Perhaps the most potent power vested in a bankruptcy trustee is the authority to bring “avoidance” or “clawback” litigation, most commonly actions to recover “preferences” and “fraudulent conveyances” under Sections 544, 547 and 548 of the Bankruptcy Code.

Section 544 authorizes the trustee to avoid transfers that would have been avoidable by a creditor under applicable state fraudulent conveyance law, which typically will permit the trustee to pursue actual and constructive fraudulent transfers made four years or more prior to bankruptcy.

Section 547 permits the trustee to recover a transfer made within 90 days prior to bankruptcy on account of an existing debt on the basis that the creditor has been “preferred” over other creditors, permitting the creditor to obtain more on its claim.

Section 548 authorizes the trustee to avoid two types of fraudulent conveyances made by the debtor within two years prior to bankruptcy: 1) transfers made by the debtor with actual intent to hinder, delay or defraud creditors (“actual” fraudulent conveyances); and 2) transfers made for less than reasonably equivalent value while the debtor was insolvent on a balance sheet basis, unable to pay its debts as they came due, or undercapitalized for its intended business (a “constructive” fraudulent conveyance).

Of course, these formidable powers are subject to important limitations.

An increasingly significant defense to avoidance actions is found in Bankruptcy Code Section 546(e), which insulates from recovery any transfer “that is a margin payment… or settlement payment… made by or to (or for the benefit of) a…financial institution, financial participant, or securities clearing agency, or that is a transfer to [such an entity] in connection with securities contract,” unless such transfer constitutes an “actual” fraudulent conveyance under Section 548(a)(1)(A).

The Bankruptcy Code’s definition of “financial institution” includes all commercial and savings banks, savings and loans associations and federally insured credit unions. A “security contract” is defined as “a contract for the purchase, sale or loan or a security.” The term “security” is defined to include any stock, treasury stock, note, bond, debenture, certificate or deposit and other similar financial assets. The Bankruptcy Code’s definition of “settlement payment” is almost tautologically circular but has been judicially construed to encompass most transfers of money or securities made to complete a securities transaction.

Read literally, these provisions suggest that Section 546(e) insulates from recovery an enormous range of payments that would otherwise qualify as preferences or constructive fraudulent conveyances under federal law, or as actual fraudulent conveyances under state law, if such payments were made to complete a securities transaction or in connection with a securities contract.

Legislative history behind 546(e)

Courts uniformly acknowledge that the legislative intent behind Section 546(e) was to protect the nation’s financial markets from the “instability caused by the reversal of settled securities transactions.” As originally enacted in 1978 in Section 764(c), the 546(e) safe harbor applied exclusively to commodities markets.

Recognizing the complex relationships between — and the often volatile nature of — the commodities and securities markets, in 1982 Congress expanded Section 546(e)’s protection to include margin and settlement payments to and from brokers, clearing organizations and financial institutions in both markets.

Over the last 31 years, Congress has amended Section 546(e) four times, consistently adding new types of contracts and market participants within the scope of transactions and parties protected. Often these amendments have been accompanied by statements of legislative intent reflective of the same concerns that led to the original passage of the safe harbor in 1978. For example, in 1982 Congress stated its purpose was to “minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.”

In 2006, when Congress extended the safe harbor to, among others, transactions involving “financial participants” and “securities contracts,” the legislative history indicates that Congress acted as a result of the “systemic risk concerns” in those markets.

But while Congress’ stated intent has invariably been to minimize displacement and systemic risk in the commodities and securities markets caused by a major bankruptcy, the statute itself has never contained any such limitation.

Case law under 546(e)

Mindful of the legislative history, numerous lower courts have declined to extend 546(e) protection to transactions and recipients where avoidance would not lead to systemic disorder and/or ripple effects in the financial markets. With but one exception, however: in recent years, at least six federal courts of appeal have shielded transfers from recovery without requiring any evidence that such transfers would implicate the risks identified in the legislative history.

Beginning with the 10th Circuit’s decision in Kaiser Steel Corp., these courts have defined settlement payment “extremely broadly” and include parties afforded 546(e) protection well beyond the actual participants in the securities clearance and settlement system, including: 1) selling shareholders in a public leverage buyout (Resorts International and Kaiser); 2) selling shareholders in a private LBO (Contemporary Industries and QST); 3) holders of redeemed commercial paper (Enron); 4) holders of “private placement notes that had been issued by one of the debtor’s affiliates” (Quebecor); and 5) holders of redeemed equity interests in an investment firm that had become a Ponzi scheme (Peterson v. Somers Dublin).

Applying the “plain meaning” of the statutory text, these courts have relied heavily upon the fact that nothing in that language: 1) limits the application of Section 546(e) to transfers made through the normal settlement system for publicly traded securities; 2) requires that there have actually been a purchase or sale of the securities that are the subject of the transaction in order to have a protected “settlement payment”; or 3) requires that the relevant financial institution or intermediary — which often plays a role no more significant than as depository bank for the recipient defendant — actually hold a beneficial interest in the transferred securities at some point during the course of the transaction.

Responses to case law

Predictably, the breadth of these rulings has prompted countermeasures by both creditors, whose bankruptcy recoveries have been diminished as a result, and legislators, who view these rulings as expanding 546(e)’s protection far beyond that envisioned by the statute’s drafters.

For example, recognizing that Section 546(e) applies only to bankruptcy trustees, creditors in the Tribune Co. case sought leave to bring constructive fraudulent conveyance actions directly in courts other than the Bankruptcy Court.

On Sept. 23, 2013, the U.S. District Court for the Southern District of New York ruled that Section 546(e) did not bar such actions, but that the actions were subject to the automatic stay for so long as the Creditors Committee in the Tribune Co. case was seeking to avoid the same transfers as actual fraudulent conveyances.

Legislatively, the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 reportedly has been considering narrowing the exception from avoidance action recovery.

While any congressional action may still be a year or more away, and any American Bankruptcy Institute proposal may be tempered after further debate, market participants would be wise to check regularly for legislative developments in this regard.


Section 546(e) has evolved into an extraordinarily effective defense in avoidance action litigation, arguably well beyond the scope that Congress originally intended. Section 546(e) therefore needs to be considered carefully by avoidance action defendants as it is been construed to apply to situations well beyond the normal securities clearing system, including cases involving fraudulent enterprises.