District of Delaware Bankruptcy Judge Mary F. Walrath denies motion of Citibank National Association (“Citibank”) to dismiss the bankruptcy preference avoidance complaint for failure to state a claim for relief.  In her March 26, 2012 opinion, Judge Walrath holds that Citibank failed to establish that the transfers sought to be avoided were “settlement payments” protected by section 546(e).  Distinguishing the recent decision in Official Comm. of Unsecured Creditors of Quebecor World (USA) Inc. v. Am. United Life Ins. Co. (In re Quebecor), 453 B.R. 201 (Bankr. S.D.N.Y. 2011), Judge Walrath finds that the transfers were to “collateralize Citibank’s exposure under a [letter of credit]” issued to secure payment of industrial revenue bonds.  Although the transfers to Citibank were used to retire these industrial revenue bonds, the transfers to Citibank were not solely for the purpose of completing a securities transaction but also had the purpose of fulfilling an “obligation independent from any securities transaction”.

The Transfers 

The avoidance action was brought by a trustee for a liquidating trust (the “Liquidation Trustee”) in the bankruptcy case of Qimonda Richmond, LLC, et al., (D. Del. Bankr. Case No. 09-10589)(“Debtor”). The Liquidation Trustee sought to avoid as both preferential (under Section 547) and constructively fraudulent (under Section 548) “transfers” by the Debtor to Citibank made during the 90 days prior to the Debtor’s bankruptcy filing.

In 2000, Citibank issued a letter of credit (the “LC”) in the amount of $34,103,332 in favor of an indenture trustee (the “Indenture Trustee”) under an industrial revenue bond (“Bond”) indenture. Within the 90 day preference period, three transfers occurred: the Debtor deposited $47,937,873 into the Debtor’s deposit account at Citibank (the “Deposit”); Citibank debited the Debtor’s deposit account for $33,715,873; and Citibank paid that amount to the Indenture Trustee, which retired the Bonds. 

Citibank’s Arguments for Dismissal

 Citibank asserted three grounds for dismissal of the Trustee’s preference claims: (1) the Deposit and Debit fall within the safe harbor provisions of section 546(e), which protects from avoidance settlement payments made “in connection with a securities contract;” (2) as a fully secured creditor, Citibank could not receive more pursuant to the Deposit and Debit than it would have received in a liquidation; and (3) the preference claim was deficiently pleaded because it did not specify who made the Deposit.  To see a prior note discussing Citibank’s initial memorandum of law click this link.   

Judge Walrath’s  Section 546(e) Opinion

Judge Walrath’s discussion and rejection  of the Section 546(e) argument for dismissal follows (to read the entire opinion click this link):

Citibank argues that both preference claims fail as a matter of law because the Deposit and Debit are settlement payments or made in connection with a securities contract and thus are protected from avoidance under section 546(e) of the Bankruptcy Code. Section 546(e) shields certain securities transactions from the trustees avoidance powers for the purpose of promoting stability and finality in the securities markets. See Official Comm. of Unsecured Creditors of Hechinger Inv. Co. of Del. v. Fleet Retail Fin. Grp. (In re Hechinger Co. of Del.), 274 B.R. 71, 83-84 (D. Del 2002).

The Bankruptcy Code defines a settlement payment as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.” 11 U.S.C. § 741(8). Settlement payments have been defined broadly by the Third Circuit to include “the transfer of cash or securities made to complete a transfer payment.” Brant v. B.A. Capital Co. (In re Plassein Intl Corp.), 590 F.3d 252, 258 (3d Cir. 2009).

Citibank relies in large part on the Quebecor decision, which held that a series of transactions including the debtors transfer of money into an account at Bank of America, the disbursement of those funds to the indenture trustee of the debtors notes, and the retirement of those notes when the holders received payment constituted a “settlement payment.” Official Comm. of Unsecured Creditors of Quebecor World (USA) Inc. v. Am. United Life Ins. Co. (In re Quebecor), 453 B.R. 201 (Bankr. S.D.N.Y. 2011). Citibank contends that the series of events in this case similarly falls within the definition of a settlement payment.

The Trustee asserts that the Deposit and Debit are not settlement payments protected under section 546(e). First, the Trustee argues that the payment to Citibank was made to secure Citibanks exposure under the LC, not to pay off the Bonds. Because a letter of credit is specifically exempted from the definition of security under section 101(49)(B)(i), the Trustee contends that the Deposit and Debit cannot be construed as settlement payments under section 741(8). Further, the Trustee asserts that Citibank has made no showing that collateralization of a letter of credit would commonly be termed a “settlement payment” by those who work in the public securities market. See Plassein, 590 F.3d at 257-58 (holding that the most important element in determining if a transaction constitutes a settlement payment is if it “involved any other similar payment commonly used in the securities trade” and if it is a “common securities transaction”). Finally, the Trustee argues that even if a series of transactions ultimately includes a purchase or sale of a security, that does not automatically make each link in the chain of events a settlement payment, rather the Court must analyze each discrete transaction separately to determine whether it meets the definition of a settlement payment. Mervyns Holdings, LLC v. Lubert-Adler Grp., 426 B.R. 488, 500 (D. Del. 2010) (holding that section 546(e) did not apply because the individual transaction at issue, one in a series of transactions resulting in a securitization of real estate assets to obtain financing, did not meet the definition of settlement payment).

The Court agrees that Citibank has failed to establish that the Deposit and Debit are settlement payments protected by section 546(e). The instant case is easily distinguishable from Quebecor where the only purpose of the transfer was to complete a securities transaction and there was no other independent obligation between the debtor and the financial institution. Quebecor, 453 B.R. at 215. Here the Debtors made the payments to Citibank to fulfill an obligation independent from any securities transaction. The Debtors paid Citibank in order to collateralize Citibanks exposure under the LC. This transaction is separate and discrete from any payment of the Bonds. Mervyns, 426 B.R. at 500. Further, Citibank has not proven that payment on a letter of credit is considered a settlement payment in the securities industry or is a commonly used payment structure in a securities transaction. Plassein, 590 F.3d at 257-58. The payment of a letter of credit is specifically excluded from the definition of a security and thus any payment on a letter of credit cannot comprise a settlement payment. 11 U.S.C. § 101(49)(B)(i).

Citibank argues nonetheless that the Deposit and Debit were made “in connection with a securities contract” and therefore still fall within the safe harbor provisions of section 546(e). The definition of a securities contract includes “other credit enhancements related to” a securities contract. 11 U.S.C. § 741(7)(A)(i)-(x). Citibank argues, therefore, that the Bonds (and their Indenture) are “securities contracts.” See Alden v. Maine, 527 U.S. 706, 804 n.38 (“bonds are binding contracts”); Lorenz v. CSX Corp., 1 F.3d 1406, 1409 n.1 (3d Cir. 1993) (“An indenture is a contract . . . .”). Because the Trustee has admitted that the LC is a credit enhancement to the Bonds and the Indenture, Citibank contends that the payment on the LC is protected under section 546(e).

The Trustee responds that the LC is not a credit enhancement to any of the securities contracts defined in section 741(7)(A). The Trustee acknowledges that the LC is a credit enhancement to the Bonds, but argues that bonds do not fall within the Bankruptcy Codes definition of a securities contract. 11 U.S.C. § 741(7)(A).

Although it is settled law that bonds and indentures are contracts, the Court is not persuaded that the Bonds and Indenture are securities contracts within the definitions in the Bankruptcy Code. Therefore, the Court cannot conclude that the Deposit and Debit made in connection with the LC (even if the LC was a credit enhancement to the Bonds) were “in connection with a securities contract” and protected by section 546(e).