit for the clearance or settlement of securities transactions, and a wide array of related contracts, including security agreements and guarantee agreements.”

In re Lehman Bros. Holdings Inc., 469 B.R. 415, 438 (Bankr. S.D.N.Y. 2012)

Securities Contact Exclusion 30

A securities contract “does not include any purchase,

sale, or repurchase obligation under a participation

in a commercial mortgage loan”

11 U.S.C. § 741(7)(B)

Commodity Contract 31

Defined 11 U.S.C. § 761(4)

“The term commodity contract encompasses purchases

and sales of commodities for future delivery on, or

subject to the rules of, a contract market or board of

trade, and leverage transactions.”

In re Olympic Nat. Gas Co., 294 F.3d 737, 741 (5th Cir.

2002) citing 5 Collier on Bankruptcy ¶ 556.02[2], at 556-5

(Lawrence P. King ed., 15th ed. 2002). (Internal quotation

omitted).

Forward Contract 32

Defined in 11 U.S.C. § 101(25)

“Reduced to its essence for purposes of this case, the definition of forward contract is a contract (other than a commodity contract) for the purchase [or] sale ... of a commodity, as defined in section 761(8) ... or any similar good ... or interest which is presently or in the future becomes the subject of dealing in the forward contract trade ... with a maturity date more than two days after the date [of] the contract.”

In re Mirant Corp., 310 B.R. 548, 565 (Bankr. N.D. Tex. 2004) (internal quotation omitted).

Forward Contract 33

"Generally speaking, ‘forward contracts' are contracts for the future purchase or sale of commodities that are not subject to the rules of a contract market or board of trade. Thus, the terms ‘commodity contract’ and ‘forward contract,’ taken together, seamlessly cover the entirety of transactions in the commodity and forward contract markets, whether exchange-traded, regulated, over-the-counter or private.“

In re Borden Chemicals & Plastics Operating Ltd. P'ship, 336 B.R. 214, 218 (Bankr. D. Del. 2006)

"[T]he distinguishing characteristics of a forward contract is that the parties expect to make actual delivery"

Id. citing In re Olympic Nat. Gas Co., 294 F.3d 737, 741 (5th Cir. 2002)

A. Madoff Cases

Recent Case Developments 34

The “546(e) Decision” 35

“Section 546(e) sets a low bar for the required

relationship between the securities contract and the

transfer sought to be avoided.”

In re Bernard L. Madoff Inv. Sec. LLC, 773 F.3d 411 (2d

Cir. 2014) cert. denied sub nom. Sec. Inv'r Prot. Corp. v.

Ida Fishman Revocable Trust, 135 S. Ct. 2858, 192 L.

Ed. 2d 910 (2015) and cert. denied sub nom. Picard v.

Ida Fishman Revocable Trust, 135 S. Ct. 2859, 192 L.

Ed. 2d 910 (2015)


Transaction Background

Investors Executed Account Documents which authorized BLMIS to trade stocks on Investor’s behalf

Inventors Paid in Funds

BLMIS Never Executed any Stock Transaction

BLMIS simply used other investor funds to pay back investors seeking to exit


Trustee Argued:

BLMIS never actually performed a securities transaction

It was unclear what, if any securities were to be purchased

The Account Documents didn’t actually purchase securities, only authorized the purchase

The payments to exiting investors did not come from securities trading

*A SIPC argument


Held:

The repayments sought were covered by the safe

harbor provision as securities contract payments

The repayments sought were covered by the safe

harbor provision as settlement payments

Actual Fraud 39

“If an investor knew that BLMIS was a Ponzi scheme,

he had no reasonable expectation that he was

signing a securities contract with BLMIS for the

purposes of trading securities for his account.”

In re Madoff, 542 B.R. 100 (Bankr. S.D.N.Y. 2015)

Section 548(c) provides a “good faith” defense

Subjective v. objective

Actual Fraud 40

“In the context of the Madoff litigations, Judge Rakoff

has rejected willful blindness as a substitute for actual

knowledge for the purposes of the safe harbor.”

In re Bernard L. Madoff Inv. Sec. LLC, No. 08-99000 (SMB),

2015 WL 4734749 (Bankr. S.D.N.Y. Aug. 11, 2015)

Actual knowledge negates good faith under section

548(c)

Id.

The “Net Equity v 546” Decision 41

In re Bernard L. Madoff Inv. Sec., LLC,, No. 15 CIV. 1151 (PAE), 2016 WL 183492, at *3 (S.D.N.Y. Jan. 14, 2016).

§ 546(e) v. the Net Equity calculation

“There is no legal basis to treat the two-year reach back restriction on avoidance of fraudulent transfers as inhibiting the ability of the Trustee to calculate net equity”

Recent Case Developments 42

All Rights Reserved. This communication is for general informational purposes only and is not intended to constitute legal advice

or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied

upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged

to consult independent counsel before making any decisions or taking any action concerning the matters in this communication.

This communication does not create an attorney-client relationship between Sutherland and the recipient.

© 2016 SUTHERLAND ASBILL & BRENNAN LLP / SUTHERLAND (EUROPE) LLP

Bankruptcy: 546(e) Safe Harbor Exemptions for

Swaps, Securitized Loan Payments, LBO

Shareholder Payments and More

Mark Sherrill

March 1, 2016

44


Roadmap

Recent case law developments (continued)

- In re Hellas Telecomms (Luxembourg) II SCA

- In re MCK Millennium Centre Parking L.L.C.

Additional developments

- In re Sabine Oil & Gas Corp.

Application of case law to structuring financial contracts

and transactions to preserve safe harbor protections

Brief summary of ABI’s recommendations of reforms for

safe harbor exemptions

Final thoughts

45


Recent Case Law Developments

TIM Hellas Communications S.A. was Greek telecom,

purchased in LBO in 2005 by private equity firms

Structure of LBO creates several layers of affiliates, which

PE sponsors then sought to discard

- Dec. 2006: Debtor raised €1.57 B

Debtor transferred full € 1.57 B to parent company, partially to

redeem convertible preferred equity certificates (“CPECs”)

Additional transfers among affiliates and PE sponsors to redeem

other CPECs issued by other Hellas entities

In re Hellas Telecomms (Luxembourg) II SCA

46



Nov. 2009: English court places Debtor into

administration, later converted into liquidation

Feb. 2012: Liquidators file Chapter 15 petition under U.S.

Bankruptcy Code

March 2014: Liquidators file complaint for avoidance of

fraudulent conveyances (both actual and constructive

fraud) under New York law, and also including action for

unjust enrichment

- Seeks to avoid €1.57 B in initial transfers to parent company, and

€973.7 MM in subsequent transfers


47



Defendants filed Motions to Dismiss on a number of

bases, including § 546(e)

- Bankruptcy court dismissed New York fraudulent conveyance

claims, without reaching § 546(e)

- Court refused to dismiss unjust enrichment claim against PE firms

Relatively little 546(e) discussion at this stage


48



Defendants then filed motion seeking to reargue

applicability of § 546(e)

- Court allowed reargument, but reiterated prior holding on unjust

enrichment actions

Recognized that courts have applied § 546(e) to “state law claims

that are premised on recovering transfers protected from

avoidance under section 546(e)”

But here, analog to unjust enrichment action is fraudulent

conveyance with actual fraudulent intent

Based in large part on degree of control exercised by PE

sponsors


49



Currently bogged down on a number of other issues

- Amended complaint

- Several additional motions to dismiss based on other legal theories

- 546(e) ruling likely to stand

Hosking v. TPG Capital Mgmt., L.P. (In re Hellas

Telecomms (Luxembourg) II SCA), 524 B.R. 488 (Bankr.

S.D. N.Y. 2015)


50



2 relevant entities on debtor side:

- MCK Millennium Centre Retail, LLC (“Retail”) – non-debtor

- MCK Millennium Centre Parking, LLC (“Parking”) – debtor

- Retail was affiliate and insider of Parking

2008: Key Bank extends $11.2 MM loan to Retail, then

sold Note to a trust

- Trust qualified as real estate mortgage conduit, or REMIC

- Note pooled with other mortgages, beneficial interests sold

- Wells Fargo, as trustee, would pay investors amounts from

principal and interest from pool of mortgages

- “Key Bank”* stays on as master servicer

In re MCK Millennium Centre Parking L.L.C.

51



Chapter 7 trustee alleged that equity owners caused

Parking to make loan payments to Key Bank for benefit of

Retail

- Trustee seeks to avoid:

$2.2 MM as fraudulent conveyances under § 548 (both actual

fraud and constructive fraud prongs)

$4.3 MM as fraudulent conveyances under state law

$280K as preferences under § 547

- Trustee argued payments made for no consideration because they

were repayments on loan for which Parking was not an obligor


52



Key Bank filed Motion to Dismiss based on safe harbors

Trustee argued safe harbors not available because:

- Not made “in connection with a securities contract”

- Defendant should not qualify as financial institution, because Key

Bank was “mere conduit” to REMIC


53



In April 2015 opinion, bankruptcy court issues proposed

findings of fact and conclusions of law, siding with Key

Bank

First, court holds that transfers were made to a financial

institution

- Recognizes split in authority regarding role that financial institutions

must play

- “Most circuits that have addressed this issue have held that the

plain language of the statute includes transfers made to financial

institutions that serve only as a conduit or intermediary”


54



Second, court holds that transfers were made in

connection with securities contract

- Commercial mortgage securitization is a securities contract

“a contract for the purchase, sale, or loan of a security, … a

mortgage loan, any interest in a mortgage loan, a group or index

of securities… or mortgage loans or interests therein (including

an interest therein or based on the value thereof)”

- Emphasizes expansive interpretation, as further supported by

catchall language in definition of securities contract

“… any other agreement or transaction that is similar to an

agreement or transaction referred to in this subparagraph”


55



Court therefore proposed granting Motion to Dismiss

(other than counts based on actual fraud)

Krol v. Key Bank National Association (In re MCK

Millennium Centre Parking L.L.C.), 2015 WL 2004887

(Bankr. N.D. Ill. Apr. 29, 2015); Krol v. Key Bank National

Association (In re MCK Millennium Centre Parking

L.L.C.), 532 B.R. 716 (Bankr. N.D. Ill. 2015)

…. but, before reaching district court….


56



June 2015: trustee filed Motion for Reconsideration,

based on newly discovered evidence:

- In Motion to Dismiss, defendants asserted “Key Bank, National

Association” was master servicer

- After bankruptcy court issued proposed findings/conclusions, Key

filed disclosure that master servicer was actually “KeyCorp Real

Estate Capital Markets, Inc.”

That entity was transferee of payments

Likely not a “financial institution”

Sept. 2015: court granted Motion for Reconsideration,

vacated order, allowed trustee to file amended complaint


57


Other Developments

2015 E&P bankruptcy

On Day 1, debtor filed complaint against administrative

agent under syndicated loan

- Arises out of 2014 merger between Sabine and Forest Oil Corp.

- Alleges:

Forest was insolvent at time of merger

Its unencumbered assets were pledged to secure $650 MM in

pre-existing Sabine debt

- Seeks to avoid those liens

Agent filed Motion to Dismiss, including on 546(e)

grounds – no ruling to date

In re Sabine Oil & Gas Corp.

58


Application of Case Law

Plan for legislative change

- LBOs featuring privately held securities are likely protected today,

but may not be in future

- Repo and forward protections may be narrower in future

If relying on involvement of a “financial institution,” make

sure the right legal entity is transferee

Courts somewhat likely to allow defense when financial

institution is “mere intermediary,” but may be preferable to

structure differently if possible

Best Practices for Mitigating Avoidance Risk

59



Commodity cases:

- Plan for worst in terms of definitions of “forward contract” and

“swap agreement”

Statutory definitions are straightforward, but National Gas and

others have muddied waters

- National Gas addressed “forward agreement,” which is part of swap

agreement definition, not “forward contract”

- Other courts have misapplied dicta to impose requirements such as

fixed quantity and time of delivery

Other pitfalls in forward contract issues

- Spot transactions (i.e., less than 2 days after execution)

- Emphasis on merchant in forward contract merchant


60



Remember that letter of credit excluded from definition of

securities contract – payment related to L/C may not

qualify for safe harbor

Beware of any indicia of actual fraud

- If you were on notice, safe harbors may be unavailable – and court

may extend this rule to state law claims/actions

After bankruptcy, watch for attempts to circumvent safe

harbors through use of state law


61


ABI Recommendations

In June 2011, American Bankruptcy Institute formed

Commission to study changes needed in commercial

bankruptcies

Commission included 13 advisory committees, including

one for “Financial Contracts, Derivatives and Safe

Harbors”

Commission issued far-reaching report in Dec. 2014

- Many points of emphasis unrelated to safe harbors

- Nevertheless, some recommendations would have dramatic effects

on financial/commodity trading industries

Commission to Study the Reform of Chapter 11

62


ABI Recommendations

Proposals from Commission’s Report:

- Amend 546(e) to remove protections for beneficial owners of

privately issued securities

- Continue existing 546(e) protection for (i) securities industries

participants who act as conduits, and (ii) public securities holders

- Continue not to apply 546(e) protections to actual fraud, and extend

that exclusion to actual fraud provisions under state law

- Narrow scope of definition of:

“repurchase agreement” to exclude contracts that are essentially

financing arrangements for mortgage loan portfolios

“forward contract” to exclude physical supply contracts

Commission to Study the Reform of Chapter 11

63


Final Thoughts

General trend: mixed results in lower courts, strict

construction in courts of appeal -- exemplified by Grede v.

FCStone, LLC

- District court: “regardless of whether the distribution … fits under a

literal interpretation of § 546(e), I find it inconceivable that

Congress intended the safe harbor provisions to apply to the

circumstances of this case”

- 7th circuit: “We are not persuaded that Congress could not have

intended to protect even pre-petition transfers like the one in this

case… Congress has balanced many of the difficult choices that

must be made in bankruptcy cases, and … courts may not decline

to follow those policy choices on equitable grounds”

546(e) in the Future

64


Final Thoughts

If appellate courts adhere to strict construction of statute,

then legislature should be open to amending statute in

response to case law

- With some degree of consensus that 546(e) is too broad as written

(blowback from MacMenamin’s Grill), look for amendments along

the lines of ABI Commission Report

Notwithstanding, watch for other forms of attack on safe

harbor provisions

- Recent legislation to repeal safe harbors

- Erosion of some safe-harbor rights through outside channels

E.g., ISDA Stay Protocol

546(e) in the Future

All Rights Reserved. This communication is for general informational purposes only and is not intended to constitute legal advice

or a recommended course of action in any given situation. This communication is not intended to be, and should not be, relied

upon by the recipient in making decisions of a legal nature with respect to the issues discussed herein. The recipient is encouraged

to consult independent counsel before making any decisions or taking any action concerning the matters in this communication.

This communication does not create an attorney-client relationship between Sutherland and the recipient.


Mark Sherrill

Sutherland Asbill & Brennan

Washington, D.C.

[email protected]