• Fifth Circuit Holds that Bankruptcy Code Safe Harbors for “Forward Contract” Apply to Supply Contract
  • August 28, 2012 | Authors: Hollace Topol Cohen; Brian C. Harms; John J. Leonti; Carolyn Peterson Richter
  • Law Firms: Troutman Sanders LLP - New York Office ; Troutman Sanders LLP - Atlanta Office ; Troutman Sanders LLP - New York Office ; Troutman Sanders LLP - Atlanta Office
  • On August 2, 2012, the United States Court of Appeals for the Fifth Circuit (the “Fifth Circuit”) in Lightfoot v. MXEnergy Electric, Incorporated, [1] affirmed the decisions of the district court and bankruptcy court below, holding that payments made by the debtor, MBS Management Services, Incorporated (“MBS”) to MXEnergy Electric, Inc. (“MX”) to reimburse MX for supplying electricity to apartment complexes within the 90 days preceding the MBS chapter 11 filing could not be avoided as preferential transfers because the electric requirements contract was a “forward contract” and therefore, the payments were exempt from avoidance under section 546(e) of the Bankruptcy Code.

    This case is significant because it holds that a supply contract for electricity can qualify as a “forward contract” and benefit from the safe harbor afforded to forward contracts from avoidance of certain transfers under section 546(e) of the Bankruptcy Code.

    Factual Background

    The Debtor, a provider of management services for apartment complexes in Texas and Louisiana, entered into a contract to purchase the “full electric requirements” for certain properties run by its affiliates from Vantage Power Services, LP (“Vantage”) for a 24-month period at a set price per kilowatt hour, based on actual usage. Vantage sold its electrical service agreements in Texas to MX. Within the 90-day period preceding MBS’s filing under the Bankruptcy Code, MBS paid $156,345.93 to MX to cover its affiliates’ electric bills.

    Claude Lightfoot, the Trustee for the MBS Unsecured Creditors’ Trust, brought an avoidance action to recover the payment as an avoidable preferential transfer under section 547(b) of the Bankruptcy Code. The parties stipulated that all the requirements of a preference action had been met. MX, however, countered that the safe harbor provided under section 546(e) of the Bankruptcy Code exempted the payment from avoidance under section 547(b) of the Bankruptcy Code as “a transfer that is a ...settlement payment...made by or to (or for the benefit of) a...forward contract merchant...that is made before the commencement of the case....” A “forward contract” is defined in section 101(25) of the Bankruptcy Code as “a contract...for the purchase, sale, or transfer of a commodity...with a maturity date more than two days after the date the contract is entered into.” A “forward contract merchant” is defined in section 101(26) of the Bankruptcy Code 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...which is presently or in the future becomes the subject of dealing in the forward contract trade.”

    The Trustee’s Position

    The Trustee maintained that the electric requirements agreement was not a “forward contract” because it did not specify the quantity of electricity to be purchased or the specific delivery dates. As the Fifth Circuit noted, the Trustee’s argument, if correct, would exclude many natural gas, fuel and electricity requirements contracts from the safe harbor provided in section 546(e). The Fifth Circuit noted that its task was “to apply the statutory provisions as Congress wrote them” and found nothing in the definition of “forward contract” or section 546(e) that supported the Trustee’s limitation that the contract must specify the quantity of electricity and the specific delivery dates. The Fifth Circuit found it sufficient that no delivery of electricity under the contract was scheduled to occur in less than two days from the date thereof for the contract to qualify as a forward contract.

    In support of his argument, the Trustee contended that in both the decision of the Fifth Circuit in In re Olympic Natural Gas, [2] and in the Fourth Circuit’s decision in In re National Gas Distributors, LLC, [3] the contract in question specified exact quantities and delivery dates. However, the Fifth Circuit pointed out that in Olympic, while exact price and delivery date were embodied in the forward contracts, there was no such statutory requirement. The court further held that the National Gas Distributors decision was inapposite since that involved a “forward agreement” as used in the definition of “swap agreement” and not a “forward contract” and, as such, related to the definition of swap agreement in section 101(53B) and the safe harbor for swap agreements in section 546(g) of the Bankruptcy Code.

    The Fifth Circuit’s Analysis and Holding

    The Fifth Circuit noted that the Trustee’s arguments reflected concerns previously expressed in other cases that “ordinary supply contracts” should not have the benefit of the safe harbors. The court held that these concerns are immaterial to the plain statutory language and noted that in Olympic, it had rejected several arguments designed to narrow the scope of the definition of “forward contract” under section 101(25). In Olympic, the Fifth Circuit found “no reason to...distinguish between ‘financial’ forward contracts, and ‘ordinary purchase and sale’ forward contracts, when the statutory language made no such distinction.” [4] The court also rejected the Trustee’s argument below that both parties to the forward contract needed to be a forward contract merchant and pointed out that the language of section 546(e) “by or to a forward contract merchant” indicated that a forward contract merchant need only be on one side of the purchase or sale.

    The court quoted from the bankruptcy court’s opinion summarizing the expert testimony before the bankruptcy court:

    “[F]orward contracts are negotiated between industry participants and forward contract merchants. The industry participants are either producers or users of the commodity who sell or purchase the commodity in advance to hedge against price fluctuations. Forward contract merchants create or manage commodity markets by providing a place for industry participants to buy or sell a commodity in advance of its actual production.

    ...The forward contract merchant must deliver on the contracts to which it commits by supplying the commodity or taking delivery. While forward contracts provide an imperfect hedge against fluctuations in supply, the risks...can be managed.... As a result, forward contracts for electricity do not typically limit the quantity sold or purchased. Instead, they are generally for the entire needs or demands of the purchaser.” [5]

    The Fifth Circuit, thus, found the type of forward contract between the debtor and MX was within the class covered by sections 101(25) and 546(e).

    The MX Energy decision clarifies that forward contracts which are in the nature of supply contracts should be protected by the safe harbor afforded under section 546(e) from claw back of a preferential transfer. [6] This is a welcome decision for parties who enter into forward contracts.

    [1] Lightfoot v. MXEnergy Electric, Incorporated (In re MBS Management Service, Inc.), No. 11-30553, 2012 lexis 15995 (5th Cir. Aug. 2, 2012).

    [2] 294 F.3d 737, 740-741 (5th Cir. 2002).

    [3] 556 F.3d 247 (4th Cir. 2009).

    [4] 294 F.3d at 742.

    [5] In re MBS Mgmt Svcs., Inc., 432 B.R. 570, 575-76 (Bankr. E.D. La. 2010).

    [6] It is worth noting that the Fifth Circuit in a footnote pointed out that it did not resolve whether a residential consumer, who has a contract with his local utility company to lock in a favorable rate, and who then files for bankruptcy, has entered into a contract shielded by section 546(e) from avoidance of a preference.