The Second Circuit Court of Appeals has now weighed in on the Bankruptcy Code’s safe harbor provisions. In Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., Docket Nos. 09–5122, 09–5142, 2011 WL 2536101 (2d Cir. June 28, 2011), the Second Circuit Court of Appeals faced an issue of first impression—whether Section 546(e) of the Bankruptcy Code, which shields certain payments from avoidance actions in bankruptcy, extends to an issuer’s payment to redeem its commercial paper made before maturity. Specifically, the Enron Creditors Recovery Corporation (ECRC) sought to avoid and recover payments made by Enron to redeem certain notes that Enron had issued.


Less than two months before its bankruptcy filing, Enron paid out more than $1.1 billion to retire certain of its unsecured and uncertificated commercial paper before their stated maturity dates. In redeeming this commercial paper, Enron paid the accrued par value, calculated as the price originally paid plus accrued interest, which was considerably higher than the paper’s market value.

Three broker-dealers (collectively, the “Brokers”) and The Depository Trust Company (DTC) participated in Enron’s redemption by receiving the commercial paper from the individual noteholders and paying the redemption price. Specifically, DTC deducted the redemption price from each Broker’s account and credited it to the individual noteholders’ accounts. The Brokers then transferred the notes to the DTC account of Enron’s issuing and paying agent, Chase IPA, and received payment from Enron through DTC. After the Broker received payment, the commercial paper Enron redeemed was extinguished in DTC’s system.

In connection with the redemption, the defendants, who owned Enron commercial paper in the amount of $48,200,000 and $5,667,255, respectively, agreed to transfer their commercial paper to a Broker in exchange for the redemption price.

Two years following Enron’s bankruptcy filing, ECRC brought adversary proceedings against approximately 200 financial institutions, including the defendants, seeking to avoid and recover the redemption payments as preferential transfers and fraudulent conveyances. The defendants moved to dismiss the complaints, arguing that the redemption payments were “settlement payments” protected by the Section 546(e) safe harbor.

Pursuant to Section 546(e) of the Bankruptcy Code,

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 empowers the trustee to avoid transfers made with actual intent to hinder, delay, or defraud creditors].

In turn, Section 741(8) of the Bankruptcy Code provides that a settlement payment is “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.”

Lower Court Rulings

The Bankruptcy Court for the Southern District of New York, in denying the defendants’ motion to dismiss, held that the phrase “commonly used in the securities trade” limited the payments that fell within Section 741(8) of the Bankruptcy Code to those that are common in the industry. The bankruptcy court determined that evidence was necessary to determine whether the redemption payments were commonly used and held that a factual issue existed regarding whether the redemption payments were made to retire debt or to purchase commercial paper.

Following discovery, the defendants’ filed a motion for summary judgment. In denying that motion, the bankruptcy court again concluded that the defendants failed to demonstrate that Enron’s redemptions were settlement payments as defined in Section 741(8) of the Bankruptcy Code because the defendants did not establish that they were made to acquire title to commercial paper rather than to retire debt. The bankruptcy court emphasized facts concerning the alleged unusual nature of Enron’s redemption of its commercial paper, including the above-market price paid by Enron, an alleged insistence on the use of the Brokers to act as intermediaries and the purported rarity of commercial paper prepayments in general, most of which were disputed. Thereafter, the District Court granted the defendants’ request for an interlocutory review regarding the limited question of whether the Section 546(e) safe harbor applies to an issuer’s redemption of commercial paper before maturity if the redemption is effected through the customary mechanism of transacting in commercial paper, without regard to the facts surrounding that redemption (such as motives and circumstances).

The District Court reversed the bankruptcy court and directed entry of summary judgment in favor of the defendants, holding that the redemption payment fell within the Section 546(e) safe harbor. ECRC then appealed to the Second Circuit Court of Appeals.

Second Circuit’s Opinion

In analyzing the Section 546(e) safe harbor, the Second Circuit recognized that Congress enacted Section 546(e) to “[minimize] the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries” and that the safe harbor limits this risk by prohibiting the avoidance of “settlement payments” made by, to or on behalf of participants in the financial markets. The Second Circuit also recognized that courts and parties should interpret the definition of “settlement payment” to be the transfer of cash or securities made to complete a securities transaction. Finally, the Second Circuit recognized that other circuit courts have held that Section 741(8)’s definition is extremely broad.

Although ECRC argued, and the bankruptcy court found, that (i) the final phrase of Section 741(8)—“commonly used in the securities trade”—excludes all payments that are not common in the securities industry, including Enron’s redemption; (ii) the definition only includes transactions in which title to securities changes hand, and not redemptions payments intended to retire debt; and (iii) the redemption payments were not settlement payments because they did not involve a financial intermediary, the Second Circuit concluded that there is nothing in the Bankruptcy Code or relevant case law that supports ECRC’s or the bankruptcy court’s limitations. First, the Second Circuit found that the final phrase of Section 741(8)—“commonly used in the securities trade”—only modifies the final term “any other similar payment” and was intended as a catch-all phrase intended to underscore the breadth of the Section 546(e) safe harbor.

Second, the Second Circuit found no basis in the Bankruptcy Code to limit the 546(e) safe harbor or the definition contained in Section 741(8) to exclude the redemption of debt securities. Instead, because Enron’s redemption payment completed a transaction in securities, the Second Circuit concluded that they constitute settlement payments within Section 741(8). In reaching this conclusion, the Second Circuit distinguished its prior decision in SEC v. Sterling Precision Corp., 393 F.2d 214 (2d Cir.1968), which was relied upon by ECRC and the bankruptcy court. In distinguishing Sterling Precision, in which the Second Circuit concluded that a redemption of bonds did not constitute a “purchase” within the Investment Company Act of 1940, the Second Circuit recognized that Section 741(8) did not require a purchase or sale like the Investment Company Act of 1940. Instead, the Second Circuit concluded that a settlement refers to the completion of a securities transaction and does not require that securities actually change hands.

Third, the Second Circuit concluded that the absence of a financial intermediary that takes title to the transferred securities is insufficient to deny application of the Section 546(e) safe harbor. In so concluding, the Second Circuit recognized that unwinding Enron’s redemption would have a substantial impact on the market because it involved in excess of $1 billion and 200 noteholders. Moreover, the Second Circuit recognized that the Section 546(e) safe harbor applied to settlement payments made to or for the benefit of a number of participants in the financial markets and that it would be inconsistent for courts to limit the safe harbor to exclude payments that did not involve a financial intermediary.


The Second Circuit’s opinion was not unanimous, with one judge dissenting, finding that the term “settlement payment” is ambiguous. The dissenting judge held that by eliminating the “purchase or sale” requirement, the Court of Appeals has undermined the ability of bankruptcy trustees to avoid preferential payments on account of ordinary debts. Given the unique facts before the Court and the narrowness of the issue presented—whether the premature redemption of commercial paper by the issuer falls within the safe harbor of a “settlement payment” under Section 546(e)—it may be some time before the industry will know if other courts of appeal will follow the Second Circuit’s opinion. Nonetheless, the narrowness of the issue presented does not undermine the fact that the Second Circuit broadly interpreted the safe harbor in Section 546(e).