In June 2007, I wrote here about Judge Small’s opinion that BAPCPA’s expanded "safe-harbor" definition of "swap agreement" did not apply to ordinary supply agreements in which a seller and an end-user entered into a contract "for delivery of a product that happen[ed] to be a recognized commodity."  As such, Judge Small held, these contracts were not exempt from avoidance as fraudulent transfers (on the theory that the supply contracts were made for less than market value when the debtor was insolvent).

Well, to the delight of the ISDA, which filed an amicus brief in support of the appellant-purchasers of natural gas under various supply contracts with the debtor, the 4th Circuit yesterday reversed Judge Small and remanded with instructions that the Bankruptcy Court "allow the customers to attempt to demonstrate facutally and legally that their natural gas supply contracts were swap agreements based on the classification included in § 101(53B)."  Hutson v. E.I. du Pont de Nemours and Co. (In re Nat’l Gas Distribs., LLC), 2009 WL 325436 (4th Cir. 2/11/09) (pdf)

In reaching this decision, the 4th Circuit undertook to determine the meaning of "commodity forward agreements," and ultimately concluded that "the bankruptcy court in this case construed ‘commodity forward agreements’ too narrowly–i.e., by requiring that they be traded on an exchange and not involve physical delivery of the commodity."  In so doing, the 4th Circuit found:

  • First, that "the Bankruptcy Code does not require that a ‘forward contract’ [which necessarily is narrower in scope than "forward agreements"] be traded on an exchange or in a market";
  • Second, that the contracts at issue were not "simple supply contracts" because "they also were part of a series of contracts in which the customers hedged their risk of future fluctuations in the price of natural gas … that were only a part of a larger risk management program in which the customers ‘regularly use[d] forwards and other derivatives."
  • Third, that while BAPCPA’s legislative history, which Judge Small quoted, "does provide support for the notion that traditional supply agreements are not ‘swap agreements’ … the conclusion that the contracts in this case are traditional supply contracts overlooks the fact that the contracts in this case contained real hedging elements … [and thus] Congress did not preclude physical delivery in connection with a ‘commodity forward agreement,’ as defined in § 101(53B)(A)."

Notably, however, the Court "[did] not direct the bankruptcy court to find that the contracts in this case are ‘commodity forward agreements’ or ‘swap agreements.’"  Recognizing that § 101(53B) "contains its own counterintuitive definitions, as well as inconsistencies," the 4th Circuit would not attempt to provide its own definition.  Instead, it "point[ed] to certain nonexclusive elements that the statutory language appears to require," those being:

  • "First, the subject of a commodity forward agreement must be a commodity.  That is, substantially all of the expected costs of performance must be attributable to the expected costs of the underlying commodity, determined at the time of contracting.  This element, which is inherent in the word ‘commodity,’ distinguishes a commodity forward agreement, in which the benefits or detriments depend on future fluctuations in commodity prices, from many supply contracts, in which costs attributable to other factors, such as packaging, marketing, transportation, service, and similar matters contribute to a greater portion of the costs."
  • "Second, a forward commodity contract, in being ‘forward,’ must require a payment for the commodity at a price fixed at the time of contracting for delivery more than two days after the date the contract is entered into. Cf. 11 U.S.C. § 101(25)(A) (requiring the same of ‘forward contracts’). A maturity date in the future means that the benefit or detriment from the contract depends on future fluctuations in the market price of the commodity."
  • "Third, as a forward agreement in relation to a commodity, in addition to the price element, the quantity and time elements must be fixed at the time of contracting."
  • "Finally, while the broad class of ‘swap agreements’ includes contracts that are readily assignable and therefore tradable, ‘swap agreements’ also include forward contracts, which are not necessarily assignable.

The 4th Circuit’s citation to Morrison and Riegel’s article, Financial Contracts and the New Bankruptcy Code: Insulating Markets from Bankrupt Debtors and Bankruptcy Judges, 13 Am. Bankr.Inst. L.Rev. 641 (2005), is most telling, for–as noted in my previous post on this case–Morrison and Riegel argued in their article that in BAPCPA’s amendments to the definition of "swap agreements" and related sections, "judges are strongly discouraged from engaging in functional analysis of financial contracts."  In the end, the 4th Circuit did just that by focusing on four "nonexclusive" elements, none of which involve a functional analysis of the agreements at issue.  Guess this means Judges handling these cases, and their clerks, get to leave work earlier than before.

Thanks for reading!

© Steve Jakubowski 2009