The Bottom Line:

In a case of first impression on the circuit court level, the Second Circuit in Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., 09-5122-BK L, 2011 WL 2536101 (2d Cir. June 28, 2011), held that an issuer’s early redemption of commercial paper fell within the safe-harbor protections of section 546(e).  The Second Circuit affirmed a district court decision overruling the bankruptcy court and declined to limit protected “settlement payments” to the “purchase” of a security.  As a result, the pre-maturity redemption of certain of Enron’s commercial paper was protected from avoidance.

What Happened

Prior to its bankruptcy, Enron redeemed certain of its commercial paper prior to the maturity date.  After the bankruptcy, Enron sought to recover those redemption payments from a number of parties, including “Alfa” and “ING,” as a preferential transfer under 11 U.S.C. § 547(b), or as a constructively fraudulent transfer because the price paid by the debtor exceeded the commercial paper’s fair market value, pursuant to 11 U.S.C. § 548(a)(1)(B).  The essence of Enron’s arguments was that the redemption payments were unusual and not the type of “settlement payments” protected from avoidance.  The dispute focused on the “safe harbor” provisions of 11 U.S.C. § 546(e), which, as framed by the Second Circuit, provides in relevant part :

[n]otwithstanding sections ... 547 [and] 548(a)(1)(B) ... of this title, [which empower the trustee to avoid preferential and constructively fraudulent transfers,] the trustee may not avoid a transfer that is a ... settlement payment, as defined in section ... 741 of this title, made by or to (or for the benefit of) a ... stockbroker, financial institution, financial participant, or securities clearing agency ... that is made before the commencement of the case, except under section 548(a)(1)(A) of this title [which relates to actual fraudulent intent].

Arguing that redeeming commercial paper fell within the safe harbor, Alfa and ING filed a summary judgment motion against Enron. The bankruptcy court denied the motion, holding that because commercial paper redemptions are rare, they are not “commonly used in the securities trade,” pursuant to the definition of “settlement payment” in 11 U.S.C. § 741(8). The district court reversed, holding that any payment made to complete a transaction involving the exchange of money for securities is a “settlement payment.” The Second Circuit considered the following question:

whether the § 546(e) ‘safe harbor’ ... extends to transactions in which commercial paper is redeemed by the issuer prior to maturity, using the customary mechanism of the Depository Trust Company ... for trading in commercial paper ..., without regard to extrinsic facts about the nature of the [transactions], the motive behind the [transactions], or the circumstances under which the payments were made.

The decision focused on statutory construction of section 741(8), which defines a “settlement payment” as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.”   The specific dispute centered over the modifier “commonly used in the securities trade” and whether it modified the entire definition or only the immediately preceeding clause “any other similar payment”. (The case illustrates the importance of punctuation – here a comma – in statutory construction.)  Enron argued that (i) the definition in section 741(8) excludes all payments that are not common in the securities industry, and (ii) commercial paper redemptions are infrequent and thus not “commonly used”.  However, based upon the lack of a comma before the words commonly used in the securities trade, the Second Circuit found that the phrase only modifies the immediately preceding phrase – “any other similar payment” – and not the entire phrase.  The Court rejected the notion that the safe harbor exception should require a factual determination in every case as to whether the subject transaction was “common” or not.  As such, the Second Circuit found that the frequency of commercial paper redemptions – and whether they are common or not – is irrelevant.

Enron also argued that a commercial paper redemption cannot be considered a “settlement payment” because it involves the retirement of a debt security, and not the “purchase or sale” of a security. Enron argued that allowing the safe harbor to apply to commercial paper redemption contradicts two decades of case law which allows the “avoidance of debt-related payments.”  The Second Circuit rejected this argument, holding that Enron’s suggested interpretation of section 741(8) had no basis in the statutory language or case law.  The Second Circuit distinguished the cases upon which Enron relied, pointing out that those involved non-tradable bank loans, and not widely issued debt securities, concluding that “[i]nterpreting the term ‘settlement payment’ in the context of the securities industry will exclude from the safe harbor payments made on ordinary loans.”

Finally, Enron claimed that Alfa and ING’s debt redemption “does not constitute a protected settlement payment because it did not involve a financial intermediary that took a beneficial interest in the securities during the course of the transaction.”  The Second Circuit rejected this argument, holding that the Third, Sixth and Eighth Circuits disagree with Enron’s interpretation, and because interpreting § 741(8) as Enron urged would have a substantial impact on the stability of the financial markets.

The Second Circuit affirmed the district court’s decision reversing the bankruptcy court, and directed entry of summary judgment in favor of Alfa and ING.

Why the Case is Interesting:

This is the first Circuit level decision to apply the safe harbor exception to redemption of commercial paper, whether customary or not.  The Court declined to limit the interpretation of the scope of sections 741(8) and 541(e), allowing for future broad payments tied to the securities market.