On April 24, 2015, the US Bankruptcy Court for the Northern District of Illinois, in Krol v. Key Bank National Association (In re MCK Millennium Centre Parking, LLC), held that repayments made by a debtor to a commercial bank on a loan, where the promissory note evidencing the loan was held by a commercial mortgage-backed securitization (CMBS) real estate mortgage conduit (REMIC) trust, were not avoidable because the repayments were found to be made "in connection with" a "securities contract" and therefore protected by the safe harbor under section 546(e) of the Bankruptcy Code, even though the defendant transferee lacked a beneficial interest in the transferred funds (, (Bankr. N.D. Ill. Apr. 24, 2015)).

In 2008, MCK Millennium Centre Retail, LLC (Retail) obtained a loan from Key Bank National Association in the amount of $11,200,000. As part of a securitization transaction, the loan was sold to a CMBS REMIC trust, with Wells Fargo Bank, N.A., serving as trustee. The trust was governed by a pooling and servicing agreement (PSA) among Key Bank, Wells Fargo and other financial institutions.

Between June 26, 2008 and June 19, 2012, an affiliate of Retail, MCK Millennium Centre Parking, LLC (MCK), made a series of payments totaling over $5 million to Key Bank in repayment of the Retail loan. These payments were held temporarily by Key and then transferred to the REMIC trust and applied to the Retail loan by the trust.

On June 19, 2012, MCK filed for bankruptcy under Chapter 11. On September 10, 2013, the case was converted to a Chapter 7 bankruptcy, and a Chapter 7 trustee was appointed. On June 18, 2014, the Chapter 7 trustee filed an adversary proceeding seeking to avoid as fraudulent transfers and preferential transfers the $5 million in aggregate payments that MCK made to Key Bank (defendant), which were applied to the Retail loan. The Chapter 7 trustee asserted that these payments were made for no consideration since they amounted to repayment on a loan on which MCK was not the obligor (Retail, a subsidiary and insider of MCK, was the obligor on the loan).

The MCK Chapter 7 trustee:

The Bankruptcy Code allows a trustee to avoid and recover pre-petition fraudulent and preferential transfers made by a debtor (see Practice Notes, Fraudulent Conveyances in Bankruptcy: Overview and Preferential Transfers: Overview and Strategies for Lenders and Other Creditors). However, Key Bank sought to dismiss all counts in the Chapter 7 trustee's complaint, arguing that the transfers were protected by section 546(e) of the Bankruptcy Code, which provides a safe harbor from a debtor's or trustee's bankruptcy avoidance powers for payments "made by or to (or for the benefit of) a... financial institution ... in connection with a securities contract."

In order to bar a plaintiff from avoiding a transfer, a defendant must prove each element of section 546(e):

The parties agreed that Key Bank, a commercial bank, fell within the Bankruptcy Code's definition of "financial institution" (11 U.S.C. § 101(22)). The dispute centered around whether the payments from Retail to Key were "in connection to a securities contract," as required under section 546(e).

Section 741(7)(A) of the Bankruptcy Code broadly defines "securities contract," in part, as "a contract for the purchase, sale, or loan of a security, a certificate of deposit, a mortgage loan, any interest in a mortgage loan, a group or index of securities, certificates of deposit, or mortgage loans or interests therein (including an interest therein or based on the value thereof), or option on any of the foregoing, including an option to purchase or sell any such security, certificate of deposit, mortgage loan, interest, group or index, or option, and including any repurchase or reverse repurchase transaction on any such security, certificate of deposit, mortgage loan, interest, group or index, or option (whether or not such repurchase or reverse repurchase transaction is a repurchase agreement, as defined in section 101)." The court recognized the PSA governing the CMBS trust as a securities contract within the meaning of section 741(7)(A) of the Bankruptcy Code and focused on whether payments to Key Bank under the loan were made “in connection with” the PSA as required under Code section 546(e).

Courts have disagreed about whether the party protected from avoidance must acquire a beneficial interest in the transferred property under section 546(e), or if it is sufficient if the protected party acts as a mere intermediary or conduit. The majority of circuit courts ruling on this issue have held that because the plain language of the Bankruptcy Code does not expressly require that the protected party obtain a beneficial interest in the transferred property, any participation by a protected party will result in safe harbor protection (see, QSI Holdings, Inc. v. Alford, 571 F.3d 545, 550-551 (6th Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F.3d 981, 987 (8th Cir. 2009); Lowenschuss v. Resorts Int’l, Inc., 181 F.3d 505, 516 (3d Cir. 1999)). However, the US Court of Appeals for the Eleventh Circuit has held that payments are not made "by or to" a protected party unless the protected party is a transferee that acquires a beneficial interest in the transferred property.

Key Bank argued that the payments in this case fell under section 546(e) since Key is a financial institution and the payments were made in connection with a securities contract. Key argued that the loan to Retail should be integrated with the PSA and therefore be considered a securities contract. The trustee countered that Key’s payments were made on account of the loan agreement between Key to Retail which was plainly not a securities contract.

The court agreed with Key, and determined that the safe harbor provision protects the transfers at issue in counts 1, 3, 4 and 6 of the Chapter 7 trustee's amended complaint. Counts 2 and 5 alleged actual fraud, which the safe harbor does not cover. The court explained that the promissory note evidencing the loan was owned by the trust and therefore was governed by the PSA. Therefore, the court “properly consider[ed] two separate transactions as a single transaction when doing so would align with the economic realities” and held that the payments made by Key had enough of a relationship to the PSA to be considered a securities contract for purposes of section 546(e).

The court focused on the broad language of sections 546(e) and 741(7) and explained that the term "in connection with" has historically been interpreted very liberally to mean "related to." While the payments were not necessarily made for the purchase or sale of securities, the payments were made in relation to a security agreement (the PSA) and therefore fell within the section 546(e) safe harbor. The court rejected the Chapter 7 trustee's argument that any two-tiered transaction precludes a finding that a securities contract is involved.

In what appears to be a matter of first impression, the court held that a commercial mortgage securitization is considered to be a "securities contract" for the purposes of the section 546(e) safe harbor provision. This decision reinforces the basic legal tenets of securitization transaction structure and provides comfort to both arrangers of and investors in asset-backed securities (ABS) that the underlying revenue stream that provides the cash flow for their securities will not be interfered with by bankruptcy courts in this jurisdiction. The decision is applicable to any transaction in which loans are securitized and held by a party other than their originator.

The decision also illustrates that loan repayments may receive an extra layer of avoidance protection from courts when the loan is securitized. It will be interesting to see whether other bankruptcy courts and circuit courts, especially the Second Circuit, interpret the Code similarly.

Note: On April 30, 2015, the court published an Amended Memorandum Opinion (, (Bankr.N.D.Ill. Apr 30, 2015)). However, there are no substantial differences between this opinion and the previous one. The amended memorandum opinion included a line that states "The April 24, 2015 Order entered herein stands."

Update: On September 10, 2015, the court vacated the original April 24, 2015 Amended Memorandum Opinion (see Krol v. Key Bank National Association (In re MCK Millennium Centre Parking, LLC), No. 12 B 24676 (Bankr. N.D. Ill. Sept. 10, 2015)). Material evidence provided by defendant since the original opinion was issued indicates that KeyBank National Association (which is a "financial institution") was not the actual master servicer of the loan during the relevant period. The master servicer was KeyCorp Real Estate Capital Markets, Inc., which is not a "financial institution." Because the original decision relied heavily on Bankruptcy Code exceptions available for "financial institutions," the court vacated its earlier decision and a status hearing is currently scheduled for November 10, 2015.