Defense to Bankruptcy Preference Actions For Parties Engaged in Securities or Commodities Industry and Those Involved with Forward Contracts


If your company is sued to recover money or property transferred to it by a debtor prior to the filing of its bankruptcy petition, be aware that there is a potentially dispositive defense under Section 546(e) of the Bankruptcy Code for defendants in such actions in the financial and securities industries as well as the commodity or forward contract markets. This provision was intended to minimize displacement in the commodities and securities markets in the event of a major bankruptcy affecting those industries.

The Section 546(e) defense may be raised with respect to bankruptcy preference avoidance actions and some fraudulent conveyance avoidance actions. Sometimes those actions are known as “clawbacks.” Since this defense can be asserted only in special circumstances, it may be overlooked on occasion. Remember these watchwords: wherever there is a situation involving forward contracts, securities, or commodities, this defense should be considered.

Securities Industry and Securities Contracts

“Margin” or “settlement” payments to or from stockbrokers, financial institutions, financial participants, or securities clearing agencies are included in the defense. Transfers by or to such entities made in connection with “securities contracts” are also exempt. So, for example, payments made by a debtor securities firm to its clients to settle trades should not be recoverable.

Forward Merchants and Forward Contracts

If an avoidance defendant is a “forward contract merchant,” settlement payments or margin payments made to it may not be recovered. Also, any transfers by or to a forward contract merchant in connection with a “forward contract” or “commodity contract” are also included within the Section 546 (e) safe harbor.

The defense has been successfully raised by defendants in the energy industry who supply commodities such as natural gas or oil. Such “merchants” include entities whose business consists in whole or in part of entering into forward contracts with other merchants in a commodity or anything which is the subject of dealing in the forward contract trade. The contract must settle in more than two days from execution (so “spot” contracts are not covered by the defense). Forward contracts, generally speaking, are non-market traded, private agreements. An example might be payments made to a supplier of natural gas under a “requirements” contract or other supply agreement by the debtor in bankruptcy.

Commodity Brokers and Commodity Contracts

Transfers to a commodity broker that are margin or settlement payments, or any transfer to a commodity broker that is made in connection with a commodity contract (as defined the Bankruptcy Code), securities contract or forward contract, are also included within the safe harbor of Section 546 (e). As opposed to a “forward contract,” which need not be traded on any exchange or in any financial market, a “commodity contract” means an on-exchange futures transaction in commodities, where the contract is subject to the rules of a contract market or board of trade.

In summary, if your company is in the securities industry, whether as a stockbroker, financial institution, participant or securities clearing agency; or is involved in forward or commodity contracts, the Section 546 (e) defense to bankruptcy avoidance actions should always be considered to avoid the potential “clawback” claim asserted by a debtor or trustee in bankruptcy.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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