The US Supreme Court on Monday heard oral arguments [transcript, PDF] in Merit Management Group, LP, v. FTI Consulting, Inc. [docket], a case concerning the scope of protection afforded certain institutions acting as so-called “safe harbors” in claims against bankruptcy trustees.

The controversy arose out of a securities transaction between FTI as the estate bankruptcy trustee and Merit Management as the recipient of the alleged fraudulent transfer. Specifically, “the trustee attempted to avoid a payment by the bankrupt company, Valley View Downs”—a horse race track company—”to Merit Management, in exchange for Merit Management’s shares in Bedford Downs,” a competing race track company. Such a scenario presents competing interpretations of Section 546(e) [text] of the Bankruptcy Code.

Section 546(e) “protects from avoidance any ‘settlement payment’ that is made in connection with a ‘securities contract,’ so long as the payment is ‘by or to (or for the benefit of)’ any of six listed types of financial intermediaries [SCOTUSblog report].”

The US Court of Appeals for the Seventh Circuit ruled in favor of FTI, finding “that the safe harbor does not apply when a financial institution ‘is neither the debtor nor the transferee but only the conduit.'” Thus, the transfer was not protected under Section 546(e) and Merit’s portion could be voided. Despite the Seventh Circuit’s holding in this case, other Federal courts support Merit’s view; specifically, “the Second Circuit is very concerned about the effect that this would have on the leveraged buyout industry and — and, therefore, the economy more broadly.”

The question presented before the Supreme Court is whether Section 546(e) concerns avoidable transfers or party liability and whether this transfer was fraudulent and voidable to FTI, where Merit and the intervening banks were conduits and not direct transferees in the transaction. Merit Manager, the petitioner, “argues that Section 546(e) protects the payment because it came into Merit’s hands from a financial intermediary,” but FTI, on the other hand, alleges 546(e) protects the types of financial intermediaries and a transfer six bankruptcy trustees’ interests in avoiding fraudulent transfers that deprive the first owed creditors of money owed.

Evident throughout the argument is the court’s hesitation to adopt Merit Management’s interpretation because such a ruling could drastically broaden the scope of transactions unavoidable to bankruptcy creditors. The court referenced the so-called “Tribune case” [oral argument, transcript] which is another bankruptcy case before the Court raising a similar issue under the Bankruptcy Code. It is possible that a decision in either case will affect the Court’s decision in the other.