The Bankruptcy Code gives a trustee and a debtor-in-possession the authority to avoid fraudulent transactions. However, 11 U.S.C. § 546(e) limits the trustee’s avoiding powers by providing a safe harbor for “settlement payments.” Generally, a “settlement payment” is a payment of cash or securities made to complete a securities transaction. For example, money that an individual pays to a stockbroker to buy publicly traded shares is a settlement payment. A recent issue that has arisen is whether payments made to former shareholders in connection with a private leveraged buyout (LBO) constitute a “settlement payment.”
Depending on which jurisdiction a bankrupt corporation finds itself, a trustee may be able to avoid LBO payments. Courts are sharply divided on whether § 546(e) applies to private LBOs. There are three approaches to the issue, although courts have only adopted two of them. The first approach focuses on the legislative history of § 546(e). In contrast, the second approach strictly focuses on the plain meaning of § 546(e). Lastly, the third approach takes a middle-ground approach and harmonizes the plain meaning of § 546(e) with its legislative history. The legislative history approach creates a bright-line rule that § 546(e)’s safe harbor does not apply to private LBO payouts. The plain meaning approach, however, holds that § 546(e)’s the safe harbor provision applies to a private LBO just as it would to a public LBO. Harmonizing these two approaches, the middle-ground approach holds that § 546(e) only protects large private LBOs but not small private LBOs. Many bankruptcy courts follow the first approach, while three circuit courts follow the second approach. Although the third approach has not yet been adopted by any court, some courts have intimated that it is a sound approach.
Part I of this memorandum explains the safe harbor provision of § 546(e). Part II discusses the legislative history approach. Part III discusses the plain meaning approach. Part IV discusses the middle-ground approach. Finally, this article concludes by discussing the implications that these three approaches might have on future LBO transactions.