The bankruptcy trustee of a property management company sought to recover money paid to a power company prior to bankruptcy as an avoidable preference. The Fifth Circuit agreed with both the bankruptcy court and the district court that the payments were settlement payments under a forward contract exempt from avoidance.
MBS Management was the property management company for a number of apartment complexes. MBS Management had a two year contract with Vantage Power Services, LP (predecessor of MX Energy) to purchase the “full electric requirements” for specified properties at a fixed price per kilowatt hour based on actual metered usage. Shortly before MBS Management filed bankruptcy, it paid MX Energy ~$156,000 for its affiliate property owners’ past-due electric bills. After MBS Management filed bankruptcy, an adversary proceeding was initiated to recover the payment as an avoidable preference.
The parties stipulated that all of the elements of a preference set forth in Section 547 of the Bankruptcy Code were met (see Construction Lien as Catch-22 for elements of a preference). However, MX Energy argued that the payment was protected: Under Section 546(e) of the Bankruptcy Code a “settlement payment” made by or to a forward contract merchant or in connection with a forward contract may not be avoided as a preference. (It also may not be avoided as a fraudulent transfer unless the transfer was made with actual intent to hinder, delay or defraud.)
Section 101 of the Bankruptcy Code defines “forward contract” to include:
a contract (other than a commodity contract, as defined in section 761 [which contains definitions used for a commodity broker liquidation]) for the purchase, sale, or transfer of a commodity, as defined in section 761(8) of this title, or any similar good, article, service, right, or interest which is presently or in the future becomes the subject of dealing in the forward contract trade, or product or byproduct thereof, with a maturity date more than two days after the date the contract is entered into, including, but not limited to, a repurchase or reverse repurchase transaction (whether or not such repurchase or reverse repurchase transaction is a “repurchase agreement”, as defined in this section) consignment, lease, swap, hedge transaction, deposit, loan, option, allocated transaction, unallocated transaction, or any other similar agreement.
Section 101 of the Bankruptcy Code also defines “settlement payment” as follows:
The term “settlement payment” means, for purposes of the forward contract provisions of this title, a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, a net settlement payment, or any other similar payment commonly used in the forward contract trade.
The trustee contended that the agreement with the power company was not a forward contract. He tried arguing that it was not a forward contract because it did not have a specific quantity of electricity to be purchased nor specific delivery dates. After noting that the trustee’s argument would exclude many natural gas, fuel and electricity requirements contracts, the court reviewed a prior decision in which it concluded that the Bankruptcy Code divides commodities contracts into only two categories: “(1) on-exchange futures transactions [commodities contracts] and (2) off-exchange forward contracts.” It pointed out that neither the definition of a forward contract nor the exemption in Section 546(e) contained any limitation that would require forward contracts to have a specific quantity and/or delivery dates.
The trustee also argued that the agreement did not have a “maturity date,” so could not meet the requirement that a forward contract must have a maturity date more than two days after the date of the contract. The court responded that (1) no electricity was to be delivered within two days after the date of the contract, and (2) although courts have been uncertain about the meaning of maturity date, that did not mean that contracts that do not specify a maturity date do not have one.
The trustee’s various arguments stemmed from an underlying theory that ordinary supply contracts should not be exempt from avoidance as preferences. However, the expert testimony of the president and CEO of MX Energy provided a critical link by explaining the use of forward contracts to the bankruptcy court. Basically industry participants are producers or users who sell or purchase a commodity in advance to hedge against price fluctuations, and the agreement at issue in this case came within that scope.
Section 546(e) also covers transfers made in connection with a securities contract and a commodity contract in addition to a forward contract. As suggested by this case, the protection afforded to “settlement payments” or other transfers made in connection with these types of contracts can have a surprisingly wide scope. Be aware that almost any transaction involving a “commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency” might possibly have protection from most avoidance actions.
Vicki R. Harding, Esq.