Bankruptcy Code Definition: Financial Institution

The Bankruptcy Code defines the term “financial institution” as meaning:

(A) a Federal reserve bank, or an entity that is a commercial or savings bank, industrial savings bank, savings and loan association, trust company, federally-insured credit union, or receiver, liquidating agent, or conservator for such entity and, when any such Federal reserve bank, receiver, liquidating agent, conservator or entity is acting as agent or custodian for a customer (whether or not a “customer”, as defined in section 741) in connection with a securities contract (as defined in section 741) such customer; or
(B) in connection with a securities contract (as defined in section 741) an investment company registered under the Investment Company Act of 1940.
-         11 U.S.C. § 101(22).

The term “financial institution” only appears in nine sections of the Bankruptcy Code.  See 11 U.S.C. §§ 101(22); 362(b)(2); 546(e); 548(d)(2)(B); 555; 562; 741(7)(xi); 753; and 767.  Aside from the definition “financial institution” in § 101(22), the use of this term in the Bankruptcy Code can generally be divided into three broad categories: (1) the automatic stay; (2) bankruptcy avoidance actions and (3) specialized Chapter 7 liquidations (i.e., liquidations of stockbrokers and commodity brokers).

Under the first category, the Bankruptcy Code creates an exception to the automatic stay for any “financial institution” from “the exercise…of any of any contractual right (as defined in section 555 or 556) under any security agreement or arrangement or other credit enhancement forming a part of or related to any commodity contract, forward contract or securities contract, or of any contractual right (as defined in section 555 or 556) to offset or net out any termination value, payment amount, or other transfer obligation arising under or in connection with 1 or more such contracts, including any master agreement for such contracts.”  11 U.S.C. § 362(b)(6).

The second category—avoidance actions—provides additional protections for “financial institutions.”  Section 546(e) of the Bankruptcy Code protects “financial institutions” from having any transfer made to them under “sections 544, 545, 547, 548(a)(1)(B) or 548(b)” of the Bankruptcy Code which constitutes a margin payment or settlement payment or in connection with a securities contract, commodity contract or forward contract.  Section 548(d)(2)(B) further provides that a “financial institution” that “receives a margin payment…or settlement payment…takes for value to the extent of such payment.”  Section 555 of the Bankruptcy Code adds further clarification and protections to financial institutions for the exercise of contractual rights.  11 U.S.C. § 555.  Finally, section 562(a) identifies the time when damages are measured in the event that a “financial institution” “liquidates, terminates, or accelerates” a “swap agreement, securities contract…, forward contract, commodity contract, repurchase agreement, or master netting agreement.”

The third category deals with Chapter 7 liquidation of stockbrokers and commodity brokers.  Section 741 of the Bankruptcy Code contains a very broad definition of “securities contract” which includes, in part, “any security agreement or arrangement or other credit enhancement related to any agreement or transaction referred to in this subparagraph, including any guarantee or reimbursement obligation by or to a…financial institution…in connection with any agreement or transaction referred to in this subparagraph…”  11 U.S.C. § 741(7)(xi).  Section 753 of the Bankruptcy Code then provides additional protections to “financial participants.”  Specifically, it provides that “[n]otwithstanding any other provision of this title, the exercise of rights by a…financial institution…shall not affect the priority of any unsecured claim it may have after the exercise of such rights.”  Those protections are similar to those for “financial institutions” in a commodity broker liquidation.  See 11 U.S.C. § 767.

There is relatively little case law dealing with “financial institutions” specifically.  The little case law that does exist tends to arise in the context of § 546(e) of the Bankruptcy Code.  In In re D.E.I. Sys., Inc., 996 F. Supp. 2d 1142 (D. Utah 2014) the District Court of Utah noted that settlement payments were protected from avoidance because they were made by and two a financial institution.  See also In re Plassein Int'l Corp., 366 B.R. 318 (Bankr. D. Del. 2007), aff'd, 388 B.R. 46 (D. Del. 2008), aff'd, 590 F.3d 252 (3d Cir. 2009).  However, recently the Seventh Circuit Court of Appeals held that the safe harbor provision under § 546(e) did not prohibit a bankruptcy trustee from avoiding a transfer which was conducted through a financial institution that acted as a conduit for the transaction.  FTI Consulting, Inc. v. Merit Management Group, LP, F. 3d, 2016 WL 4036408 (7th Cir. 2016).

Michael D. Fielding 
Husch Blackwell LLP

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