Member Article

The Bankruptcy Code provides a number of “safe harbors” for forward contracts and other derivatives. These provisions exempt derivatives from a number of Bankruptcy Code provisions, including portions of the automatic stay,¹ restrictions on terminating executory contracts,² and the method for calculating rejection damages.³ The safe harbor provisions also protect counterparties to certain types of contracts from the avoidance actions created under Chapter 5 of the Bankruptcy Code, such as the preference and fraudulent transfer statutes.⁴

In Lightfoot v. MXEnergy Elec., Inc. (In re MBS Mgmt. Servs., Inc.), the bankruptcy trustee brought a preference action against MXEnergy Electric, Inc. (“MX”), a power company. Prior to the bankruptcy, the debtor – a management company for multiple apartment complexes – contracted to purchase the “full electric requirements” for certain properties from MX for 24 months at a specified rate, based on actual usage. Within the 90 days before the bankruptcy filing, the debtor paid MX approximately $156,000 for electric services under this contract. After the bankruptcy was filed, the trustee sought to avoid the transfer as a preference.

The parties agreed that the elements of a preference could be proven, but MX claimed that the transfer was protected by the safe harbor provision of § 546(e), because the electricity contract was a “forward contract” under the Bankruptcy Code. Section 546(e) specifically exempts transfers “made by or to (or for the benefit of) a … forward contract merchant … in connection with a … forward contract.” A forward contract, in turn, is a “contract … for the purchase, sale, or transfer of a commodity … with a maturity date more than two days after the date the contract is entered into.”⁵

The trustee argued that in order to be a forward contract, an agreement must contain exact quantities of the commodity and specific delivery dates. Otherwise, the provision could be viewed as protecting “ordinary supply contracts”. The Fifth Circuit, however – like the bankruptcy court and district court before it – was unmoved by the trustee’s arguments. Noting its duty to “apply the statutory provisions as Congress wrote them,” the Fifth Circuit found no support in the statute for the trustee’s proposed limitations since it had previously determined in In re Olympic Natural Gas Co.⁶ that the statutory language made no distinction between “financial” forward contracts and “ordinary purchase and sale” forward contracts. The court affirmed the lower courts’ decision and determined that the safe harbor provisions applied to the transaction.

Haynes and Boone stands ready to assist clients in connection with issues involving application of the safe harbor provisions. For more information, please contact: