The Supreme Court’s recent decision in Merit Management Group, LP v. FTI Consulting, Inc. has appropriately drawn significant attention.  The Court, by narrowing the “safe harbor” provision of Section 546(e) of the Bankruptcy Code, has opened the door for representatives of bankruptcy estates to use the avoidance powers of the Bankruptcy Code to seek to unwind a wider range of pre-bankruptcy transactions and recover value for the benefit of creditors.  Most of the focus on the ruling has been on its anticipated impact on the administration of business bankruptcy cases.  However, it is worth noting that the Court in Merit Management has taken a more pragmatic approach to statutory interpretation in its reading of the Bankruptcy Code than in two of its other recent business bankruptcy decisions, Baker Botts v. Asarco and Czyzewski v. Jevic Holding Corp., and the result in Merit Management appears to be more consistent with the intent of Congress than in those earlier cases

The issue in Merit Management was straight forward.  Trustees in bankruptcy are authorized to set aside certain transfers made by a debtor prior to bankruptcy.  Among these, under Section 548 of the Bankruptcy Code, are so-called “constructive” fraudulent transfers, which (regardless of intent) are transfers of property made by a debtor at a time when it was insolvent and for which it received less than reasonably equivalent value.  Section 550 of the Bankruptcy Code provides that the recovery can be obtained either from the initial transferee of such property or “any immediate or mediate transferee of such initial transferee.”  A trustee’s avoidance powers are limited, however, by other sections of the Bankruptcy Code.  One of these is Section 546(e), which exempts from avoidance certain securities transactions “made by or to (or for the benefit of)” qualifying “financial institutions” or others securities entities.

Merit Management Group was a large shareholder of Bedford Downs Management Corp.. Bedford Downs’ stock was acquired by Valley View Downs LP, which borrowed $55 million to fund the transaction.  The $55 million was not paid by Valley View directly to the Bedford Downs shareholders; there were intermediate transfers.  Specifically, Valley View borrowed funds from its lender, Credit Suisse, which transferred the money to another financial institution, Citizens Bank of Pennsylvania, as escrow agent, which in turn paid the purchase price to the shareholders of Bedford Downs, including Merit Management, in exchange for the surrender of their stock certificates.

Valley View intended to develop a race track and casino in Pennsylvania, but the project never came to fruition and it eventually filed for relief under chapter 11 of the Bankruptcy Code. FTI Consulting was appointed as trustee to pursue certain causes of action on behalf of Valley View’s bankruptcy estate, and it sought to avoid the $16.5 million portion of the Bedford Downs purchase price that had been received by Merit Management.  FTI contended that Valley View was insolvent at the time it bought the Bedford Downs stock and that it did not receive reasonably equivalent value in exchange for the payment.  Among the defenses raised by Merit Management was that the transaction fell within the Section 546(e) “safe harbor” because it included transfers “to (or for the benefit of)” two “financial institutions.”   The lower court granted Merit Management’s motion to dismiss.  The Seventh Circuit Court of Appeals reversed, however, reasoning that Section 546(e) did not apply to transactions where the financial institutions involved serve as “mere conduits.”  The Supreme Court granted certiorari to resolve a split between circuits on this issue, and unanimously affirmed.

The question before the Court was whether, for purposes of applying Section 546(e), a court should consider only the challenged transaction itself (in this case, the payment from Valley View ultimately received by Merit Management), or all of the component transfers within such challenged transaction (in this case, the transfers involving two financial institutions). The Court, noting the “specific context” of the language of Section 546(e), rejected Merit Management’s argument that the statutory language “to (or for the benefit of) a . . . financial institution” required reversal, and held instead that “the [Section 546(e)] exception applies to the overarching transfer that the trustee seeks to avoid, not any component part of that transfer.”

The result in Merit Management reflects a common sense reading of the Bankruptcy Code.  The clear intent of Section 546(e) is to safeguard various types of securities transactions from being unwound in order to prevent market disruption.  Allowing an ultimate transferee such as Merit Management to benefit simply because the transferred funds passed through one or more financial institutions would not further the purpose of the safe harbor.

Unfortunately, the Court does not always temper its reading of the statutory language of the Bankruptcy Code with the “specific context” in which such language is used. Other recent Supreme Court business bankruptcy decisions have not been as pragmatic as Merit Management.

In Baker Botts v. Asarco a few years ago, the Court majority applied a narrow and literal reading to the language of Section 330(a) of the Bankruptcy Code.  The result was to deny a law firm the ability to recover the costs that it incurred in defending its application for fees in representing a debtor, even though the Bankruptcy Code requires that all such fees be approved by the bankruptcy court and that other parties receive specific notice and be given an opportunity to object.

Last year, in Czyzewski v. Jevic Holding Corp., the Court also took a narrow approach in its reading of the Bankruptcy Code.  It refused to permit an order of dismissal in a chapter 11 case to contain substantive provisions regarding the distribution of assets of a debtor’s bankruptcy estate that would contravene the Bankruptcy Code’s priority scheme.  The Court declined to allow for any flexibility on this issue, even though such “structured dismissals” had become relatively common, and the bankruptcy court in Czyzewski had expressly found that without such provisions there would have been no recovery to any parties other than the senior lenders.

A similar approach in Merit Management would likely have led to a reversal of the Seventh Circuit.  The plain language of Section 546(e) makes no distinction between transfers where a financial institutions is the actual party to a transaction and those where it simply acts as a conduit.

The Bankruptcy Code was intentionally drafted to be flexible. Jurists and practitioners must contend all the time with difficult issues which do not fit within its strict parameters.  Adherence to the plain meaning of the Bankruptcy Code’s language is important, but the language usually is not unambiguous, and the intent of Congress cannot be properly understood without reference to “specific context.” Baker Botts and Czyzewski both ignored the realities of large corporate bankruptcy cases and long-standing commercial practice. Merit Management may signal a different direction by the Court in its approach to business bankruptcy cases.