Repayment of Loans that are Separate from Securities Contracts are not Protected by Section 546(e) Safe Harbor

Dennis Mossberg

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

            Under title 11 of the United States Code (the “Bankruptcy Code”), certain transfers made before a bankruptcy filing may be avoided.[1] Section 546(e) provides a “safe harbor” and prevents trustees from avoiding transfers made to a financial institution in connection with a securities contract made prior to the commencement of the case.[2] In In re BWGS, a bankruptcy court in Indiana held that repaying a bridge loan used to acquire the stock in a debtor’s company with a subsequent loan is not a transfer “in connection with” a securities contract, and thus is not protected under section 546(e).[3] As of 2016, the stock of Worm’s Way Inc. (the “Debtor”), was held in a Trust.[4] In 2016, Sun Capital Partners VI, L.P (“Sun Capital”) agreed to buy all of the stock in the Debtor from the Trust.[5] Sun Capital’s affiliate (“Holding”), borrowed money from BMO Harris Bank N.A. (“BMO”) to fund the cash due for the acquisition.[6] Following the closing, the Debtor and Holding entered into a Term Loan as co-borrowers, the proceeds of which were used to repay the BMO loan .[7] Shortly after the payment of the BMO Bridge Loan, an involuntary petition for relief was filed against the Debtor with the Southern District of Indiana.[8] The court entered an order for relief under Chapter 7 of the Bankruptcy Code and appointed a trustee to administer the liquidation of the Debtor.[9] Thereafter, the trustee filed a complaint against BMO seeking to recover the Bridge Loan repayment as a fraudulent transfer.[10] In response, BMO filed a motion to dismiss, arguing there was a failure to state claim and that trustee did not state plausible claim upon which relief can be granted since the transfer was protected by section 546(e).[11]

            According to the Indiana bankruptcy court, financially challenged participants are often required to make additional deposits of capital as collateral to clearing agencies during the slide into bankruptcy.[12] Further, the court explained Congress addressed the concern that the transfers might be exposed to avoidance in bankruptcy which could ripple throughout and destabilize the economy.[13] Thus, the court asserted that Congress amended the safe harbor provision to include all transfers made to intermediaries “in connection” with their facilitation of trades.[14]   

            The bankruptcy court found that there were two wholly separate transactions that were closed approximately one month apart.[15] According to the court, the first transaction (i.e., the purchase agreement for the outstanding stock of the debtor from the Trust) was a securities contract because it involved the purchase and sale of stocks.[16] However, the trustee did not seek to avoid that transaction.[17] The second transaction, which the trustee was seeking to avoid, was not a securities contract.[18] Instead, the court found it was a separate loan that was used to pay off a debt owed to BMO.[19]According to the court, that transaction had no direct connection to the purchase or sale of securities or any “securities contract.”[20] Thus, the court held that there was not a sufficient nexus between the purchase agreement and the loan repayment and thus the transfer was not a transaction intended by Congress to be protected by the safe harbor.[21]Therefore, the court denied BMO’s motion to dismiss.[22] Following the order, BMO filed a notice of appeal which is currently pending.

           Section 546(e) provides a safe harbor to protect certain transfers related to a securities contract from being avoided.  A court will identify the transaction to be avoided when considering whether to apply the safe harbor.  A court may refuse to apply the safe harbor if the transfer to be avoided has no direct connection to or have a sufficient nexus to the securities contract.