may 13, 2009

In an important decision published two weeks ago, the Eighth Circuit unanimously affirmed a decision by the United States District Court for the District of Nebraska affirming a Bankruptcy Court’s grant of summary judgment in favor of the former shareholders of Contemporary Industries, a privately held corporation.  Following the holdings of the Third and Tenth Circuits, and rejecting decisions from the Ninth Circuit and other jurisdictions, the Eighth Circuit held that payments made to selling shareholders in the course of a leveraged buyout qualify as “settlement payments” within the plain meaning of 11 U.S.C. § 546(e) and were thus exempt from attempts by unsecured creditors to avoid the payments as fraudulent transfers.  In so doing, the Court rejected the argument that the definition of “settlement payment” does not encompass payments for privately held securities, holding that the text of section 546(e) “plainly and unambiguously encompasses these payments.”  The decision evidences a trend by courts to broadly apply the section 546(e) exemption. 

Contemporary Indus. Corp. v. Frost, No. 08-1325, 2009 WL 1159174 (8th Cir. Apr. 29, 2009)


Contemporary Industries Corporation (the “Company”) is a privately held convenience store operator headquartered in Omaha, Nebraska.1  In 1995, the shareholders of the Company sold their shares to an outside investment group.  The transaction took the form of a leveraged buyout, in which the outside investors obtained significant loans to cover the purchase price and pledged the assets of the Company as collateral.  In the course of the transaction, the $26.5 million purchase price as well as the shares were held in escrow at a financial institution, First National Bank of Omaha (“First National”).  In February 1998, the Company filed for chapter 11 bankruptcy protection.

The Proceedings Below

In late 1999, the Company and the Official Committee of Unsecured Creditors (the “Committee”) instituted an adversary proceeding seeking to recover the payments the former shareholders received in exchange for their stock during the leveraged buyout.  The complaint alleged, inter alia, that the payments were fraudulent transfers under 11 U.S.C. § 544 and Nevada state law.

The former shareholders moved for summary judgment, arguing that the LBO payments were exempt from avoidance under section 546(e), which provides:

Notwithstanding section []544 . . . of this title, the trustee may not avoid a transfer that is a . . . settlement payment, as defined in section . . . 741 of this title, made by or to (or for the benefit of) a . . . financial institution, . .   . that is made before the commencement of the case . . . .   11 U.S.C. § 546 (e).

Section 741 defines “settlement payment” as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other payment commonly used in the securities trade.”  11 U.S.C. § 741(8).

The bankruptcy court held that the payments at issue were “settlement payments” under section 546(e) and dismissed the complaint.  The district court affirmed. 

Eighth Circuit Decision

Plaintiffs appealed to the Eighth Circuit, urging that section 546(e) was never intended to cover payments to settle transactions for privately held securities.  Relying in part on legislative history, plaintiffs argued that section 546(e) was enacted to protect the nation’s financial markets against instability caused by the reversal of settled securities transactions, that undoing private transactions does not implicate those concerns and that the payments at issue were not intended by Congress to fall within the exemption.

In a unanimous opinion, the Eighth Circuit affirmed the dismissal of the complaint.  The Court rejected the argument that the statutory definition of “settlement payment” does not encompass payments for privately held securities, holding that the plain meaning of section 546(e) was “sufficiently plain and unambiguous.”  Contemporary Indus. Corp., 2009 WL 1159174, at *3.  Citing decisions from the Third and Tenth Circuits,2 the Court held:

[W]e conclude the term “settlement payment” . . . encompasses most transfers of money or securities made to complete a securities transaction.  That is exactly what we have before us:  the payments at issue were transfers of money made to complete a securities transaction . . . . Nothing in the relevant statutory language suggests Congress intended to exclude these payments from the statutory definition of “settlement payment” simply because the stock at issue was privately held. Id.

The Court also concluded that the payments to the former shareholders were made “by or to a . . . financial institution” even though First Financial never obtained a beneficial interest in the payments.  The Court held that the plain meaning of section 546(e) “does not expressly require that the financial institution obtain a beneficial interest in the funds.”  Id. at *4. 

Finally, the Court observed that enforcing the plain meaning of the statute would not lead to an absurd result, reasoning that allowing significant private transactions to be undone could well “impact the nation’s financial markets,” and that “Congress might have thought it prudent to extend protection to payments such as these.”  Id.

Future Implications

The Eighth Circuit’s opinion lends further support to recent decisions interpreting section 546(e) broadly, consistent with the plain meaning of the statute.  As a result, the 546(e) defense to a fraudulent transfer action may be available in a wide number of circumstances, including purely private transactions in which a financial institution merely serves as an intermediary for the transfer. 

If you have any questions, please contact either of the lawyers listed below or your regular Davis Polk contact.

Karen E. Wagner, Partner
212-450-4404 |

Elliot Moskowitz, Associate
212-450-4241 |

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1. Background details are taken from the summary at the outset of the decision.

2. See In re Resorts Int’l, Inc., 181 F.3d 505, 515-16 (3d Cir. 1999); In re Kaiser Steel Corp., 952 F.2d 1230, 1238-40 (10th Cir. 1991).