On Feb. 11, 2009, the United States Court of Appeals for the Fourth Circuit issued its opinion in Hutson v. E.I. Dupont de Nemours and Co. (In re National Gas Distributors), attempting, in a matter of first impression, to define "commodity forward agreement" for purposes of eligibility for protection under the safe harbor provisions of the Bankruptcy Code. At first blush, this decision appears to provide the additional certainty that participants in the commodities markets require. Parameters set forth in the opinion, however, may exclude a number of agreements currently in common use from the safe harbor, warranting a closer look at the decision.

National Gas Distributors, LLC ("NGD") was a distributor of natural gas to industry, government and other customers. After NGD filed for bankruptcy, the trustee commenced adversary proceedings against three of the debtor's customers, claiming that the customers' fixed-price natural gas supply contracts with NGD, and transfers of natural gas thereunder, were fraudulent transfers because the fixed prices specified in the contracts were below market prices at a time when NGD was insolvent (based on 11 U.S.C. §§ 548(a) and 550(a)). The customers filed motions to dismiss, asserting that each of the supply contracts at issue was in fact a "commodity forward agreement." As such, the customers argued, the agreements fell under the definition of "swap agreement" and therefore were protected by the safe harbor provisions of the Bankruptcy Code. These safe harbor provisions are designed to protect the financial markets and, among other things, shield swap participants from a trustee's power to seek to avoid transfers in connection with a swap as being constructively fraudulent or preferential.

The bankruptcy court denied the motions to dismiss, finding, among other things, that each supply contract was merely "an agreement by a single end-user to purchase a commodity," was insufficiently tied to financial markets, and was not an agreement of the sort Congress intended to protect by the safe harbor provisions in the Bankruptcy Code. Specifically, the bankruptcy court held that to qualify as a "commodity forward agreement," an agreement must be traded in a financial market and must not involve the physical delivery of a commodity to an end user.

The Fourth Circuit reversed the bankruptcy court's decision and remanded the matter to the bankruptcy court. In taking issue with the bankruptcy court's "oversimplification" of the definition of a commodity forward agreement, the Fourth Circuit sought to broaden what may fall under the definition of a commodity forward agreement, a term only vaguely defined in the Bankruptcy Code. The Fourth Circuit dismissed any requirement that a commodity forward agreement must be traded on an exchange, and stated that agreements resulting in the actual physical delivery of a commodity can nonetheless qualify as a commodity forward agreement. The Fourth Circuit also stated that an agreement may so qualify even if it is not freely assignable. While the foregoing will grant safe harbor protection to a broader class of agreements (such as the supply contracts at issue), other statements made by the Fourth Circuit create some uncertainty with respect to agreements having terms used by many market participants.

For example, the Fourth Circuit stated that the "forward" aspect of the commodity forward agreement requires both delivery more than two days after the contract is entered into and a fixing of the price at the time of contracting. The deferred delivery requirement is consistent with the Bankruptcy Code's definitions. However, the requirement to establish a fixed price at time of contract has no source in the Bankruptcy Code and is at odds with some pricing structures used in energy and other commodity markets. Many contracts in those markets permit one party to lock in a fixed price to be determined in the future, based on parameters agreed at the time of contracting. Based on the Fourth Circuit's analysis, such agreements may fall outside the definition of a commodity forward agreement and, thus, may be ineligible for safe harbor protections.

The Fourth Circuit stopped short of providing a definition of commodity forward agreement and remanded these cases to the bankruptcy court to apply the articulated guidelines to the subject agreements. As a result, any decision by the bankruptcy court may be limited to the particular supply contracts at issue.

While the Fourth Circuit's decision may prove valuable to those who enjoy great flexibility in structuring commodity supply contracts, it may not help the many market participants who are bound by existing contracts or whose business relationships call for prices to be fixed other than at the time of contract. These parties would be well advised to review their current contractual relationships to assess any potential impact of this decision and may want to consider appropriate amendments to protect their contractual rights in the event of a bankruptcy filing by the counterparty.