• Forward Contract Exceptions to The Automatic Stay Are Narrowed
  • December 1, 2004 | Author: Lydia T. Protopapas
  • Law Firm: Weil, Gotshal & Manges LLP - Houston Office
  • The United States Bankruptcy Court for the Northern District of Texas in the case Mirant Americas Energy Marketing, L.P. v. Kern Oil & Refining Co. (In re Mirant Corp.) recently examined the scope of the forward contract exceptions to the automatic stay. The bankruptcy court concluded that if a person does not specifically enter into a forward contract in order to earn a profit in the forward contract trade, he may not terminate and settle amounts due under a forward contract with a counterparty who is a chapter 11 debtor unless he first obtains relief from the automatic stay.

    Sections 362(b)(6) and 556 Of the Bankruptcy Code

    When a debtor files a petition to commence a case under the Bankruptcy Code, an automatic stay goes into effect that generally prohibits creditors from taking any further actions to enforce their rights against the debtor or its property. Section 362(b) of the Bankruptcy Code sets forth a list of exceptions to the automatic stay. Section 362(b)(6) excepts from the automatic stay "the setoff by a . . . forward contract merchant . . . of any mutual debt and claim that constitutes the setoff of a claim against the debtor for a . . . settlement payment against cash . . . or other property due from such . . . forward contract merchant." While section 362(b)(6) excepts offset of a forward contract by a forward contract merchant from the automatic stay, section 556 of the Bankruptcy Code excepts termination or liquidation of a forward contract by a forward contract merchant from the automatic stay.

    Sections 101(25) and 101(26) of the Bankruptcy Code define a "forward contract" and "forward contract merchant," respectively. A "forward contract" is defined by the Bankruptcy Code "as a contract (other than a commodity contract) for the purchase, sale or transfer of a commodity . . . or any similar good, article, service, right, or interest which is presently or in the future becomes the subject of dealing in the forward contract trade . . . with a maturity date more than two days after the date the contract is entered into . . . ." A "forward contract merchant" is defined, in relevant part, as "a person whose business consists in whole or in part of entering into forward contracts as or with merchants in a commodity . . . ."

    Factual Background

    Mirant Corp. and its related entities are in the business of producing, marketing and trading energy products. In 2002, Mirant Americas Energy Marketing, L.P. ("Mirant"), a subsidiary of Mirant Corp. through which the trading and supply of products such as natural gas has been conducted, and Kern Oil & Refining Co. ("Kern") entered into a gas master service agreement and transaction agreement pursuant to which Mirant agreed to sell natural gas to Kern at a fixed price. Mirant and Kern also executed a master monthly netting, close-out netting and margin agreement which permitted the parties to net-out reciprocal obligations. Mirant later filed a chapter 11 petition and upon commencement of its case, filed an emergency motion (the "Trading Motion") with the bankruptcy court seeking protections for parties to transactions with Mirant that were entitled to the benefits of sections 362(b)(6) and 556 of the Bankruptcy Code. The bankruptcy court entered an interim order authorizing the relief requested in the Trading Motion. Kern objected to the Trading Motion and requested that it receive the protections afforded to parties under the interim order. Mirant asserted that the agreement with Kern was not a forward contract and, therefore, Kern was not entitled to the protections under the interim order. The bankruptcy court entered a final order authorizing the relief requested in the Trading Motion but provided that nothing in the order shall prevent any party not treated by the debtors as protected by the order from asserting their entitlement to the benefits of section 362(b) or section 556.

    For some time after the initiation of its bankruptcy case, Mirant continued to supply gas to Kern. Thereafter, however, Mirant notified Kern that it was seeking bankruptcy court approval to reject its contracts with Kern. Before the contract rejections became effective, however, Kern terminated the gas supply contracts in accordance with section 556 of the Bankruptcy Code and reversed wire transfer payments that it had recently made to Mirant for amounts due under the contracts. Notwithstanding the termination and rejection of the contracts, Mirant continued delivering gas to Kern. Kern did not pay for these post-termination rejection date gas deliveries because it believed it was entitled to offset the amounts it owed to Mirant against the damages it suffered as a result of Mirant's rejection of its remaining obligations under the contracts.

    Mirant thereafter sued Kern seeking (a) a determination that Kern's termination of the gas supply agreements violated the automatic stay provisions of the Bankruptcy Code (which broadly prohibit creditors such as Kern from exercising control over, seeking to obtain possession of, or interfering with, a chapter 11 debtor's property interests); (b) to recover amounts owing for unpaid postpetition gas deliveries; and (c) to recover amounts removed from its accounts as a result of Kern's wire transfer reversals and to obtain a determination that such actions violated the automatic stay by improperly seeking to obtain possession of Mirant's property.

    In response to these allegations, Kern argued that its agreements with Mirant constituted a forward contract and, therefore, it was entitled to the benefits and protections of sections 362(b)(6) and 556 of the Bankruptcy Code. Kern argued that its termination of the gas supply agreements was authorized by section 556 of the Bankruptcy Code, which expressly excepts "forward contract merchants" such as Kern from the automatic stay where they are merely seeking to terminate and settle amounts owing under "forward contracts" such as the gas supply agreements. Not only did Kern argue that it was entitled to the benefits of section 556, it also argued that the final order authorizing the Trading Motion entitled Kern to liquidate its agreements with Mirant. Kern also asserted that pursuant to section 362(b)(6) of the Bankruptcy Code, its setoff of the rejection damage claim against amounts owed to Mirant was protected. Kern also argued that it did not owe Mirant for either the unpaid gas deliveries or the reversed wire transfers because the parties' netting agreement expressly entitled Kern to offset amounts it owed Mirant against amounts Mirant owed Kern for rejecting its contracts.

    The Bankruptcy Court's Decision

    The bankruptcy court first addressed whether the reversal of the wire transfer to Mirant violated the automatic stay. The court determined that the wire transfer reversals did violate the automatic stay because they resulted in the removal of property from Mirant's bank accounts and were not otherwise authorized by either section 362(b)(6) or 556 of the Bankruptcy Code. Even so, the court found that because Kern did nothing more than direct its bank to reverse the prior payments, it was unclear from the evidence in the record whether Kern or the bank violated the automatic stay. As such, the court merely ruled that someone (not necessarily Kern) violated the automatic stay.

    The bankruptcy court then addressed whether the post-termination deliveries of natural gas to Kern violated the automatic stay. The court concluded that nothing in Kern's acceptance of deliveries post-termination violated the automatic stay and that Mirant was entitled to payment for such deliveries. The court deferred a determination as to the amount owed by Kern until a later date.

    The court next considered whether the benefits of the order approving the Trading Motion could be extended to Kern. Although Kern was on notice that it was not protected by the final order approving the Trading Motion, the court concluded that Kern should not be prejudiced from its reliance on the order unless it can be shown "Kern acted in bad faith in claiming coverage by that order." The court concluded that Kern would be prejudiced if subject to sanctions for violation of the stay for the offsets it made. However, the court determined that if Kern was not protected by the order, it would remain liable for amounts offset or not paid for.

    In evaluating whether Kern's offset and termination of the gas supply contracts were subject to the automatic stay exceptions set forth in Bankruptcy Code sections 362(b)(6) and 556, the court first considered whether the relevant gas supply agreements qualified as "forward contracts." The court determined that because natural gas is a "commodity" and the contracts "matured" more than two days after the date on which they were executed, these two threshold requirements for a forward contract were met.

    The primary remaining requirement thus concerned whether the gas supply agreements were contracts "other than a commodity contract." The court suggested that although the definition of "forward contract" could be read to exclude ordinary commodity contracts such as the gas supply contracts, the better view (and the one that it was bound by Fifth Circuit precedent to follow) is that forward contracts exclude only those commodity contracts that are subject to the rules of a contract market or board of trade but include commodity contracts that are not subject to a contract market or board of trade. Because the Mirant/Kern natural gas contracts were off-exchange commodity contracts that were not subject to a contract market or board of trade, the court concluded that the gas contracts did qualify as "forward contracts" that were "other than commodity contracts."

    The court next considered whether Kern, the party seeking the protections afforded by Bankruptcy Code sections 362(b)(6) and 556, was a "forward contract merchant." Based on the definition of a "forward contract merchant," Kern urged the court to find that any person who enters into a forward contract is a "forward contract merchant" within the meaning of the Bankruptcy Code. The court rejected this view, however, reasoning that if Congress had intended such a result, it would have simply stated the definition of a forward contract merchant as "any person who enters into forward contracts." Because Congress did not so define the term, and the rules of statutory construction require that each word in a statute be accorded significance, the court proceeded to assign such significance to what it viewed as the two operative terms in the definition of a "forward contract merchant," namely "business" (i.e., something one engages in to generate a profit) and "merchant" (i.e., a person who does not act as either an end-user or a producer, but is instead a person who buys, sells, or trades in a market). Based on these definitions, the court concluded that a forward contract merchant is "a person that, in order to profit, engages in the forward contract trade as a merchant or with merchants." Because the evidence did not show that Kern entered into the gas supply agreements seeking to profit in the forward contract trade market, it was not a "forward contract merchant" and was not therefore entitled to offset or terminate the gas supply agreements pursuant to the exceptions to the automatic stay set forth in sections 362(b)(6) and 556 of the Bankruptcy Code.

    Moreover, in considering whether Kern had properly offset amounts owed to Mirant for postpetition gas deliveries against amounts owed by Mirant for contract rejection damages, the court determined that even though the gas supply agreements permitted the parties to net obligations owed by them, such provisions did not govern Kern's attempted offset because it had terminated the contracts, which included such netting provisions prior to effectuating its offset.

    Conclusion

    The Mirant court's interpretation of the term "forward contract merchant" substantially narrows the class of persons who may, absent stay relief, terminate and settle amounts owing under forward contracts to which chapter 11 debtors are parties. In accordance with this holding, only those parties who enter into forward contracts as participants seeking to profit in the forward contract trade market will be entitled to the protections of sections 362(b)(6) and 556 of the Bankruptcy Code.

    Mirant Ams. Energy Mktg., L.P. v. Kern Oil & Ref. Co. (In re Mirant Corp.), 310 B.R. 548 (Bankr. N.D. Tex. 2004).