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The U.S. Supreme Court issued an important decision late last month regarding the ability of some creditors to try and claw back money owed to them by corporations that end up going broke. The ruling overturns a defense used by many companies to shield certain payments made prior to the bankruptcy from being subject to claims by creditors. The decision is important going forward as it is expected to have a significant impact on cases involving complicated financial transfers that had previously been protected from careful scrutiny or claw back by bankruptcy trustees. To learn more about the recent case, keep reading.
The case decided by the Court is known as Merit Management Group v. FTI Consulting. The issue before the Court concerned a provision of the federal Bankruptcy Code referred to as the securities “safe harbor” provision. The safe harbor provision broadly works to shield some securities transactions from being subject to claims by creditors. For instance, certain payments that are made by companies, such as those to shareholders, cannot be undone or “clawed back” by a bankrupt company’s trustee after the fact.
This safe harbor provision has been controversial for years and has frustrated many creditors who claim that companies purposely hide money by structuring payments so that they qualify under this provision. In so doing, they game the system and deprive creditors from millions of dollars that they would otherwise have been entitled to. Moreover, creditors argue that some of these payments are potentially fraudulent, providing yet another reason to allow them to be reached by bankruptcy trustees.
The Supreme Court issued a unanimous decision written by Justice Sotomayor siding with creditors. The Court found that the safe harbor provision was not designed to protect payments made through intermediary companies. The Court said that the safe harbor provision would only protect transfers if the transferor or the transferee were itself a financial institution. This amounts to a drastic narrowing of the safe harbor loophole, something that many creditors say is long overdue.
In this case, a racetrack operator, Valley View Downs LP, borrowed $55 million to purchase the Bedford Downs Management Corp. Soon thereafter, Valley View filed for bankruptcy protection. The appointed bankruptcy trustee then sought to claw back the money paid to Bedford shareholders, claiming that Valley View had been insolvent at the time of the deal and that creditors were entitled to the money spent on the Bedford purchase. Merit Management, one of the shareholders, argued that the payment was protected under the safe harbor provision. The Supreme Court rejected that idea and instead found that the banks involved in the transfer were merely acting as conduits facilitating a transaction.
The implication of the ruling is important in that it will allow closer scrutiny of certain transactions that had been previously deemed protected. Examples include leveraged buyouts and recapitalizations as well as other transactions that involve financial institutions acting as intermediaries. Previously, this was enough to allow the companies to claim the securities safe harbor protection. Now, this will not be enough to shield the transaction, potentially allowing creditors greater opportunities to claw back money from their corporate debtors.
If you are contemplating bankruptcy in the Charlotte area, please call the skilled lawyers at Arnold & Smith, PLLC find additional resources here. As professionals who are experienced at handling all kinds of bankruptcy matters, our attorneys will provide you with legally sound advice for your particular situation.
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