In Kelley v. Safe Harbor Managed Account 101, Ltd., No. 20-3330, 2022 WL 1177748 (8th Cir. Apr. 21, 2022), the Eighth Circuit reversed the district court and remanded to consider whether certain transfers to a financial institution where made in connection with a securities contract for the safe harbor exception to avoidance pursuant to 11 U.S.C. § 546(e).
This case is one of many arising from the multi-billion-dollar fraud perpetuated by former Minnesota businessman, Thomas Petters, through his company, Petters Company, Inc. (“PCI”). Appellee Safe Harbor Managed Account 101, Ltd. (“Safe Harbor”) purchased equity in a PCI feeder fund named Arrowhead Capital Partners II, L.P. (“Arrowhead”). For the equity purchase, Safe Harbor transferred $6 million into Arrowhead’s cash account at Wells Fargo Bank (“Wells Fargo”). Pursuant to a note purchase agreement, Arrowhead bought secured notes from Metro I, LLC (“Metro”). For the secured notes, MGC Finance, Inc. (“MGC Finance”) agreed to pay amounts due and owing to Metro or its assignee. In satisfaction of the secured notes, MGC Finance transferred $6.9 million to Arrowhead’s cash account at Wells Fargo. Safe Harbor redeemed its investment in Arrowhead and received wire transfers for the $6.9 million.
Appellant, in his capacity as court-appointed trustee, previously received a default judgment for fraudulent transfers under 11 U.S.C. § 548 against Arrowhead for the pre-bankruptcy transfers from MGC Finance. In the present case, the trustee alleged that the transfers were recoverable from Safe Harbor under 11 U.S.C. §§ 550(a) and 551. Safe Harbor filed a motion to dismiss pursuant to 11 U.S.C. § 546(e), which, in relevant parts, precludes the avoidance of “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) . . . .”
The bankruptcy court denied the motion to dismiss. After discovery, the case was transferred to the district court for trial. Safe Harbor filed a motion for summary judgment and argued that the $6.9 million it received from Arrowhead cannot be avoided. The district court agreed that § 546(e) protects the transfers given Arrowhead is a “financial institution,” the note purchase agreement was a “securities contract,” and the relevant transfers were “in connection with a securities contract.” The trustee appealed.
On appeal, the trustee argued the district court erred in finding no genuine dispute of material fact as to whether (1) Arrowhead was a “financial institution,” and (2) the relevant transfers were made “in connection with a securities contract.”
The Eighth Circuit noted “financial institution” for § 546(e) includes the customer of “an entity that is a commercial or savings bank” when that “entity is acting as agent or custodian for [the] customer . . . in connection with a securities contract . . . .” 11 U.S.C. § 101(22)(A). The trustee argued Wells Fargo was not acting as Arrowhead’s custodian. In response, the Eighth Circuit indicated the transfers from MGC Finance to Arrowhead were the overarching, relevant transfers for § 546(e), and the district court properly relied on the basic assumption that the customer of a financial institution may itself qualify as a financial institution for purposes of § 546(e). The Eighth Circuit affirmed that Arrowhead was a “financial institution” for § 546(e).
The trustee argued the note purchase agreement was not a “securities contract” for § 546(e). In its statutory interpretation, the Eighth Circuit recognized a security included the senior notes as promises to pay at specified times, and a securities contract included the note purchase agreement.
Notably, the Eighth Circuit determined that the district court erroneously confused Metro as making the $6.9 million transfer to Arrowhead in the analysis of whether the transfers were “in connection with a securities contract” for § 546(e). In response, Safe Harbor asked the Eighth Circuit to view the $6.9 million transfer from MGC Finance to Arrowhead as made “in connection with” the note purchase agreement because the transactions between MGC Finance and Metro and Metro and Arrowhead were part of an “integrated transaction.” In rejecting the request, the Eighth Circuit remanded the matter so the district court can examine the facts and decide whether the transfers from MGC Finance to Arrowhead were made “in connection with” the note purchase agreement.
In summary, the Eighth Circuit affirmed that for § 546(e) Arrowhead was a financial institution, and the note purchase agreement was a securities contract. However, the Eighth Circuit reversed and remanded the matter of whether the transfers from MGC Finance to Arrowhead were made in “connection with” the note purchase agreement.
Co-Editors in Chief
Karl J. Johnson, Taft Stettinius & Hollister LLP
David M. Tanabe, Winthrop & Weinstine, P.A.