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The Ongoing Debate Over the Safe Harbor’s Scope

Almost since its enactment, courts have debated the scope of Bankruptcy Code section 546(e), a “safe harbor” that shields certain pre-bankruptcy securities transactions from most avoidance claims. Originally enacted to preserve stability in capital markets in the event of a bankruptcy of a securities or commodities firm, the expansive breadth of the statutory language and the extraordinary protection such language offers have attracted significant litigation for at least three decades.

The early years of these disputes were largely marked by defendants seeking to broaden the application of the safe harbor to a wide swath of transactions and defendants. By 2018, in most jurisdictions, courts had held that the safe harbor applies to public and private securities transactions,¹ to Ponzi schemes where there were no underlying securities transactions,² to state-law claims for unjust enrichment³ and unlawful dividends,⁴ and to any of the foregoing transactions where a “financial institution” was involved at any step of the transaction, no matter how ministerial the role.⁵

While the Supreme Court’s 2018 decision in Merit Management clarified some aspects of the safe harbor’s boundaries, it left many questions unresolved. In particular, the Supreme Court did not address the interplay between the Bankruptcy Code’s definitions of “financial institution” and “customer,” and whether these definitions could be used to sidestep the seemingly narrow confines of the ruling. Merit Management also held that, when applying the safe harbor, a court must look at the transfer to be avoided rather than the subsidiary components. The Supreme Court, however, did not consider the inverse scenario: can a court consider other, related transactions that may not otherwise qualify for the safe harbor, in evaluating a transaction that is the subject of the avoidance action?

Post-Merit Management, a wave of cases has continued to wrestle with these questions, deepening the divide among lower courts. Three recent cases—Boston Generating, Mallinckrodt and Tops Holding II—highlight this ongoing dispute and illustrate the competing approaches courts have taken.

Section 546(e)’s Safe Harbor Provision

As with any legal issue concerning statutory construction, the starting point is the language of the statute itself. While a trustee or debtor in possession may normally reclaim (or “avoid”) certain prepetition transactions as fraudulent transfers or preferences, see generally 11 U.S.C. §§ 544, 545, 547, 548, section 546(e) exempts certain transactions from being unwound. Specifically, that section safe harbors transactions “made by or to (or for the benefit of) a . . . financial institution [or a] financial participant . . . in connection with a securities contract.”

As the legislative history indicates, the purpose of section 546(e) is to prevent “the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market.” H.R. Rep. No. 97-420, at 1 (1982). Under the plain language of section 546(e), all preference, state law fraudulent transfer, and federal constructive fraudulent transfer claims are immunized from avoidance. Only an actual fraudulent transfer brought under the Bankruptcy Code is exempt from the safe harbor’s reach.

Recent Developments

The recent cases in Boston Generating, Mallinckrodt and Tops Holding II all center around the three current flashpoints in safe harbor litigation:

• What is a “financial institution,” and can a non-financial institution be converted into one by virtue of its relationship with a bona fide financial institution?
• What is a “securities contract”?
• How interconnected must two transactions be—one safe harbored, one not—to qualify as being “in connection with” each other?

In Boston Generating, the debtors executed a tender offer through U.S. Bank National Association (“U.S. Bank”) followed by a dividend payment facilitated by Bank of America (“BoA”) before filing for bankruptcy. In re Bos. Gen. LLC, 617 B.R. 442, 451 (Bankr. S.D.N.Y. 2020). After confirmation of the debtors’ chapter 11 plan, the liquidating trustee sought to recover the dividend payment as a fraudulent conveyance under New York law. Id. at 461. The defendants argued that the transfer was protected under section 546(e) because the debtors qualified as “financial institutions” by being “customers” of U.S. Bank and BoA. Id. The trustee, however, argued that the dividend transfer facilitated by BoA that it seeks to avoid was not protected by the safe harbor because the debtors were not customers of BoA. Id. at 462.

The bankruptcy court ruled in favor of the defendants, holding that the debtors qualified as “financial institutions” under section 546(e) because they were customers of at least one of the banks involved. Id. at 484. The Second Circuit affirmed, interpreting Merit Management as extending the safe harbor’s protection to any transaction where at least one step—regardless of the transfer to be avoided—involved a financial institution or its customer. In re Bos. Gen., LLC, Case No. 21-2543-br, 2024 WL 4234886, at *4 (2d Cir. Sept. 19, 2024). The liquidating trustee then petitioned the Supreme Court for certiorari, arguing that the Second Circuit’s ruling created a circuit split with the Eighth Circuit’s decision in Kelley v. Safe Harbor Managed Account, which held that only the initial transfer should be analyzed when determining whether the safe harbor applies. Pet. for Writ of Certiorari 21, In re Bos. Gen., LLC, 2025 WL 581642 (Feb. 24, 2025) (No. 24-671) (citing Kelley v. Safe Harbor Managed Account, 31 F.4th 1058, 1065 (8th Cir. 2022)). The Supreme Court declined to hear the case, signaling its reluctance to further clarify the safe harbor’s application to customers of financial institutions.

Another key decision is currently unfolding in Mallinckrodt, pending before the Bankruptcy Court for the District of Delaware in the Third Circuit. See In re Mallinckrodt PLC, 2024 WL 206682 (Bankr. D. Del. Jan. 18, 2024). In this case, the debtors, facing mounting opioid-related liabilities, were spun off from their parent company, Covidien, transferring proceeds from certain notes the debtors had issued to Covidien as part of the separation. Id. at *10–*11. After the debtors filed for chapter 11, the opioid trustee sought to avoid the spinoff transaction as a fraudulent transfer, and Covidien moved to dismiss, arguing that the transaction was protected by section 546(e)’s safe harbor because the separation agreement established its status as a qualifying “financial participant.” Id. at *14. The bankruptcy court rejected this argument, holding that financial participant status needed to pre-exist entry into the separation agreement and cannot be established solely through the separation agreement. Id. at *15.

Now at the summary judgment stage, Covidien has shifted its argument, claiming that certain indenture agreements related to the notes qualify it as a financial participant. Covidien’s Mot. Summ. J. Based on the Section 546(e) Safe Harbor, Mallinckrodt, Adv. Pro. No. 22-50433 (Bankr. D. Del. Jul. 15, 2024), ECF No. 103. The opioid trustee has countered that binding precedent establishes that a note indenture does not meet the Bankruptcy Code’s definition of a “securities contract” under section 741(7) and therefore this transaction did not qualify as a transfer “made in connection with a securities contract” under section 546(e). Opp’n Opioid Master Disbursement Trust II to Covidien’s Mot. Summ. J., Mallinckrodt, Adv. Pro. No. 22-50433 (Bankr. D. Del. Dec. 27, 2024), ECF No. 147. These issues on summary judgment are still pending before the bankruptcy court.

The Tops Holding II case similarly focuses on the nexus between a “financial institution” and a “customer” at issue in Boston Generating, but with an additional twist—how interrelated must a transfer subject to avoidance be to qualify as “in connection with” a securities contract? See In re Tops Holding II Corp., 646 B.R. 617, 682 (Bankr. S.D.N.Y. 2022). In this case, a group of private equity investors purchased the debtor, Tops Markets. Between 2009 and 2013, Tops Markets issued four dividends to the investors, three of which were financed by secured notes that Tops Markets issued on the public markets. Id. at 679. These transactions left Tops Markets saddled with additional secured debt, and its pension plan was underfunded too. Id. at 641. After Tops Markets emerged from bankruptcy in late 2018 (four years after the investors sold Tops Markets back to management), the trustee sought to claw back those dividends. Id. at 641–42.

The investors moved to dismiss the complaint, arguing that the dividends were protected by the safe harbor because they were funded from the proceeds of the notes offering issued by the debtor. Id. at 679. That issue was not seriously contested—the offering memoranda for the notes expressly stated that the proceeds would be used, at least in part, to fund a dividend, and the flow of funds memoranda demonstrated that the notes’ proceeds made their way to the company’s shareholders almost instantaneously. The dispute instead centered on whether the dividend payments themselves fell within the safe harbor’s protections.⁶ The trustee argued that under Merit Management, the court is constrained to look solely at the transfer subject to avoidance in isolation (i.e., the dividend payments). Id. at 681–82. The investor-defendants, meanwhile, argued that this was an inversion of Merit Management, which they asserted only precludes parties from artificially breaking up a transaction to shield its components, not from considering the transaction in its entirety. Id. at 683. Nothing in Merit Management, the investor-defendants countered, requires a court to disregard an integrated view of the “in connection with” language in section 546(e). Judge Drain, however, sided with the trustee and denied the investor-defendants’ motion to dismiss, rejecting the “integrated transaction” approach adopted in Boston Generating as irreconcilable with Merit Management. Id. at 685–87.

As summary judgment briefing was underway in Tops Holding II, the Second Circuit issued its opinion affirming the Boston Generating decision, and armed with that appellate guidance and a full discovery record, the investor-defendants renewed their safe harbor arguments in their summary judgment motion. Mot. Summ. J. & Mem. L. in Supp. Morgan Stanley Defs.’ Summ. J. Mot. 30, Tops Holding II, Adv. Pro. No. 20-08950, ECF No. 234. The investor-defendants also argued that the entities on both sides of the transfer qualified as “financial institutions” because they were customers of the banks that facilitated the transfers. Id. The trustee cross-moved for summary judgment, arguing that the dividend transfers neither involved a “financial institution” nor were made “in connection with a securities contract.” Mot. Summ. J. & Mem. L. in Supp. Pl.’ Summ. J. Mot., Tops Holding II, Adv. Pro. No. 20-08950, ECF No. 242. Both motions are currently pending before the court.

Conclusion

Section 546(e)’s safe harbor continues to be a central litigation battleground in fraudulent transfer litigation. The decision in Boston Generating and pending arguments in Mallinckrodt and Tops Holding II represent a new frontier, eachapproaching the interpretation of the safe harbor from different perspectives. This new wave of litigation has revealed significant bases for disagreement, particularly highlighted by the Second Circuit affirming the bankruptcy court’s decision in Boston Generating. And, by denying certiorari in Boston Generating, the Supreme Court has demonstrated no interest in wading into this dispute at this time. As the Mallinckrodt and Tops Holding II cases progress through summary judgment, courts’ interpretation of section 546(e)’s meaning could evolve even further in coming months. What is clear is that stakeholders in chapter 11 cases may find themselves navigating an unpredictable landscape, particularly in jurisdictions where these issues are pending or have not been addressed.

Copyright 2025 Creditor Rights Coalition

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1 Petr Tr. for BWGS, LLC v. BMO Harris Bank N.A., 95 F.4th 1090 (7th Cir. 2024).

2 In re Bernard L. Madoff Inv. Sec. LLC, 773 F.3d 411, 416 (2d Cir. 2014).

3 Contemp. Indus. Corp. v. Frost, 564 F.3d 981, 986 (8th Cir. 2009), abrogated in part by Merit Mgmt. Grp., LP v. FTI Consulting, Inc., 583 U.S. 366, 138 S. Ct. 883, 200 L. Ed. 2d 183 (2018).

4 U.S. Bank Nat’l Ass’n v. Verizon Commc’ns Inc., 892 F. Supp. 2d 805 (N.D. Tex. 2012), aff’d, 761 F.3d 409 (5th Cir. 2014), as revised (Sept. 2, 2014).

5 In re Tribune Co. Fraudulent Conveyance Litig., 818 F.3d 98, 112, 120–22 (2d Cir. 2016), vacated and superseded, 946 F.3d 66 (2d Cir. 2019).

6 The “financial institution” issue litigated in Boston Generating was also in dispute in Tops Holding II. See Tops Holding II, 646 B.R. at 679.