Storm Warnings for Safe Harbor of Bankruptcy Code Section 546(e)
By Paul Hastings Professional
Section 546(e) of the Bankruptcy Code limits the ability of a trustee or debtor-in-possession to avoid as a constructive fraudulent transfer or preferential transfer a transaction in which the challenged settlement payment was made through a stockbroker or a financial institution. Because of the broad protection granted by section 546(e) – the so-called “safe harbor” provision – parties structuring a leveraged buyout (“LBO”) or similar transaction have long been advised to ensure that settlement funds flow through one of the listed institutions to inoculate the beneficiaries from a later challenge as a constructive fraudulent transfer or preferential transfer. A series of recent cases, however, has revealed a material weakness in the section 546(e) safe harbor. Most notably, in a decision with both bankruptcy and transactional implications, the United States Bankruptcy Court for the Southern District of New York ruled that section 546(e) does not bar suits brought on behalf of unsecured creditors pursuant to state fraudulent transfer laws. This "Stay Current" will describe what practioners need to know about this potential trend.