Grede v. FCStone, LLC

Grede v. FCStone, LLC, No. 09 C 136 (7th Cir. Mar. 19, 2014)
The court REVERSED the judgment of the district court. The pre-petition transfer was exempted from avoidance under Section 546(e), because it was a "settlement payment" and a transfer made "in connection with" a "securities contract." The pre-petition transfer was a redemption that "settled" defendant's securities account with Debtor. Further, the transfer was made in connection with a "securities contract" because it was made pursuant to Debtor's investment agreement, which authorized Debtor to purchase and sell securities for defendant-customer's benefit. Though it created a harsh result here, "[b]y enacting § 546(e), Congress chose finality over equity for most pre-petition transfers in the securities industry . . . [which] reflects a policy judgment by Congress that allowing some otherwise avoidable pre-petition transfers in the securities industry to stand would be a lesser evil than the uncertainty and potential lack of liquidity that would be caused by putting every recipient of settlement payments in the past 90 days at risk of having its transactions unwound in bankruptcy court." The post-petition transfer was expressly authorized by the bankruptcy court and, therefore, was not reversible under Section 549. Though the bankruptcy court later "clarified" its order, "deferring to the bankruptcy court's clarification made so long after the fact, when the money has already been disbursed to [Debtor's customers] and distributed to their customers, would upset the strong and reasonable reliance interests of those parties." Further, to authorize the disbursement, the bankruptcy court was not required to make a finding that the cash was property of the estate. Section 549 "does not require that a court authorizing a transfer decide at that time that the transfer involves property of the estate." Section 549 "merely requires that, before an earlier transfer can be avoided, the court must find that it was 'a transfer of property of the estate.'" [As guidance, the court proposed a "new rule" for competing statutory trust claimants: "One such rule might be to require trust claimants to trace without the benefit of tracing conventions, but to place trust claimants who fail to trace in a class ahead of at least unsecured creditors, giving them priority in bankruptcy proceedings."]
Procedural context:
Appeal to the United States Court of Appeals for the Seventh Circuit, from the United States District Court for the Northern District of Illinois, Eastern Division.
Debtor was an investment management firm. Under Debtor's investment agreement, Debtor's customers deposited cash with the Debtor, and Debtor was supposed to use that cash to purchase securities pursuant to each customer's investment portfolio. Customers did not acquire rights to specific securities under the contract, but rather received a pro rata share of the value of the securities in their investment pool. Debtor grouped its customer accounts into segments. The segments at issue here--Segment 1 and Segment 3--were subject to federal regulations requiring Debtor to segregate their funds and hold them in trust. In fact, Debtor did not segregate the funds, and Debtor used the funds for its own benefit (for example, as collateral for business loans). Weeks prior to filing bankruptcy, Debtor transferred, from an account of commingled funds to the Segment 1 account, $264 million worth of securities. Debtor then moved $290 million worth of securities from the Segment 3 account into its own bank account. Thereafter, but prior to filing a petition, Debtor paid out full and partial redemptions to certain Segment 1 customers, including defendant. Debtor then entered Chapter 11 bankruptcy and, three days later, filed an emergency motion. The emergency motion sought an order to distribute to Segment 1 customers $300 million in proceeds from a pre-petition securities sale. Certain creditors and interested parties appeared at the hearing on the motion and expressed concern that the funds at issue might have been commingled. Nonetheless, that same day, the bankruptcy court granted the motion and issued an order allowing Debtor's bank to release the funds. The next day, the bank released the funds to Segment 1 customers, including defendant. Later, the bankruptcy court appointed a trustee for the Debtor's estate. After fully discovering Debtor's severe mismanagement of its customers' funds, the trustee filed a motion with the court to (a) "clarify" its prior order allowing disbursement to Segment 1 customers and (b) declare that it had not authorized the transfer under Section 549. The motion was filed over a year after the order was originally entered and acted upon. The court granted the motion and held that its prior order had not authorized the transfer within the meaning of Section 549 and did not prevent avoidance of the transfer. Thereafter, the trustee filed an action against defendant to avoid (1) the pre-petition transfer as a preference under Section 547 and (2) the post-petition transfer as unauthorized under Section 549. For the trustee, this was a test case to resolve common issues among defendants in other adversaries who received the transfers described above. After the reference was withdrawn, the district court held that the trustee could avoid the transfers. Defendant appealed to the circuit court. [Parts of this fact section are copied from the opinion, which provides an excellent statement of the facts.]
Manion, Rovner, and Hamilton.

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