Please join us on May 22 at Cooley’s offices to hear experts weigh in on the safe harbor playbook after Boston Generating and Nine West (see above for details).   To help get the juices going, our friends at Cooley have provided a snapshot of where we stand today. The full feature can be found here. 

Scanning the Horizon: Taking Stock of Current Safe Harbor Jurisprudence

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.  

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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.  

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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.”  

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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).  ….. 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 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, distributing proceeds from certain notes the debtors had issued to Covidien as part of the separation.  Id. at *10–*11.  

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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, the investors caused Tops Markets to issue four dividend payments, 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 an underfunded pension plan.  Id. at 641.  After Tops Markets emerged from bankruptcy in late 2018, 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.  …. 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 for the first time 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, each approaching 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.

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