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ABI Exclusive

Seventh Circuit: Transfers of Nonpublic Securities Are Protected by the 546(e) Safe Harbor

The Seventh Circuit adopted a broad reading of the Section 546(e) safe harbor to dismiss a fraudulent transfer suit attacking a sale of nonpublic securities.


Upholding reversal in district court, the Seventh Circuit declined an invitation to adopt a narrow reading of the Section 546(e) safe harbor in a case involving the purchase of nonpublic securities.

In Merit Management Group LP v. FTI Consulting Inc., 583 U.S. 366, 378 (Feb. 27, 2018), the Supreme Court held that the safe harbor only applies to “the overarching transfer that the trustee seeks to avoid.” The March 15 opinion by Seventh Circuit Judge Amy J. St. Eve is in accord with Merit Management because the trustee was attempting to avoid a transfer involving a financial institution. The financial institution was not a “mere conduit.” To read ABI’s report on Merit Management, click here.

The opinion is significant because the Seventh Circuit held that the Section 546(e) safe harbor applies to transactions “in connection with” transfers of privately held securities, not only publicly traded securities.

The Leveraged Buyout

The debtor was a company was owned by an employee stock ownership plan trust. A private equity investor purchased the debtor by acquiring the stock from the ESOP. The stock owned by the ESOP was not traded publicly.

The buyer financed the purchase with a $24.9 million bridge loan from a bank. As the target of the acquisition, the debtor was not obligated to the bank, but the buyer was. One month after closing, the debtor obtained loans from a different bank and paid off the $24.9 million bridge loan for which the buyer had been liable on a guarantee, but the debtor was not.

The debtor had pledged its assets as security for the new loans that paid off the $24.9 million bridge loan.

The debtor’s business failed more than two years after closing. Creditors filed an involuntary petition, leading to an order for relief and appointment of a chapter 7 trustee.

The payoff of the original bridge loan having occurred more than two years before bankruptcy, the chapter 7 trustee invoked Section 544(b) to step into the shoes of an actual creditor and sue the buyer and the bridge lender for a constructive fraudulent transfer under Indiana law. The trustee alleged that the transfer paying off the bridge loan was “to or for the benefit” of the buyer and that the debtor received no consideration for encumbering its property.

Narrowly reading Section 546(e), the bankruptcy court denied a motion to dismiss based on the safe harbor. Petr v. BMO Harris Bank N.A. (In re BWGS LLC), 643 B.R. 576 (Bankr. S.D. Ind. Aug. 18, 2022). To read ABI’s report, click here. The district court authorized an interlocutory appeal. Reading the safe harbor broadly, the district court reversed, ordering dismissal of the suit. Petr v. BMO Harris Bank N.A., 21-50007, 2023 BL 148417, 2023 WL 3203113 (S.D. Ind. May 2, 2023). To read ABI’s report, click here.

The trustee appealed to the circuit, to no avail.

‘In Connection with’ Securities Contracts

The new loan had paid off a financial institution whose loan was used to purchase stock from an ESOP. Applicability of the safe harbor depended on the definition of the term “securities contract” and the interpretation of Section 546(e), which reads:

the trustee may not avoid a transfer . . . made by or to (or for the benefit of) a . . . financial institution . . . or that is a transfer made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract, as defined in section 741(7), . . . except under section 548(a)(1)(A) of this title [for a transfer made with actual intent to hinder, delay or defraud].

Addressing the merits, Judge St. Eve began by saying that the Seventh Circuit had “never come close” to holding that the safe harbor applies only to transactions involving publicly traded securities. She found “nothing in the plain language of § 546(e) [that] excludes private contracts not implicating the national securities clearance system from the definition of ‘securities contract.’”

Looking at the definition of “securities contract” in Section 741(7), Judge St. Eve said that “not one of these eleven sub-definitions contains any indication that it is limited to contracts implicating only publicly held securities.” She pointed to the Third, Fifth and Eighth Circuits for having held that “securities contracts” is not limited to publicly held securities.

Judge St. Eve held “that the term ‘securities contract’ as used in § 546(e) unambiguously includes contracts involving privately held securities.” She then had “little trouble” in finding that the purchase agreement, the bridge loan and the purchaser’s guarantee were “in connection with” “securities contracts,” bringing them all within the ambit of the safe harbor.

To avoid dismissal of the complaint under the safe harbor, the trustee contended under Indiana law that the suit was not aimed at avoiding the transfer but only to recover the value of the transfer. Judge St. Eve responded by saying that the trustee was “attempting to invoke [state fraudulent transfer law] to obtain the same relief that § 546(e) otherwise precludes.”

Federal Preemption

The collision between Section 546(e) and state law raised the question of federal preemption and whether it was “conflict preemption” or “obstacle preemption.” There being no impossibility of enforcing both state and federal law, “conflict preemption” did not apply.

Judge St. Eve noted how the Second and Eighth Circuits “[b]oth held that § 546(e) preempts state law claims seeking to recover the value of transfers that the safe harbor shields.” Persuaded by “our sister circuits,” she said that holding otherwise would make Section 546(e) “meaningless” and would “wholly frustrate” the purpose behind the safe harbor.

Judge St. Eve affirmed the judgment of the district court calling for dismissal of the suit.

Opinion Link

Case Details

Case Citation

Petr v. BMO Harris Bank NA, 23-1931 (7th Cir. March 15, 2024).

Case Name

Petr v. BMO Harris Bank NA

Case Type