In what appears to be a case of first impression, the United States Bankruptcy Court for the Northern District of Illinois has concluded that payments to a master servicer of a commercial mortgage backed securitization (a “CMBS”) could not be avoided as either allegedly constructively fraudulent transfers or as allegedly preferential transfers because the securities contract “safe harbor” under section 546(e) of the Bankruptcy Code precluded such claims. Krol v. Key Bank Nat’l Ass’n. (In re MCK Millenium Centre Parking, LLC), 2015 Bankr. LEXIS 1432 (Bankr. N.D. Ill. Apr. 24, 2015). A Bryan Cave team, led by New York partner Larry Gottesman, represented the defendants.

The background of the decision is straightforward. The chapter 7 trustee of the debtor brought an adversary proceeding against Key Bank (“Key”), as master servicer, and the related CMBS trust, alleging that the debtor had made loan payments on a loan owed by the debtor’s affiliate. The plaintiff alleged that these payments were avoidable as both intentional and constructive fraudulent transfers under the Bankruptcy Code and analogous provisions under Illinois state law, as well as constituting preferential transfers. The defendants moved to dismiss the amended complaint on a variety of grounds, including that all claims for relief other than the actually fraudulent transfer claim under section 548(a)(1)(A) were barred by the section 546(e) safe harbor.

Section 546(e) provides in pertinent part that “the trustee may not avoid a transfer that . . . is a transfer made by or to (or for the benefit of) a . . . financial institution, . . . in connection with a securities contract, as defined in section 741(7), . . . that is made before the commencement of the case, except under section 548(a)(1)(A).” The effect of section 546(e) is simple: prepetition transfers within its scope are avoidable only if determined to be actual fraudulent transfers avoidable under section 548(a)(1)(A). All other prepetition transfers by a debtor are unavoidable. Three elements are required to invoke section 546(e): First, the trustee must seek to avoid prepetition transfers pursuant to one or more of the listed Bankruptcy Code provisions. Second, such transfers must have been “made by or to (or for the benefit of) a . . . financial institution.” Third, such transfers must have been “in connection with a securities contract, as defined in section 741(7).”

The defendants argued that the alleged payments by the debtor fell squarely within section 546(e). The bankruptcy court agreed. First, the parties did not dispute that Key, the master servicer, was a “financial institution” as that term is defined in the Bankruptcy Code. The bankruptcy court rejected the plaintiff’s argument that Key’s status as a financial institution should be ignored on the ground that Key did not receive the transfers for its own benefit and use, noting that, as concluded by the majority of courts to consider the issue, the plain language of section 546(e) required that Key be treated as a financial institution notwithstanding Key’s mere conduit status. 2015 Bankr. LEXIS 1432, at *24–25.

Second, the bankruptcy court agreed that the alleged transfers were in connection with a securities contract. The definition of a securities contract under section 741(7) includes any “contract for the purchase, sale, or loan of . . . a mortgage loan, any interest in a mortgage loan, a group or index of . . . mortgage loans or interests therein . . . .” The bankruptcy court concluded that a CMBS transaction falls within this definition, as it involves the sale of mortgages into the CMBS trust by the depositor and the related sale of certificates representing interests in this trust to investors. Id. at *26–32. The bankruptcy court also agreed that the alleged transfers were made “in connection with” such securities contract, as the payments were related to the securitization, even if not made in connection with the purchase or sale of securities. Id. at *32–33.

The implications of the Krol decision are twofold.   First, Krol signals a broad reading of section 546(e) and a willingness by the bankruptcy court to adhere to the plain text of the statute.   Second, Krol gives special servicers of securitized commercial mortgages a potent defense against potential avoidance claims.