08/03/2011 – Memorandum of Law in Support of Motion to Dismiss filed in the Qimonda Richmond, LLC Adversary Proceedings by Citibank, National Association et al before U.S. Bankruptcy Judge Mary F. Walrath in the District of Delaware filed by  Morris, Nichols, Arsht & Tunnell LLP (Wilmington, DE) attorneys Gregory W. Werkheiser and Andrew R. Remming; and Milbank, Tweed, Hadley & McCloy LLP (New York, NY) attorneys Scott A. Edelman and Sander Bak .

Citibank, National Association seeks dismissal of a complaint for recovery of an allegedly preferential and fraudulent transfer of approximately $34 million. Citibank makes arguments based on Citibank’s status as a secured creditor, the presence of “reasonably equivalent” value; and its exercise of a right of setoff, but the first and primary argument is based on the Section 546(e) safe harbor.

As presented by Citibank, the facts are relatively simple. In 2000, a company subsequently acquired by the Debtor, received approximately $34 million in funding through an industrial revenue bond issuance. The bonds were collateralized by a letter of credit issued by Citibank. Originally, the letter of credit was secured by various assets of the initial borrower. However, 5 months before the Debtor’s bankruptcy, the Debtor granted Citibank a lien on additional equipment (the “Pledge”) to secure the Debtor’s reimbursement obligation under the letter of credit.

In October 2008, Citibank notified the Debtor that the letter of credit would not be renewed. At the start of the preference period, November 23, 2008, the Debtor had $0 in its account at Citibank. Debtor’s made or arranged for one or more deposits in December (the “Deposit”) and as of December 31, 2008, the Debtor’s cash balance in its Citibank account was $47,937,192. On January 2, 2009, pursuant to the Debtor’s direction, Citibank withdrew from the Debtor’s account (the “Debit”) and provided funds to the bond indenture trustee, U.S. Bank, sufficient to retire the Bonds. Citibank subsequently released its lien against the collateral pledged by the Debtor to secure the letter of credit.

Citibank’s primary argument is based on the application of the safe harbor provided by Section 546(e) of the Bankruptcy Code. That portion of the Citibank brief is provided below without footnotes. Registered users click here to see a copy of this brief.

I. THE PREFERENCE AND CONSTRUCTIVE FRAUDULENT TRANSFER CLAIMS FAIL AS A MATTER OF LAW BECA– USE THE PLEDGE, DEPOSIT, AND DEBIT ARE PROTECTED UNDER 11 U.S.C. § 546(e)

Counts I and II (seeking to avoid the Deposit and the Debit as preferences) and Count IV (seeking to avoid the Pledge and the Deposit as constructively fraudulent transfers) should be dismissed because the Pledge, Deposit, and Debit were “settlement payments” or transfers “in connection with a securities contract” under 11 U.S.C. § 546(e).

Section 546(e) shields certain securities transactions from a trustee’s avoidance powers. See 11 U.S.C. § 546(e). The purpose of this rule is to protect the stability of the financial markets by ensuring that securities transactions are not undone by the bankruptcy of one of the participants to the transactions. See Official Comm. of Unsecured Creditors of Hechinger Inv. Co. of Del. v. Fleet Retail Fin. Group (In re Hechinger Inv. Co. of Del.), 274 B.R. 71, 83-84 (D. Del. 2002) (“the rationale behind exempting settlement payments from the avoidance powers of the bankruptcy representative was to prevent the bankruptcy of one party in a clearance or securities purchasing chain from spreading to other parties and possibly threatening the collapse of the securities market”); Official Comm. of Unsecured Creditors v. Clark (In re Nat’l Forge Co.), 344 B.R. 340, 357 (W.D. Pa. 2006) (“Congress’s purpose was to minimize the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.”) (quotation marks omitted); Official Comm. of Unsecured Creditors of Quebecor World (USA) Inc. v. Am. United Life Ins. Co. (In re Quebecor World (USA) Inc.) (“Quebecor”), — B.R. —-, 2011 WL 3157292, at *2 (Bankr. S.D.N.Y. July 27, 2011) (“Congress has declared that when the securities markets are involved, it is better not to disturb certain prepetition transfers than it is to collect assets for equitable distribution to creditors.”).

One such protected type of securities transaction is a “settlement payment”; another is a transfer “in connection with a securities contract.” See 11 U.S.C. § 546(e). As explained below, the Deposit and the Debit were settlement payments because they were made in order to retire the Bonds.⁹ And the Pledge, Deposit, and Debit were transfers made “in connection with a securities contract” (i.e., the agreement pursuant to which the Bonds were issued). Counts I, II and IV should therefore be dismissed.

A.   The Deposit And Debit Were “Settlement Payments” And Thus Cannot Be Avoided As Preferential Or Fraudulent Transfers

[Debtor] alleges that the Deposit and the Debit were preferential transfers (Counts I and II) and that the Deposit was a constructively fraudulent transfer (Count IV). But these payments fall directly under the definition of “settlement payment” and thus are not avoidable.

“Settlement payment” has been defined broadly in the Third Circuit (and other Circuits) to include any transfer of cash to a financial institution in connection with a securities transaction. See Brant v. B.A. Capital Co. (In re Plassein Int’l Corp.), 590 F.3d 252, 258 (3d Cir. 2009) (explaining that definition of “settlement payment” is extremely broad and includes any transfer of cash or securities made to complete a securities transaction); Lowenshuss v. Resorts Int’l, Inc. (In re Resorts Int’l, Inc.), 181 F.3d 505, 515 (3d Cir. 1999) (“the term ‘settlement payment’ is a broad one that includes almost all securities transactions”); In re Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V. (“Enron”), — F.3d —-, 2011 WL 2536101, at *7 (2d Cir. June 28, 2011) (adopting expansive definition of “settlement payment” that includes any payment that completes a transaction in securities).

In the recent Enron decision, the Second Circuit defined “settlement payment” to include the redemption of commercial paper. Enron, — F.3d —-, 2011 WL 2536101, at *7-9 (2d Cir. June 28, 2011) (holding that prepetition payments made by Enron to redeem its commercial paper prior to maturity constituted “settlement payments”). And, only days ago, the Bankruptcy Court for the Southern District of New York (relying on Enron) held that the repurchase and subsequent cancellation of privately placed notes was a “settlement payment.” Quebecor, 2011 WL 3157292, at *10-16.

In Quebecor, the debtor transferred money into its bank account at Bank of America. Id. at *7. Bank of America then wired the money to the trustee of the notes, CIBC Mellon. Id. CIBC Mellon wired to each noteholder its portion of the funds, and the noteholders later surrendered the notes to the debtor. Id.

The series of transactions in Quebecor, which were held to fall within the § 546(e) settlement exception, are directly analogous to the transactions at issue in this case. As [Debtor] alleges in the Complaint, money was deposited into [Debtor]’s account at Citibank, Citibank paid U.S. Bank (the trustee for the Bonds), and the Bonds were ultimately retired. (See Compl. ¶¶ 22- 24.) Indeed, [Debtor] specifically avers that the transactions were made for the purpose of retiring the Bonds. (See Compl. ¶ 40 (“The Deposit was for or on account of antecedent debt owed . . . to U.S. Bank under the Bonds.”).)

As the court held in Quebecor, it is irrelevant that Citibank dealt solely with the cash side of the transaction and had no direct role in retiring the Bonds. See Quebecor, 2011 WL 3157292, at *15-16 (Enron “explicitly rejects the position . . . that a transfer may only qualify as a ‘settlement payment’ if it passes through a financial intermediary serving as a clearing agency”); see also In re Plassein Int’l Corp., 590 F.3d at 257-59 (holding that transfer in connection with private leveraged buyout was “settlement payment” notwithstanding lack of true “settlement process” involving clearinghouse intermediary); In re Resorts Int’l, Inc., 181 F.3d at 516 (holding that financial intermediary need not take beneficial interest in securities during course of transaction for transfer to be a settlement payment). As explained in Quebecor, the Court should look to the ultimate result of the transactions when analyzing whether a settlement payment occurred. See Quebecor, 2011 WL 3157292, at *12 (holding that “transaction in question involves three elements that together support” conclusion that there was a settlement payment: (1) transfer by debtor of cash (2) to Bank of America and then CIBC Mellon (trustee), which transfer was (3) made for purpose of repurchasing and canceling securities); see also In re Nat’l Forge Co., 344 B.R. at 348-51 (holding that where all parties to stock redemption plan were aware of ultimate purpose of plan, all transfers made as part of that plan should be viewed as a single, integrated transaction).

In sum, the Deposit and the Debit were transfers of cash to a financial institution (Citibank) made in connection with a securities transaction (the retirement of the Bonds). They are therefore “settlement payments” exempt from [Debtor]’s avoidance power. Counts I, II and IV (as to the Deposit) should be dismissed.

B.         The Pledge, Deposit, And Debit Were Transfers Made “In Connection With A Securities Contract” And Thus Cannot Be Avoided As Preferential Or Fraudulent Transfers

As discussed above, [Debtor] alleges that the Deposit and the Debit were preferential transfers (Counts I and II) and that the Pledge and the Deposit were constructively fraudulent transfers (Count IV). In addition to the Deposit and Debit falling within the “settlement payment” exception, the Pledge, Deposit, and Debit also were transfers made “in connection with a securities contract,” and thus are not avoidable for that reason as well.

Section 546(e) exempts from a trustee’s avoidance powers transfers that were made to a financial institution “in connection with a securities contract.” 11 U.S.C. § 546(e). The definition of securities contract includes “other credit enhancement[s] related to [a securities contract].” 11 U.S.C. § 741(7)(xi). Here, the LC Agreement was a credit enhancement of the agreement pursuant to which the Bonds were issued. (See Compl. ¶ 11 (“In conjunction with the issuance of the Bonds, a letter of credit in the amount of $34,103,332 . . . was obtained from Citibank in favor of the indenture trustee under the Bonds in order to collateralize [Debtor]’s obligations under the Bonds.”).)

The Pledge, Deposit, and Debit were transfers made pursuant to the LC Agreement. (See Compl. ¶¶ 17, 22-24.) As such, all three transfers were made “in connection with a securities contract” and cannot be avoided as preferential or fraudulent transfers. See Quebecor, 2011 WL 3157292, at *9 n.7 (holding that payments made to banks for the redemption of privately placed notes were transfers “in connection with a securities contract”). Counts I, II and IV therefore should be dismissed.