Restructuring

We recently blogged about a decision from the U.S. Bankruptcy Court for the Northern District of Illinois where the court held that a debtor’s payment in respect of mortgages pooled and held by a REMIC trust were safe-harbored under section 546(e) of the Bankruptcy Code. On September 10, 2015, the bankruptcy court vacated its decision on the basis of newly disclosed information. 
To briefly recap the facts, prior to its bankruptcy, the debtor (MCK) made payments on an affiliate’s loan that was held by a REMIC trust. The payments were made to the master servicer of the trust, then were transferred to the REMIC trustee, which in turn distributed the payments to the trust’s investors. The trustee of the MCK’s chapter 7 case asserted that the payments were made for no consideration because the transfers were repayments on a loan on which MCK was not the obligor, and sought to avoid the transfers as preferential transfers and actually and constructively fraudulent transfers.
As readers may recall, defendants asserted section 546(e) of the Bankruptcy Code as a defense, contending that the payments in question were covered by the safe harbor statute because defendant, KeyBank National Association, which was represented to have received the payments in question as master servicer and held them for a period of time before transferring them to a REMIC trust, was a “financial institution,” and the payments to the trust were made in connection with a securities contract. The first requirement – that the transfers were made by and to a financial institution – was undisputed at the time of the court’s decision, given that KeyBank is a commercial bank.
Even though it was admitted that the master servicer was a financial institution, the trustee asserted that the bank was acting as a mere conduit and did not qualify for safe harbor protection. On this point, the court determined that, under section 546(e), payments made either by or to a financial institution, including those that serve only as a conduit or intermediary, qualify for safe harbor protection. The court also found that the Pooling and Servicing Agreement governing the REMIC trust was a securities contract within the meaning of section 741(7)(A) of the Bankruptcy Code and that MCK’s payments on its affiliate’s securitized loan were made in relation to the PSA and therefore fell within the section 546(e) safe harbor.
After the bankruptcy court issued its memorandum decision and proposed findings of fact and conclusions of law, the defendants in the underlying adversary proceeding filed a statement disclosing that certain facts upon which the court relied were not accurate. Defendant’s statement revealed that the master servicer for the loans held by the trust during the relevant time period was not KeyBank but an affiliate, KeyCorp Real Estate Capital Markets, Inc. (“KRECM”), which defendants acknowledged was not a financial institution, as defined in the Bankruptcy Code.
In light of these new facts, the trustee sought a stay of its appeal and moved for reconsideration of the court’s ruling. Nonetheless, defendants in their opposition to the motion for reconsideration sought to argue that the transfers at issue were still made to, or for the benefit of, a financial institution because they were made to, or for the benefit of, the trustee of the Trust (Key Bank), which held legal title to the assets of the trust under the Pooling and Servicing Agreement.
Citing the defendants’ disclosure of “material evidence/information that undermines the court’s previous rulings, i.e., that [Key Bank] as master servicer was a ‘financial institution,’ informing the Court that the actual master servicer was [KRECM], which was not a ‘financial institution,’” and noting that only financial institutions (in certain circumstances) are eligible for safe harbor protection, the court vacated its opinion and order, and granted the trustee leave to file a Second Amended Complaint.
It remains to be seen whether litigants will nonetheless look to the court’s nonprecedential opinion for its interpretation of the phrase “in connection with a securities contract” to encompass payments in respect of a securitized loan, given that it appears to have been the first court to do so.
A status hearing in the case is set for November 10th. We will keep readers updated on further developments of interest.
Debora Hoehne is an Associate at Weil, Gotshal & Manges LLP in New York.