INTRODUCTION

On February 18, 2013, we reported that the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) found that individual repurchase transactions having a purchase price of zero may fall within the definition of “repurchase agreement” under the Bankruptcy Code provided that the master agreement governing such transactions acknowledges that each transaction constitutes consideration for every other transaction under the master agreement. On March 27, 2014, the United States District Court for the District of Delaware (the “District Court”) affirmed the Bankruptcy Court’s judgment, but disagreed with its rationale. This post examines the differences in the Courts’ logic.

FACTUAL BACKGROUND

In 2005, the debtor entered into a global master repurchase agreement (the “Master Agreement”) with a counterparty. The Master Agreement acknowledged that all individual transactions entered into thereunder constituted a single business transaction. The Master Agreement also provided that any payments, deliveries, and other transfers made by either of the parties in respect of any transaction shall be deemed to have been made in consideration of payments, deliveries and other transfers in respect of any other transactions entered into under the Master Agreement.

The debtor and its counterparty entered into numerous repurchase transactions under the Master Agreement. The written confirmations for certain, but not all, of these transactions showed a purchase price of zero (“Zero Price Repos”). Immediately prior to filing for bankruptcy, the debtor failed to pay the aggregate repurchase price on the date due, and the counterparty issued formal notices of default. An aggregate repurchase amount was owed because not all of the subject transactions were Zero Price Repos. Following the bankruptcy filing and the imposition of the automatic stay, the counterparty liquidated the securities subject to the Master Agreement, including but not limited to the Zero Price Repos, by auction, and used the auction proceeds to set off against the debtor’s aggregate unpaid repurchase amount.

BANKRUPTCY COURT PROCEEDINGS

Pursuant to the safe harbor provision of section 559 of the Bankruptcy Code, the counterparty to a “repurchase agreement” with the debtor may liquidate, terminate, or accelerate the repurchase agreement notwithstanding the imposition of the automatic stay. In the instant case, the counterparty believed that the Zero Price Repos qualified for these protections and, relying upon section 559, liquidated the securities without first seeking approval from the Bankruptcy Court. To the contrary, the debtor argued that the Zero Price Repos do not constitute “repurchase agreements,” as that term is defined in the Bankruptcy Code, and, as a result, the counterparty’s reliance on the safe harbor provision of section 559 was misplaced.

The term “repurchase agreement” is defined in the Bankruptcy Code, in part, as an agreement that provides for the transfer of one or more mortgage related securities against the transfer of funds by the transferee of such securities, with a simultaneous agreement by such transferee to transfer to the transferor thereof securities at a date not later than one year after such transfer or on demand, against the transfer of funds. 11 U.S.C. § 101(47)(A)(i) (emphasis added). There also is a “catchall provision” providing that the term “repurchase agreement” includes any security agreement or arrangement or other credit enhancement related to any agreement or transaction described above. 11 U.S.C. § 101(47)(A)(v).

The debtor argued that the Zero Price Repos cannot be “repurchase agreements” because the corresponding confirmations noted a zero purchase price, meaning that the securities were not transferred to the counterparty “against the transfer of funds.” The Bankruptcy Court disagreed. Relying upon the acknowledgment contained in the Master Agreements that each transaction thereunder constituted consideration for every other transaction, the Bankruptcy Court held that any transaction under the Master Agreements with a purchase price greater than zero provided sufficient consideration to satisfy the “transfer of funds” requirement with respect to the Zero Price Repos. Because the Zero Price Repos constituted “repurchase agreements” under the Bankruptcy Code, the Bankruptcy Court held that such transactions were entitled to the benefits provided to repurchase agreements under the safe harbor of section 559.

DISTRICT COURT’S ANALYSIS

The District Court agreed with this result, but not the Bankruptcy Court’s rationale. As a threshold matter, the District Court agreed that the acknowledgments in the Master Agreement make the Zero Price Repos part of a larger package for which there was consideration. However, citing to statements in the record, and without any analysis, the District Court found that the Zero Price Repos “could have been transferred back . . . without being ‘against the transfer of funds.’” Because of this possibility—that the Zero Price Repos could have been transferred back without consideration—the District Court concluded that the Zero Price Repos did not fall within the plain meaning of “repurchase agreement” under section 101(47)(A)(i) of the Bankruptcy Code.

The District Court then examined the “catchall provision” of section 101(47)(A)(v) and observed that there is no question that the Zero Price Repos were part and parcel of the Master Agreement. Consequently, the extra securities held by the counterparty in connection with the Zero Price Repos were within the umbrella of “credit enhancements” for the other undisputed repurchase transactions under the Master Agreement. As “credit enhancements,” the Zero Price Repos fall within the meaning of “repurchase agreement” under the catchall provision of section 101(47)(A)(v) of the Bankruptcy Code. Although the District Court’s rationale differs, the result is the same: liquidation of the securities associated with the Zero Price Repos was permitted by the safe harbor of section 559 of the Bankruptcy Code

The case may be found here.