An interesting article recently published in the National Law Review by David A. Zdunkewicz of Andrews Kurth LLP regarding the Second Circuit Court of Appeals protecting payments made by Enron to redeem commercial paper prior to maturity as “Settlement Payments” under the Bankruptcy Code’s Safe Harbor Provisions.
In a matter of first impression in In Re: Enron Creditors Recovery Corp., v. ALFA, S.A.B. DE C.V., et al., No. 09-5122-bk(L) the United States Court of Appeals for the Second Circuit sided with two holders of Enron’s commercial paper who received prepetition payments redeeming the paper prior to its stated maturity. The price paid by Enron to redeem the debt was considerably higher than the market value of the debt.
Enron argued that the payments were either preferential or constructively fraudulent transfers and were not “settlement payments” under section 546(e) of the Bankruptcy Code because (i) the payments were not “commonly used in the securities trade,” (ii) the definition of “settlement payment” includes only transactions in which title to the securities changes hands and, therefore, because the redemption was made to retire debt and not to acquire title to the commercial paper, no title changed hands and the redemption payments are not settlement payments, and (iii) the redemption payments are not settlement payments because they did not involve a financial intermediary that took title to the transacted securities and thus did not implicate the risks that prompted Congress to enact the safe harbor.
The Second Circuit rejected each of Enron’s arguments, holding that the payments qualified as “settlement payments” under the Bankruptcy Code’s safe harbor provisions.
As to Enron’s first argument, the Court disagreed that the payments must have been common in the securities trade to qualify as a settlement payment under the Bankruptcy Code. Section 741(8) of the Bankruptcy Code defines “settlement payment” as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.” Enron argued that the phrase “commonly used in the securities trade” modified each of the preceding terms in section 741(8), not only the immediately preceding term. The Second Circuit disagreed and held that the phrase “commonly used in the securities trade” only modified the immediately preceding term in Section 741(8), i.e. it only modified “similar payment.” Thus there is no requirement that the payments made to the holders be common in the securities trade.
As to Enron’s second argument, the Second Circuit found nothing in the Bankruptcy Code or the relevant caselaw to exclude the redemption of debt securities from the definition of a settlement payment. Accordingly, there is no requirement, as Enron argued, that title to the securities change hands for the payment to be considered a settlement payment under the Bankruptcy Code.
Finally, the Second Circuit rejected the third argument advanced by Enron. Enron argued that the redemption of debt did not constitute a settlement payment because it did not involve a financial intermediary that took a beneficial interest in the securities during the course of the transaction. Thus, the argument goes, the redemption would not implicate the systemic risks that motivated Congress to enact the safe harbor provision for settlement payments.
The Second Circuit rejected the argument and held that the fact that a financial intermediary did not take title to the securities during the course of the transaction is a proper basis to deny safe-harbor protection, joining the Third, Sixth, and Eighth Circuits in rejecting similar arguments. The Court stressed that § 546(e) applies to settlement payments made “by or to (or for the benefit of)” a number of participants in the financial markets and it would be inconsistent with this language to restrict the definition of “settlement payment” to require that a financial intermediary take title to the securities during the course of the transaction.
While each case must be determined on a case-by-base analysis, the Second Circuit’s ruling in Enron reflects a continued trend among the Court of Appeals to broadly interpret the safe harbor provisions of the Bankruptcy Code and protect covered transactions.