Section 546(e) of the Bankruptcy Code is a “safe harbor” provision which restricts a debtor’s ability to recover or “clawback” what would otherwise be “avoidable” payments made to creditors. In the recent case of Lightfoot v. MXEnergy Elec., Inc., 690 F.3d 352 (5th Cir. 2012), the Fifth U.S. Circuit of Appeals followed what has become a recent trend (see “Decisions in Enron and Madoff Cases Confirm Safe Harbor Protections,” International Restructuring NewsWire (February 2012)) in broadly interpreting section 546(e)’s safe harbor protections. In Lightfoot, Chief Judge Edith Jones held that a relatively ordinary electricity requirements contract (as opposed to the financial instruments that often obtain the benefit of safe harbor provisions) was a “forward contract” and that, accordingly, payments made thereunder by the debtors were protected from clawback as “settlement payments.” This article will briefly review the Fifth Circuit’s decision and the implications that this and other recent decisions on section 546(e) will likely have on clawback actions.

Background

In 2005, MBS Management Services, Inc., a management company for apartment complexes, entered into a two-year contract agreement with the predecessor of MXEnergy Electric, Inc. to purchase “full electric requirements” for specific properties at a fixed rate. After MX acquired the contract in 2007, MBS paid MX approximately $156,000 to cover past-due electricity bills owed under the contract. MBS subsequently filed for bankruptcy, thus making any payments made within the previous 90 days potentially subject to clawback as preferences under the Bankruptcy Code. Thereafter, the MBS trustee brought a preference action to avoid and recover the payment made to MX.

MX did not dispute that the statutory elements of a preference claim had been satisfied (the payment was made while the debtor was insolvent, was made within 90 days of the debtor’s bankruptcy filing and allowed the creditor to receive more than it would have received in a chapter 7 liquidation). Instead, MX argued that the payment was protected from avoidance under a special safe harbor provision which exempted “settlement payments” made under a “preexisting forward contract.” The bankruptcy and district court determined that the safe harbor was available in this instance because the contract at issue was, in fact, a “forward contract.”

The Fifth Circuit’s Decision

On appeal to the Fifth Circuit, the court explained that while preference actions and other clawback provisions are bankruptcy tools used to ensure an equitable distribution of a debtor’s limited assets, Congress grafted qualifications on the use of such tools. One such exception, noted the Fifth Circuit, is the safe harbor provided under section 546(e) for “forward contracts.”

A “forward contract” is defined under section 101(25) (A) of the Bankruptcy Code as “a contract (other than a commodity contract []) for the purchase, sale or transfer of a commodity . . . with a maturity date more than two days after the contract is entered into . . . .” The contract at issue in this case, found the Fifth Circuit, tracks that statutory language. However, the MBS trustee asserted that a “forward contract” must, to be so defined, have an exact quantity and a delivery date. The Fifth Circuit disagreed.

The Fifth Circuit explained that the statutory language creating the safe harbor do not impose a requirement that forward contracts include a specific delivery date or specific quantity. Further, the court concluded that the trustee’s second argument concerning a lack of an explicit “maturity date” was also not compelling. While the meaning of “maturity date” remains ambiguous, the Fifth Circuit has pointed out that courts have never “suggest[ed] that contracts that do not specify a maturity date do not have one.” Putting their legal rationale aside, the Fifth Circuit turned to what the court seems to have surmised was the real reason for the dispute.

The Fifth Circuit explained that the MBS trustee’s arguments expressed concerns raised in similar cases as to whether an “ordinary supply contract” should be protected under the financial and security-driven protections provided to forward contracts. The Fifth Circuit recognized (but explicitly did not decide) that under its interpretation of the statute, a “forward contract” could include residential consumer contracts with utilities. While the Fifth Circuit noted the trustee’s concern that including more “ordinary” contracts certainly did not appear to be consistent with the original purpose of the statute (which was to protect financial and securities markets from disruption), it decided that this was irrelevant to its analysis. The Fifth Circuit focused on the clear statutory language of the relevant provisions, which made no distinction between “financial” forward contracts and “ordinary purchase and sale” forward contracts.

Conclusions and Takeaways

While the Lightfoot decision is at odds with a Fourth Circuit decision on whether a “forward contract” must identify a fixed quantity and/or fixed delivery terms, what appears to be far more important is the growing trend of courts (which we first highlighted in our February 2012 issue of the News- Wire) to broadly interpret section 546(e). In the Lightfoot case, the Fifth Circuit applied the safe harbor to what the court described as an “ordinary purchase and sale” contract. As such, the Fifth Circuit has confirmed that section 546(e) now debatably covers, at least in many jurisdictions, contracts that have nothing to do with what we would typically consider the traditional financial securities market contracts for which the safe harbor was designed. Creditors against whom fraudulent conveyance actions are brought should always consider whether a safe harbor is available.