"Fifth Circuit Holds That Electricity Agreements Are Shielded From Avoidance Powers Under Bankruptcy Safe Harbor"

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

[authors: Mark S. Chehi, John K. Lyons]

In its recent decision in Lightfoot v. MXEnergy Electric, Inc. (In re MBS Mgmt. Serv., Inc.), No. 11-30553, 2012 U.S. App. LEXIS 15995 (5th Cir. Aug. 2, 2012), the United States Court of Appeals for the Fifth Circuit ruled that a requirements contract for electricity supply that did not specify quantities or delivery dates is a “forward contract” within the meaning of Section 101(25)(A) of the Bankruptcy Code. Therefore, such contracts are within the ambit of Bankruptcy Code Section 546(e)’s “safe harbor,” which exempts nondebtor parties to forward contracts from preference liability for contract payments received from the debtor before the commencement of its bankruptcy.

Section 546 and other provisions of the Bankruptcy Code provide “safe harbors” for specified commodities and financial contracts and related payments and transactions. The bankruptcy safe harbors limit the application and effect of the automatic stay and avoidance actions to recover fraudulent transfers and preferential payments, thereby insulating nondebtor counterparties to specified contracts from preference and fraudulent transfer liability, and permitting them to close and settle transactions and exercise other rights under specified contracts following the commencement of a bankruptcy case without violating the automatic stay. See, e.g., 11 U.S.C. §§ 362(b)(6) & (7) (limitations on automatic stay of certain contract rights) and 546(e), (f), (g) & (j) (limitations on avoidance powers of trustee). In particular, Section 546(e) of the Bankruptcy Code exempts from the operation of various bankruptcy avoidance statutes “a transfer that is a … settlement payment … made by or to [a] … forward contract merchant . …” 11 U.S.C.§ 546(e).

In MBS Mgmt., the Fifth Circuit ruled that a contract between an electricity supplier and a real estate management company, which became a Chapter 11 debtor, was a “forward contract” as defined by Section 101 of the Bankruptcy Code: “a contract (other than a commodity contract[]) for the purchase, sale, or transfer of a commodity …with a maturity date more than two days after the contract is entered into . …” 11 U.S.C. § 101(25)(A). The Fifth Circuit applied this “statutory language alone” to conclude that the contract was a “forward contract” — even though it did not specify quantity or delivery dates — and therefore the contract fell within the Section 546(e) safe harbor. Accordingly, the Fifth Circuit held that Section 546(e) insulated pre-bankruptcy payments made by the debtor to the electricity supplier from avoidance as preferential payments under Section 547(b) of the Bankruptcy Code.

The MBS Mgmt. decision stands in contrast to the Fourth Circuit’s decision in In re National Gas Distributors, LLC, 556 F.3d 247 (4th Cir. 2009), which held analogous “forward agreements” must specify price, quantity and “time element” terms to fall within a Section 546 safe harbor. MBS Mgmt. appears to extend, in the Fifth Circuit at least, Section 546 safe harbor protections to energy and other commodity supply requirements contracts that do not specify fixed quantities or delivery dates.

Background

The debtor, MBS Management Services, Inc., was a residential real estate management company that had agreed to purchase electricity from an energy supplier (the Supplier) for certain properties pursuant to 24-month contracts that specified a fixed rate per kilowatt-hour, based on actual metered usage. The post-confirmation trustee for the unsecured creditors’ trust later initiated an adversary proceeding against the Supplier to avoid and recover from the Supplier, as preferential transfers under Section 547(b) of the Bankruptcy Code, debtor payments made prepetition to the Supplier on account of the debtor’s affiliates’ past-due electric bills. The Supplier responded that the prepetition payments it received were exempt from Section 547(b) avoidance because the underlying contract was a “forward contract” that qualified for the Section 546(e) safe harbor protection against such avoidance actions. Following a bench trial, the bankruptcy court held that the underlying agreement was a “forward contract,” the transfers in question were “settlement payments” under the Section 546(e) safe harbor and, therefore, the post-confirmation trustee could not avoid and recover the pre-petition payments to the Supplier as preferential transfers. The district court affirmed, and the trustee appealed to the Fifth Circuit.

The Fifth Circuit Decision

The Fifth Circuit affirmed that the bankruptcy court properly determined that the parties’ electricity supply agreement was a forward contract exempt from preference recovery under Section 546(e). Slip Op. at 14-15. The Fifth Circuit explicitly rejected the trustee’s argument that the supply contract could not be a “forward contract” within the meaning of the Bankruptcy Code because it did not specify the quantity of electricity to be purchased or precise delivery dates. Slip Op. at 10-11. The Fifth Circuit concluded that the agreement was “well within the class covered” by Bankruptcy Code Section 101(25)’s definition of “forward contract” and the Section 546(e) safe harbor. Slip Op. at 10.

The Fifth Circuit reasoned that “close statutory analysis” of Bankruptcy Code terms addressing forward contracts was required, as was undertaken in its prior decision in In re Olympic Natural Gas, 294 F.3d 737 (5th Cir. 2002), and said “we rely on the statutory language alone” to conclude that “specific quantity and delivery date” terms are not requirements of the definition of a “forward contract” under Section 101(25) of the Bankruptcy Code or the safe harbor exemption from preference recovery under Section 546(e). Slip Op. at 6-7.

The MBS Mgmt. court distinguished the Fourth Circuit’s decision in National Gas Distributors, which observed that “the Bankruptcy Code uses both ‘forward contract’ and ‘forward agreement’ but defines only ‘forward contract,’ and not ‘forward agreement,’ apparently making a distinction between the terms.” Slip Op. at 8 (quoting National Gas Distributors, 556 F.3d at 255 (emphasis in original)). The MBS Mgmt. court acknowledged that the Fourth Circuit’s National Gas Distributors opinion “lists ‘fixed’ ‘quantity and time elements’ as characteristics of forward agreements.” Slip Op. at 8. However, the Fifth Circuit said that the Fourth Circuit’s opinion had “little bearing” because it was “open-ended” and focused on “forward agreements,” the Section 546(g) safe harbor (against fraudulent transfer liability) and the Section 101(53B) definition of “swap agreement” — instead of the Section 546(e) safe harbor (against preference liability) and Section 101(25) definition of “forward contract.” Slip Op. at 8.

Although the Fifth Circuit recognized “concerns expressed in various cases that payment debtors make on ‘ordinary supply contracts’ should not be protected from preference litigation,” it concluded “these concerns are immaterial when laid against the statutory text.” Slip Op. at 9. The Fifth Circuit adopted the Bankruptcy Court’s finding (based on expert testimony) that “forward contracts for electricity do not typically limit the quantity sold or purchased,” and its reasoning that “because forward contracts are individually negotiated and not exchange-traded, the Bankruptcy Code reasonably forewent encumbering the definition [of ‘forward contract’] with technical requirements.” Slip Op. at 11.

Accordingly, the Fifth Circuit affirmed the bankruptcy court ruling that the Supplier’s electricity requirements contract with the debtor was a “forward contract” within the meaning of Section 101(25)(A) of the Bankruptcy Code, and therefore Section 546(e) insulated payments made to the Supplier under the contract from preference liability under Section 547 of the Bankruptcy Code.

Implications

MBS Mgmt. arguably creates a split of authority between the Fifth and Fourth Circuits on the issue of whether requirements contracts (or other commodity supply contracts) without fixed quantity or delivery terms are “forward contracts” for purposes of Section 546 and other safe harbor provisions of the Bankruptcy Code. The MBS Mgmt. ruling may be of special importance to investors in energy tax credit driven transactions and agreements that require ongoing supply of electricity or other commodities to a site host or other long-term purchasers. Following MBS Mgmt., investors, energy suppliers and other parties in such transactions may confront less bankruptcy-related risk and uncertainties to the extent their agreements are “forward contracts” within the meaning of Section 101(25) of the Bankruptcy Code. Also, the applicability of bankruptcy safe harbors to energy requirements contracts and similar commodity supply agreements may make it easier for financially distressed companies with energy and commodity supply needs to obtain more flexible and favorable terms from energy and commodity suppliers, even when financial distress is perceived by suppliers who might otherwise avoid entering into contracts with financially distressed companies.

While courts outside the Fifth Circuit are not bound by the MBS Mgmt. decision and may or may not follow its reasoning, MBS Mgmt. affords the prospect of bankruptcy safe harbor protections to requirements and other commodity supply contracts that do not have fixed quantity and delivery terms.

Download PDF

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.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.