Kelley v. Safe Harbor Managed Account 101, Ltd.

Background

Douglas A. Kelley, acting as trustee of the PCI Liquidating Trust, sued Safe Harbor Managed Account 101, Ltd. He sought to recover $6,898,923.39 that Safe Harbor received from Arrowhead Capital II, L.P. Kelley asserted claims under Sections 550 and 551 of the Bankruptcy Code and Minnesota Statute § 513.48(b).

The underlying transfers arose from a Ponzi scheme involving Tom Petters and Petters Company, Inc. Metro, a special-purpose entity for Petters Company, sent money to Arrowhead. Arrowhead later transferred approximately $6.9 million to Safe Harbor. A bankruptcy court separately found that transfers from Metro to Arrowhead totaling approximately $1 billion, including the money later sent to Safe Harbor, were avoidable. The bankruptcy court entered default judgment against Arrowhead because Arrowhead did not answer or otherwise defend itself.

Safe Harbor had invested $6 million in Arrowhead in 2002 and redeemed its investment in 2003. It received two wire transfers totaling $6,898,923.39, representing its original investment plus an approximately 15% gain.

Motion and Issues

Safe Harbor moved for summary judgment. Summary judgment is entered when the evidence shows no genuine dispute over a fact that could affect the outcome and the moving party is entitled to judgment under the law. Safe Harbor argued that:

The parties also disputed whether the default judgment against Arrowhead prevented Safe Harbor from raising the Section 546(e) defense. The court held that it did not. Safe Harbor was not a party to, and had not participated in, the earlier proceeding against Arrowhead. The court therefore concluded that issue preclusion—the rule preventing relitigation of an issue already finally decided—did not bar Safe Harbor’s defense.

Section 546(e) Analysis

Section 546(e) generally prevents a bankruptcy trustee from avoiding certain transfers made by or to a financial institution in connection with a securities contract. The court held that Safe Harbor, as a later recipient, could assert defenses that Metro or Arrowhead could have raised concerning the original transfer.

The court found that Arrowhead qualified as a financial institution under the Bankruptcy Code. Wells Fargo was a commercial bank and acted as Arrowhead’s custodian. Under the statutory definition, Arrowhead, as the customer of the bank acting in that capacity, also qualified as a financial institution.

The court also held that the Note Purchase Agreement between Arrowhead and Metro was a securities contract. The Bankruptcy Code defines a securities contract to include a contract for the purchase of a security, and defines “security” to include a note. The court rejected Kelley’s argument that the notes were merely ordinary bank-like loans and concluded that the agreement fit the statutory definition.

Because the transfer from Metro to Arrowhead was made in connection with the Note Purchase Agreement, the court held that the transfer qualified for Section 546(e)’s protection. The court therefore found that Section 546(e) immunity applied to the funds at issue.

Other Arguments and Disposition

The court stated in a footnote that it would have denied summary judgment on Safe Harbor’s other arguments. It concluded that federal law governed rather than Delaware’s statute of repose because the state rule conflicted with the Bankruptcy Code’s limitations provision and congressional bankruptcy policy. The court also found a factual dispute about whether Safe Harbor acted in good faith because Safe Harbor admitted that it had not conducted proper due diligence before investing in Arrowhead.

Despite those conclusions, the Section 546(e) ruling resolved the motion. The court granted Safe Harbor’s Motion for Summary Judgment and ordered that judgment be entered accordingly.