July 20, 2009

Sixth Circuit Joins Other Circuits in Holding that Payments Made to Selling Shareholders in the Course of a Leveraged Buyout Qualify as “Settlement Payments” and Are Thus Exempt from Avoidance Pursuant to Section 546(e) of the Bankruptcy Code; Court Embraces Broad Application of Section 546(e)

In an important decision published two weeks ago, the Sixth Circuit unanimously affirmed a decision by the United States District Court for the Western District of Michigan affirming a Bankruptcy Court’s grant of summary judgment in favor of the former shareholders of QSI Holdings, Inc., a privately held corporation. In so doing, the Sixth Circuit became the latest circuit court to hold 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 are thus exempt from attempts by unsecured creditors to avoid the payments as fraudulent transfers. Following the holdings of the Third, Eighth and Tenth Circuits, the Court rejected the argument that the definition of “settlement payment” does not encompass payments for privately held securities, concluding that “nothing in the statutory language indicates that Congress sought to limit that protection to publicly traded securities.” The decision is further evidence of a trend by courts to broadly apply the section 546(e) exemption.

In re QSI Holdings, Inc., No. 08-1176, 2009 WL 1905237 (6th Cir. July 6, 2009)


Quality Stores, Inc. (“Quality” or the “Company”) was a privately held corporation that operated a chain of retail stores specializing in agricultural and related products.[1]  In 1999, the shareholders of Quality sold their shares to Central Tractor Farm and Country, Inc. (“Central Tractor”) and its parent company.  The transaction took the form of a leveraged buyout, in which Quality would be merged into Central Tractor, and the assets of Quality and Central Tractor were pledged to obtain significant loans to cover the purchase price of $208 million, of which $111.5 million in cash was paid to shareholders.  In the course of the transaction, the $111.5 million cash payment and the shares were held in escrow at a financial institution, HSBC Bank USA (“HSBC”).  In November 2001, the Company filed for chapter 11 bankruptcy protection.

The Proceedings Below

In October 2003, the Company 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 Michigan 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.

Sixth Circuit Decision

Plaintiffs appealed to the Sixth 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 Sixth Circuit affirmed the dismissal of the complaint.  Noting that the matter presented “an issue of first impression in this circuit,” the Court rejected the argument that the statutory definition of “settlement payment” does not encompass payments for privately held securities, holding that section “546(e) is not limited to publicly traded securities but also extends to transactions, such as the leveraged buyout at issue here, involving privately held securities.”  In re QSI Holdings, Inc., 2009 WL 1905237 at *1.  Citing the recent opinion of the Eighth Circuit in Contemporary Industries, the Court held:

This case... considers a transaction with the characteristics of a common leveraged buyout involving the merger of nearly equal companies, and nothing in the statutory language indicates that Congress sought to limit that protection to publicly traded securities.  The value of the privately held securities at issue is substantial and there is no reason to think that unwinding that settlement would have any less of an impact on financial markets than publicly traded securities.  Id. at *4 (citing Contemporary Indus. Corp. v. Frost, 564 F.3d 981, 987 (8th Cir. 2009)).

The Court also concluded that the payments to the former shareholders were made “by or to a... financial institution” even though HSBC never obtained a beneficial interest in the payments.  The Court adopted the holding of the Third Circuit that the plain meaning of section 546(e) “simply does not require a ‘financial institution’ to have a ‘beneficial interest’ in the transferred funds.”  In re QSI Holdings, 2009 WL 1905237 at *5 (citing In re Resorts Int’l, Inc., 181 F.3d 505, 516 (3d Cir. 1999)). 


In re QSI Holdings, Inc., No. 08-1176, 2009 WL 1905237 (6th Cir. July 6, 2009)

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

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Karen E. Wagner, Partner
212 450 4404 | karen.wagner@davispolk.com

Elliot Moskowitz, Associate
212 450 4241 | elliot.moskowitz@davispolk.com