Bankruptcy ‘Safe Harbor’ Protection to Get Supreme Court Review

(Bloomberg) -- The U.S. Supreme Court agreed to hear a case that could make it easier for creditors to claw back cash that was paid out by a company before it went bankrupt.

Bankruptcy law offers a “safe harbor” to financial institutions that perform securities transactions. The provision was intended to protect trades from creditor claims, to promote stability in financial markets in the face of complicated corporate reorganizations. The justices are being asked to consider whether the shield should apply when a financial institution merely acted as a conduit for a transaction. 

FTI Consulting Inc., the trustee of Valley View Downs LP, a casino and racetrack company that went bankrupt in 2009, contends that creditors are entitled to recover money paid for shares in rival Bedford Downs in 2007. Merit Management Group received $16.5 million in the transaction, which was carried out through Citizens Bank of Pennsylvania and Credit Suisse, according to court papers. 

The trustee sued Merit, saying Valley View should get the money back because the company didn’t get equivalent value in exchange and was insolvent at the time of the deal. A district judge, invoking safe harbor, ruled that Merit could keep the money, but an appeals court reversed, saying the financial institutions involved in the trade were just conduits for the deal. Two federal appeals courts have reached the same conclusion, while five have gone the other way.

“This could be a another case where the outcome depends on whether a majority of the court is swayed by the plain language of the exception, regardless of the result, or whether the justices conclude that these types of privately-held stock sales, which use banks as payment conduits, do not fall within the ambit of the transactions Congress sought to protect,’’ Andrew Muller, a bankruptcy partner at law firm Stinson Leonard Street LLP, said in an interview Monday.

Tribune Dispute

A similar dispute involves noteholders in Tribune Co., the media company taken over in a $8.3 billion leveraged buyout in 2007. When it filed for bankruptcy the following year, the noteholders sued, saying the buyout was so ill-conceived as to leave Tribune unable to pay its debts and amounted to an intentional “fraudulent transfer” of assets.

Last year, a federal appeals court in New York threw out the case, citing the safe harbor provision. The Tribune creditors say safe harbor doesn’t apply, in part because they are trying to get money back from shareholders, not the banks that the shield was designed to protect and that merely delivered the cash brought in by the stock sale.

The Supreme Court Monday took no action on a pending appeal in the Tribune case. The court probably will hold that appeal until the justices resolve the FTI-Merit case.

The case is Merit Management Group v. FTI Consulting Inc., 16-784.