Case No. 16-784 | 7th Cir. Decision
Valley View Downs LP and Bedford Downs both operated casino and racetrack companies in Pennsylvania and competed against the other to obtain the last harness-racing license in the state. Ultimately, they joined forces: Valley View acquired all of Bedford’s shares in exchange for $55 million. The companies did this through an escrow agreement where Citizens Bank of Pennsylvania was the escrow agent. Merit Management, a shareholder in Bedford Downs, also placed its stock certificate into escrow with Citizens Bank. Merit Management received $16.5 million from this transaction. Unfortunately, Valley View then went bankrupt in 2009. FTI Consulting, Inc., the trustee of Valley View Downs LP, brought this suit against Merit Management, a 30% shareholder of Bedford Downs, claiming that they are entitled to the $16.5 million from Bedford’s transfer to Valley View and thus to Merit Management.
The question—whether the creditors (FTI Consulting) are entitled to the money in Merit Management’s hands—turns on the scope of a safe harbor offered in Section 546(e) of the Bankruptcy Code. The safe harbor was created to protect financial institutions performing securities transactions from having to disgorge payments initially made by a now-bankrupt company. Litigation over this safe harbor statute has greatly increased in recent years, particularly in efforts to avoid payments from failed brokerage firms and investment banks like Madoff and Lehman Brothers. These cases often involve high stakes litigation; after all, entities bringing these suits are frequently seeking to get money back from investors that might have distributed their money elsewhere by the time of suit.
A circuit split has emerged as to how broadly the courts should interpret these protections from avoidance actions. Three circuit courts have ruled that Congress only intended to protect market players, such as banks, brokers, clearinghouses, and high-volume traders. Five circuit courts have found that, in addition to these market players, Congress intended to also protect anyone receiving payments through those market players—including, in this case, Merit Management. In other words, this latter view claims the safe harbor also applies when financial institutions are acting as a “conduit” for a transaction.
The Seventh Circuit reached the conclusion that Merit Management was only a conduit for the deal and could not benefit from the safe harbor. Merit Management argues that the Seventh Circuit’s decision completely disregards the plain language of § 546(e)—particularly when it refers to transfers “by or to” financial institutions, as well as “or for the benefit of” financial institutions. The Seventh Circuit and FTI Consulting mostly rely on congressional intent but also argue that the the statutory language is ambiguous. Depending on the result, the Court might dramatically limit or extend who gets to benefit from this safe harbor statute.