The Forward Contract Merchant Requirement
Having established the existence of a forward contract, one of the parties to the contract must be a forward contract merchant to invoke section 546(e). The Bankruptcy Code defines in section 101(26) a “forward contract merchant” in relevant part as “an entity the business of which consists in whole or in part of entering into forward contracts as or with merchants in a commodity or any similar good . . . which is presently or in the future becomes the subject of dealing in the forward contract trade.” Courts and commentators alike have interpreted this definition broadly and narrowly. For instance, Collier on Bankruptcy ¶ 556.03 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.) provides that “[t]he language ‘in whole or in part’ in th[e] definition substantially broadens its coverage to include any person that enters into forward contracts as or with merchants in a commodity business context.” At least one bankruptcy court has followed Collier’s broad definition, which arguably would apply to supply-of-goods contracts.
Other courts, however, have followed a narrower definition espoused by Judge Dennis M. Lynn in Mirant Americas Energy Marketing, L.P. v. Kern Oil & Refining Co. (In re Mirant Corp.), 310 B.R. 548 (Bankr. N.D. Tex. 2004). In that case, Judge Lynn focused on the undefined terms “business” and “merchant” within the term “forward contract merchant” and found that the definition is limited in scope. Specifically, Judge Lynn defined “merchant” as “one that is not acting as either an end-user or a producer. Rather, a merchant is one that buys, sells, or trades in a market.” Judge Lynn further defined “business” as “something one engages in to generate a profit.” Accordingly, the court defined a forward contract merchant to be “a person that, in order to profit, engages in the forward contract trade as a merchant or with merchants,” with “merchant” meaning an individual or entity that is not acting as either an end-user or a producer. This construction gives effect to all parts of the definition because “[w]ithout references to ‘business’ and ‘merchant,’ the definition of ‘forward contract merchant’ could as easily have been ‘a person that enters into forward contracts.’” Most courts have adopted this interpretation over Collier’s construction.
Judge Lynn’s interpretation, if followed, might preclude the application of section 546(e) to an ordinary supply-of-goods contract. In such a context, a buyer simply purchases goods from a supplier. The buyer is an end-user and the supplier is a producer. To fall within the definition’s scope, a merchant would have to buy, sell, or trade the underlying contract in a financial market. This interpretation is not only logical, but also gives effect to Congress’s overall intentions in enacting section 546(e).
Transfers as Settlement Payments
Once the existence of a forward contract and forward contract merchant are established, a defendant must finally show that the transfers at issue constitute settlement payments. The Bankruptcy Code at section 101(51A) defines a “settlement payment” as, “for purposes of the forward contract provisions of this title, a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, a net settlement payment, or any other similar payment commonly used in the forward contract trade.” Although tautological, courts have held that a commodity settlement payment must, at a minimum, be some kind of payment on a commodity forward contract. Therefore, any payment on account of a forward contract likely falls within the definition, making this element easily met.
As the foregoing discussion demonstrates, the requirements to enter the safe harbor are seemingly straightforward, but the definitional issues may make section 546(e) much broader than Congress intended.
Section 546(g) and Swap Agreements
If unable to meet any of the elements contained in section 546(e), a party may seek protection under section 546(g). Except for actual fraudulent transfers, section 546(g) prohibits a bankruptcy trustee from avoiding a transfer made by or to (or for the benefit of) a swap participant or financial participant, under or in connection with any swap agreement that is made before the commencement of the case. To establish a section 546(g) defense, a defendant must show that: (1) the parties entered into a “swap agreement”; (2) one of the parties to the swap agreement is a “swap participant” or “financial participant”; and (3) the transfer was made “under or in connection with” the swap agreement. The second and third elements rarely are litigated because the essential element is whether a swap agreement exists. If a swap agreement exists, section 546(g) undoubtedly will be satisfied because the transfer sought to be avoided will be in connection with a swap agreement to a “swap participant,” which is defined as an entity that, at any time before the filing of the petition, has an outstanding swap agreement with the debtor.
Establishing the Existence of a Swap Agreement
The Bankruptcy Code defines a “swap agreement” broadly as, in relevant part, a commodity index or a commodity swap, option, future, or forward agreement. Although the Bankruptcy Code defines a “forward contract,” it does not define a “commodity forward agreement.” The leading and only authoritative case on the term “commodity forward agreement” is the Fourth Circuit’s decision in Hutson v. E.I. du Pont de Nemours & Co. (In re National Gas Distributors, LLC), 556 F.3d 247, 259–60 (4th Cir. 2009). In that case, the Fourth Circuit held that a commodity forward agreement exists when the following are present: (1) the subject of the agreement must be a commodity; (2) the agreement must require a payment for the commodity at a price fixed at the time of contracting for delivery more than two days after the date into which the contract is entered; (3) the quantity and time elements of the agreement must be fixed at the time of contracting; and (4) the agreement must have a relationship with the financial markets (although it need not be traded on an exchange or be assignable).
Subject to the previous discussion regarding section 546(e), the first three elements for a swap agreement likely will be met in the context of an ordinary supply-of-goods contract. Yet, the contract must also have a relationship with the financial markets. Whether this is the case depends on the terms of the contract. For instance, a purchase order for oil could have a relationship to the financial markets if the price of the oil depends on the overall market price for oil. On the other hand, a purchase order for corn at a fixed price likely lacks a relationship with the financial markets. Again, a litigator could use expert testimony to determine whether the agreement has such a relationship.
To be fair, Hutson’s interpretation of “commodity forward agreement” is problematic because it nullifies the forward contract merchant requirement that exists in section 546(e). In other words, a contract that does not meet the definition of “forward contract” for purposes of section 546(e) may meet the requirements of a forward agreement for purposes of section 546(g). In reaching its decision, the court in Hutson determined that the term “agreement” is broader than the term “contract”: “As Black’s states, the term ‘agreement,’ although frequently used as synonymous with the word ‘contract,’ is really an expression of greater breadth of meaning and less technicality. Every contract is an agreement; but not every agreement is a contract.” Using Hutson’s definition, any party to a commodity forward agreement can invoke the safe-harbor protections, even if neither party is a forward contract merchant.
Whether this was Congress’s intention is unclear. On the one hand, Congress seemingly intended a broad definition by stating that “[t]he use of the term ‘forward’ in the definition of ‘swap agreement’ is not intended to refer only to transactions that fall within the definition of ‘forward contract.’ Instead, a ‘forward’ transaction could be a ‘swap agreement’ even if not a ‘forward contract.’” H.R. Rep. No. 109-31, at 122 (2005), reprinted in 2005 U.S.C.C.A.N. 88, 184. On the other hand, Congress also stated that “[t]he definition of ‘swap agreement’ . . . should not be interpreted to permit parties to document non-swaps as swap transactions. Traditional commercial arrangements, such as supply agreements . . . cannot be treated as ‘swaps’ under . . . the Bankruptcy Code because the parties purport to document or label the transactions as ‘swap agreements.’”
As of now, the Hutson elements, if followed, would protect any commodity forward agreement that has a relationship with the financial markets, even if neither party is a forward contract merchant. Similar to section 546(e), the definitional issues of section 546(g) may render section 546(g) broad enough to encompass supply-of-goods contracts.
Congress’s adoption of sections 546(e) and 546(g) has created unintended results. Although clearly seeking to protect transfers made in connection with forward contracts and swap agreements relating to financial markets, Congress may have inadvertently protected transfers made in connection with ordinary supply-of-goods contracts. If the legislative history surrounding the safe-harbor provisions accurately reflects Congress’s intentions, the provisions should be amended to expressly exclude supply-of-goods contracts. As it currently stands, litigators that prosecute or defend bankruptcy avoidance actions should familiarize themselves with the safe-harbor provisions because their ambiguities may present unanticipated curveballs in what normally are considered straightforward avoidance actions.