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US Supreme Court Agrees to Hear Case with Potential to Increase Clawback Actions

The United States Supreme Court has agreed to hear the case FTI Consulting, Inc. V. Merit MGMT. Grp. LP 16-784, that has the potential to make it easier for creditors to claw back cash that was paid out by a company for extended time periods before filing for bankruptcy. FTI Consulting, Inc. V. Merit MGMT. Grp. LP 16-784 involves a dispute on the outcome of a buyout of a horse racing track by Valley View Downs, an entity which is currently a debtor to FTI Consulting. FTI Consulting is Trustee to Centaur LLC, a litigation trust, that is the primary debtor to which Valley View Downs owes funds. Valley View Downs purchased another race track, Bedford Downs, by acquiring 100% of the stock of Bedford Downs in exchange for $55 million in cash. Merit Management Group was a 30% shareholder of Bedford Downs. After Valley View purchased Bedford Downs in a cash-for-stock transaction, similar to a leveraged buyout, Valley View was forced to file Chapter 11 due to an inability to secure a gambling license for the Bedford Downs race track. FTI Consulting, the Trustees to the entity Centaur LLC to which Valley View Downs owes funds, subsequently sued Merit for $16.5 million, which is to say the 30% stake Merit Management held in Bedford Downs stock for which it received a cash transfer in the buyout.

Bankruptcy law currently provides a ‘safe harbor’ to financial institutions that conduct securities transactions. The rationale behind this protection is to shield securities trades from creditor claims, thereby promoting stability in financial markets in the face of corporate restructuring that involves bankruptcy filings. The downside to these bankruptcy protections however is that they can provide protections for fraudsters, who use these transactions to trade funds out of a fraudulent entity, and then file for bankruptcy protection. Under the current law, it can be difficult to claw back these funds. The Supreme Court will consider whether these ‘safe harbor’ bankruptcy protections should apply to entities that acted merely as pass-through conduits for fraudulent financial transactions.

A federal appeals court in New York dismissed FTI Consulting, Inc. V. Merit MGMT. Grp. LP 16-784, citing ‘safe harbor’ protections, and ruling that the shareholders were except from clawback action. The Plaintiffs in the suit argued that the ‘safe harbor’ shield was designed to protect the banks who facilitated the transaction, not the shareholders who are being sued, and because they acted only as a conduit to facilitate the leveraged buyout, the protection should not extend to the shareholders in clawback actions.

The outcome of FTI Consulting, Inc. V. Merit MGMT. Grp. LP 16-784 could have enormous implications for plaintiff law firms in the securities industry, and give victims of fraud more avenues through which to claw back funds. The attorneys at Lax & Neville LLP have extensive experience in successfully prosecuting claims on behalf of customers who have suffered losses as a result of investment and securities fraud.  If you are a victim of fraud, please contact Lax & Neville LLP today at (212) 696-1999 to schedule a consultation.