Section 546(e) Safe Harbor Held Inapplicable to Small Private LBOs

By:  Shlomo Lazar

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re MacMenamin’s Grill Ltd.,[1] the Bankruptcy Court for the Southern District of New York held that 11 U.S.C. section 546(e)’s safe harbor for settlement payments does not apply to private leveraged buyouts (LBOs).[2]  MacMenamin’s, a closely-held corporation, funded a stock purchase agreement in the form of a LBO through a $1.15 million loan from Commerce Bank, N.A., secured by a security interest in substantially all of MacMenamin’s assets.[3] The lender transferred the loan proceeds directly to the bank accounts of three former shareholders that controlled 93% of MacMenamin’s stock.[4] The court held that the LBO payouts were not settlement payments under 546(e) and were, therefore, avoidable as constructively fraudulent.[5]

The court noted that the plain meaning of “settlement payment” in section 546(e) appears to exempt private stock transactions or small private LBOs from avoidance as constructively fraudulent transfers.[6]  Although a statute’s plain meaning is normally controlling, courts often refuse to enforce the statute as written where it would lead to an absurd result.[7]  The court determined that Congress’s intent when enacting section 546(e) was clear: to reduce systematic risk in the financial markets that would result by the undoing of settled securities transactions.[8] The court reasoned that the plain meaning of section 546(e), however, prevents trustees from avoiding LBO transactions involving small dollar amounts that pose absolutely no danger to financial markets, even though it lacks any relation to the purpose behind section 546(e) and its 2006 amendment.[9] Concerned that enforcing the plain meaning of section 546(e) would lead to an absurd result, the court looked to the legislative history. The court concluded that because Congress intended to protect the financial markets and small, private LBOs do not pose a systematic risk to the financial markets, they are not protected under section 546(e)’s safe harbor.[10]

This decision is very interesting because it represents a departure from the Third, Sixth, and Eighth Circuits which all held that section 546(e) does apply to private LBOs.[11]  The court noted that this case is hard to distinguish from LBOs like in QSI Holdings, Inc. v. Alford.  However, in dicta the QSI court indicated that a small LBO is not subject to section 546(e)’s safe harbor provision.[12] In reaching its conclusion, the MacMenamin’s court relied on the decisions of other bankruptcy courts and section 546(e)’s legislative history.[13] The court noted that its decision might be limited to its facts, considering the small purchase price paid in connection with the LBO. [14] A resulting issue, however, is left unresolved; namely, whether LBOs with large dollar amounts are protected under the safe harbor.  If large LBOs are protected, courts must decide when private securities transactions pass the tipping point from a small purchase price to a large purchase price.  Furthermore, although LBOs are a very common solution to boosting revenue and making operational improvements, private companies may now be hesitant to arrange LBOs knowing that they are subject to avoidance as constructively fraudulent. Shareholders may also be less likely to enter into LBO transactions knowing that they may have to return the money they received for their shares.  Absent clarification by the United States Supreme Court or by Congress, bankruptcy courts and circuit courts will continue to disagree whether section 546(e) applies to private LBOs.

 

 


[1] In re MacMenamin’s Grill Ltd., 450 B.R. 414 (Bankr. S.D.N.Y. 2011).

[2] Id. at 425. A public LBO is a leveraged buyout of a publicly traded company while a private LBO is a leveraged buyout of a closely-held company. Section 546(e) and its 2006 amendment do not distinguish between private and public LBOs but they indisputably protect agreements to purchase stock of public companies.

[3] Id. at 417. TD Bank, N.A., was Commerce Bank, N.A.’s successor-in-interest.

[4] Id.

[5] Id.

[6] Id. at 418–19.

[7] United States v. Ron Pair Enters., 489 U.S. 235, 242 (1989); see also Lamie v. U.S. Trustee, 540 U.S. 526, 534 (2004) (recognizing the “absurd result” to rule of strict statutory construction).

[8] In re MacMenamin’s Grill Ltd., 450 B.R.at 419–20.

[9] Id. Private LBOs naturally have small dollar amounts because private companies are typically not involved in large dollar amount transactions because of their limited funds.

[10]  Id. at 425.

[11] Brandt v. B.A. Capital Co. LP (In re Plassein), 590 F.3d 252 (3rd Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009); QSI Holdings, Inc. v. Alford (In re QSI Holdings, Inc.), 571 F.3d 545 (6th Cir. 2009).

[12] In re QSI Holdings, Inc., 571 at 550.

[13] In re MacMenamin’s Grill Ltd., 450 B.R. at 423, 425 (citing In re Norstan Apparel Shops, Inc., 367 B.R. 68, 73, 76-77 (Bankr. E.D.N.Y. 2007)).

[14] Id. at 425.