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“Safe Harbor” for Transfers to or for Banks May Not Keep Them Safe from Bankruptcy Trustees: Seventh Circuit


Federal bankruptcy law confers on trustees the power, in some circumstances, to “avoid”––that is, claw back––from creditors money transferred to those creditors pre-bankruptcy to pay the debtor’s obligations. However, if such a transfer was “made by or to (or for the benefit of)” a financial institution, it may be protected from avoidance under Bankruptcy Code Section 546(e). The transfers at issue here are not ordinary loan payments to lenders by debtors, but, rather, transfers between third parties that make use of banks or other financial institutions. Many courts extend this safe harbor to protect otherwise avoidable transfers that are merely facilitated by a bank or financial institution, even if the institution has no beneficial interest in the transfer.

The Seventh Circuit, however––whose rulings control bankruptcy courts in Illinois, Indiana, and Wisconsin––recently made the safe harbor a little less safe.  In FTI Consulting, Inc. v. Merit Management Group, LP, No. 15-3388, 2016 WL 4036408 (7th Cir. July 28, 2016), the appellate court held that the safe harbor does not protect a transfer by or to a financial institution, if the institution serves merely as a conduit for funds that moved from the debtor to a third party.

In FTI Consulting, a racetrack owner agreed to buy all the shares of its competitor for $55 million in order to operate a combination horse track and casino. The racetrack owner borrowed money from Credit Suisse to pay for the shares and exchanged the money for the shares through Citizens Bank, as escrow agent. Thirty percent went to a shareholder of the competitor. After the transfer, the racetrack owner failed to obtain a necessary gambling license and filed for bankruptcy relief.

FTI (the trustee of a litigation trust formed to pursue litigation for the benefit of the racetrack owner’s creditors) filed a suit seeking to recover for all creditors equally the shareholder’s share of the $55 million, on the ground, among others, that the shareholder had received a “fraudulent transfer”––that is, one made while the debtor-racetrack owner was insolvent and in which the racetrack owner received property worth far less than the $16.5 million paid to the shareholder.

The shareholder argued that “the transfers were ‘made by or to’ a financial institution because the funds passed through Citizens Bank and Credit Suisse” and that, therefore, the transfer was protected under the safe harbor of Section 546(e). The bankruptcy court agreed and barred the trustee from recovering the $16.5 million.

However, on appeal, the Seventh Circuit reversed, holding that the Section 546(e) safe harbor does not protect transfers that involve financial institutions acting as mere conduits. The court determined that the safe harbor’s purpose and its language in context made clear that it protects transfers to a financial institution only where the recipient financial institution was itself a creditor. Credit Suisse and Citizens Bank were merely intermediaries in the exchange of stock for cash, so Section 546(e) did not provide a safe harbor against avoidance by the trustee.

Five other appellate courts––including the influential Third Circuit, which includes Delaware––have more broadly extended the safe harbor protection to any transfer that is effected through a financial institution, even if the institution is just a conduit between the real parties. This split may ultimately require resolution by the Supreme Court.

Until then, parties to transfers involving a financial institution should be alert to the fact that the mere use of a bank to effectuate a transfer may not insulate that transfer from attack by a bankruptcy trustee.

For questions, please contact Thanhan (An) Nguyen at an.nguyen@quarles.com/(312) 715-5058, Christopher Combest at (312) 715-5091/christopher.combest@quarles.com, or your local Quarles & Brady attorney.

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