James M. Lawniczak on the Applicability of Section 546(e)'s Forward Contract Payment Defense to Commodity Supply Contracts

James M. Lawniczak on the Applicability of Section 546(e)'s Forward Contract Payment Defense to Commodity Supply Contracts

When a settlement payment is made under a "forward contract," there almost always exists a safe harbor defense, found in Bankruptcy Code section 546(e). Accordingly, parties entering into "forward contacts" should consider the defense in advance. In this Emerging Issues Analysis, James M. Lawniczak identifies and discusses cases that have considered the meaning of "forward contract" and the application of the safe harbor defense.

Excerpt:

It isn't good to be a defendant in a bankruptcy avoidance action. Indeed, the defendant has likely already suffered a loss because of the bankruptcy filing due to an outstanding receivable that will be treated as an unsecured claim, paid in many cases at a fraction of face value. Then, things turn for the worse when the trustee seeks to make the loss even greater by avoiding and recovering a prepetition transfer.

There is, however, an absolute safe harbor defense to almost all avoidance actions for settlement payments made under "forward contracts." Parties entering into what might be "forward contracts" should carefully consider this defense at the time of contract formation. In addition, attorneys defending avoidance actions must be aware of the defense. This topical expert commentary identifies and discusses the cases that have discussed what a "forward contract" is and the circumstances under which the safe harbor defense applies.

Statutory Analysis

The Bankruptcy Code contains several sections that allow a trustee to avoid certain transactions and then recover the property or its value for the benefit of the estate. These avoidance powers are contained in chapter 5 of the Bankruptcy Code, and the most relevant one for purposes of the forward contract defense is section 547, which provides for the avoidance of payments made to creditors on antecedent debt within the 90-day preference period prior to the bankruptcy filing. However, section 546 then provides some limitations on those avoidance powers.

Code section 546(e), the focus of this online commentary, provides an absolute defense to all of the trustee's avoidance powers, except for fraudulent transfers based on actual fraud. By its terms, section 546(e) excepts from avoidance recoveries any "settlement payment," made by or to or for the benefit of "a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency," in connection with "a forward contract." [footnote omitted]

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