When considering defenses to avoidance actions, ordinary course, new value and contemporaneous exchange often come to mind. A less common defense arises under 11 U.S.C. § 546(e), excluding from avoidance actions "settlement payments" as defined under the Bankruptcy Code. A recent decision in the United States Bankruptcy Court for the District of Delaware, Elway Company, LLP v. Miller, et.al (In re Elrod Holdings), highlights the expansive scope courts in Delaware, as well as the Third Circuit, apply when deciding whether payments from a debtor constitute settlement payments and are therefore sheltered from avoidance actions.
Jack K. Elrod Company, Inc. designed, installed and serviced spectator seating. In 2005, the Elrod family sold the business to Champlain Capital Partners, L.P.. As part of the transaction, the parties executed a stock purchase agreement whereby the family sold all of its interest in the company in exchange for cash and secured notes. The holding company Champlain created after it purchased Elrod filed for Chapter 7 liquidation in October of 2006. Approximately eleven months after filing for bankruptcy, the former owners of the debtor (the "Elrods") filed an adversary action in the debtor’s bankruptcy seeking a determination of the validity of their liens and an allowance of their claims.
In responding to the Elrods’ adversary action, the bankruptcy trustee claimed that $21 million in wire transfers to the Elrods in 2005 and 2006 were fraudulent conveyances and therefore subject to avoidance under the Bankruptcy Code. In response, the Elrods filed a motion for summary judgment seeking a finding that the wire transfers were "settlement payments" to "financial institutions" as defined under the Code. Disagreeing with the Elrods, the bankruptcy trustee argued that the term "settlement payments" applies only to publicly-traded securities, not the privately held securities involved in the Elrod bankruptcy. Whether the transfers were settlement payments under the Code was significant to both parties, as section 546(e) excepts settlement payments from avoidance actions.
Judge Brendan L. Shannon, the bankruptcy judge assigned to the case, agreed with the Elrods and rejected the bankruptcy trustee’s narrow definition of settlement payment. The court began its analysis looking at the Bankruptcy Code’s definition of a "settlement payment" under § 741(8). Pursuant to the Code, settlement payments include "a preliminary settlement payment … a final settlement payment, or any other similar payment used in the securities trade." The court found the trustee’s argument limiting settlement payments to public securities "unconvincing" especially given that the securities trade includes a "robust trade or market for non-publicly traded securities."
In ruling against the chapter 7 trustee, the Bankruptcy Court also relied on the Third Circuit’s decision in Lowenschuss v. Resorts Int’l, Inc. (In re Resorts Int’l Inc.), 181 F.3d 505, 515 (3rd Cir. 1999). In Lowenschuss, the appellate court found that a settlement payment "is generally the transfer of cash or securities made to complete a securities transaction." Judge Shannon noted that the Lowenschuss definition of settlement payment was an "expansive one" citing the appellate court’s finding that "settlement payments" under the Bankruptcy Code "includes almost all securities transactions."
Elrod is helpful as it reaffirms the wide brush court’s use when applying the Bankruptcy Code’s definition of a settlement payment. Where appropriate, creditors should consider the settlement payment defense when faced with an avoidance action. Creditors who were a party to security transactions will therefore appreciate Elrod’s finding that the settlement payment safe harbor applies to both public and privately held securities.