Shmuel Vasser
Dechert LLP 1095 Avenue of the Americas New York, New York 10036 +1 212 698 3500

This presentation is provided by Dechert LLP for educational and informational purposes only and is not intended and should not be construed as legal advice. This presentation is considered attorney advertising in some jurisdictions. © 2008 All Rights Reserved

© 2008 Dechert LLP

Table of Contents
I. II. III. IV. V. VI. VII. VIII. IX. X. XI. XII. XIII. XIV. XV. XVI. XVII. XVIII. Public Policy Concerns Repurchase Agreements Forward Contracts Securities Contracts Swaps Commodity Contracts Distinction Between Forwards and Commodities Contracts Ipso Facto Provisions Enforceable Application of Automatic Stay to Termination Setoff/Netting Damages Avoidance Actions Exception Section 105 Recharacterization Issues Mandatory Subordination issues Preemption/Chapter 11 Plan Conflict Applicability to Chapter 9/Ancillary Proceedings Glossary of Commonly Used Terms 3 7 12 16 23 26 30 34 38 41 47 50 56 57 58 62 63 64


Derivatives in Bankruptcy

I. Public Policy Concerns


The legislative history to the Safe Harbor Provisions indicates strong Congressional policy to protect American financial markets and institutions from the ripple effects resulting from a bankruptcy filing by a major player in the financial markets. These provisions are designed to protect the financial markets from systemic risks.
± It is essential that stockbrokers and securities clearing agencies be protected from the issuance of a court or administrative agency order which would stay the prompt liquidation of an insolvent's positions, because market fluctuations in the securities markets create an inordinate risk that the insolvency of one party could trigger a chain reaction of insolvencies of the others who carry accounts for that party and undermine the integrity of those markets.

See Statement of Senator Dole, 128 Cong. Rec. S8,132-33 (daily ed. July 13, 1982).
± The legislative history to the Act to Amend Title 11 of the United States Code Regarding Swap Agreements and Forward Contracts, Pub. L. 101-311, 104 Stat. 268, is similarly a testament to the public policy behind the safe harbor provisions.

See Statement of Senator DeConcini, 135 Cong. Rec. S1414 (daily ed. Feb. 9, 1989).


Derivatives in Bankruptcy

forward contracts. at S1416. The 1982 amendments were "intended to minimize the displacement caused in the commodities and securities markets in the event of a bankruptcy affecting these industries. Congress has recognized the need to amend certain aspects of the Bankruptcy Code in order to continue to provide the necessary speed and certainty in complex financial transactions." 128 Cong. The same rationale supported the 1984 amendments. Id." recognizing the "potential volatile nature of the markets. I am not aware of any opposition to the legislation. at S1415. H261 (daily ed. 9. These protections should be extended to the swap and forward foreign exchange agreements for the same reasons. Feb. 1982). Public Securities Association. and others. Securities Industry Association. Rec. commodity contracts and repurchase agreements. 4 Derivatives in Bankruptcy . ‡ As new financial instruments have been developed. Id.Public Policy Concerns (cont¶d) ‡ The legislation is supported by the Federal Reserve Board. In 1982 and again in 1984 Congress amended section 362 to exempt the termination and setoff of mutual debts and claims arising under securities contracts. New York Clearinghouse Association. International Swap Dealers Association.

. ± ³The commodities and securities markets operate through a complex system of accounts and guarantees. 97-420. Rep. 5 Derivatives in Bankruptcy .´ H. Rep.Public Policy Concerns (cont¶d) ‡ As Congress recognized at the time of the 1982 and 1984 amendments. 98-65. counterparties could be faced with substantial losses if forced to await bankruptcy court decision on assumption or rejection of financial transaction agreements. at 1 (1982).R. Because of the structure of the clearing systems in these industries and the sometimes volatile nature of the markets. certain protections are necessary to prevent the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market. There is a clear need for Congress to assure counterparties that they will be able to terminate these agreements and exercise contractual liquidation and netting rights if a party to the agreement files for bankruptcy relief. . at 44-49 (1983) contains a description of importance of repo markets ³to the health of the country¶s financial system´ ± including importance to state and local governments ± and uncertainty as to coverage of securities contract provisions. the financial markets can move significantly in a manner of minutes. ± S. No. at S1417. No. . where the markets change gradually. Id. Unlike ordinary leases or executory contracts. The markets will not wait for a court decision .

± 6 Derivatives in Bankruptcy . Rep. 109-8. 2006. and contains provisions expanding the protections for derivative and financial contract transactions. at 1-4 (1990) contains description of importance and vulnerability of swap and forward contract markets. Pub. L. No. Pub. 109-390. signed into law on April 20. signed into law on December 12. 101-484. 2005.Public Policy Concerns (cont¶d) ± ± H. L. amends the Bankruptcy Code effective October 17. 2005. The Financial Netting Improvements Act of 2006. makes certain technical amendments and clarifications to the various provisions dealing with derivative and financial contract transactions.R. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

or that is fully guaranteed by.S. qualified foreign government securities (representing a direct obligation of. a master agreement that provides for an agreement or transaction referred to above. with simultaneous agreement by transferee to transfer the instruments back. interests in mortgage related securities or mortgage loans. ‡ ‡ ‡ ‡ ± ± ± any combination of agreements or transactions described in (i) and (iii). or are fully guaranteed by the U. eligible bankers¶ acceptances. mortgage related securities (as defined in Section 3 of the Securities Exchange Act of 1934). including related terms ‡ ‡ ‡ provides for a transfer. an option to enter into an agreement or transaction described in (i) or (ii). against transfer of funds by the transferee. together with all supplements to any such master agreement. Repurchase Agreements ‡ Defined in §101(47): ± an agreement.II. except that such master agreement shall be considered to be a repurchase agreement under this paragraph only with respect to each agreement or transaction under the master agreement that is referred to above. at a date certain not later than one year after the transfer. securities that are direct obligations of.S. or U. against transfer of fund. without regard to whether such master agreement provides for an agreement or transaction that is not a repurchase agreement under this paragraph. of certificates of deposit. agency. or on demand. mortgage loans. or 7 Derivatives in Bankruptcy . the central government of a member of the organization for Economic Cooperation and Development).

Del. ‡ Does not include a repurchase obligation under a participation in a commercial mortgage loan. D. ‡ 8 Derivatives in Bankruptcy . (iii). Mortgage related securities: A security that is rated in one of the two highest rating categories by at least one nationally recognized statistical rating agency. 388 B.R. but not to exceed the damages in connection with any such agreement or transaction. 69 (Bankr. measured in accordance with section 562. (ii). or (iv). ‡ Applies to reverse repos: A Repo in which the broker-dealer rather than being the initial seller. is the initial buyer. do not meet the definition). Lehman Brothers. including any guarantee or reimbursement obligation by or to a repo participant or financial participant in connection with any agreement or transaction referred to in any such clause. 2008) (notes secured by mortgages rated BBB by S&P and Baa2 by Moody¶s. American Home Mortgage v.Repurchase Agreements (cont¶d) ± any security agreement or arrangement or other credit enhancement related to any agreement or transaction referred to in clause (i).

The legislative history to the 2005 amendments states that the intent is to cover obligations issued or guaranteed by Fannie Mae and Freddie Mac as well as all obligations eligible for purchase by Federal Reserve banks under the similar language of § 14(b) of the Federal Reserve Act. Lehman. codified at 12 C. What is a U.F. § 201.108 (2005). American Home Mortgage v.Repurchase Agreements (cont¶d) ‡ Interest in mortgage loans: Notes secured by mortgage loans qualify. Board of Governors¶ interpretation FRRS 2-040.R. Eligible bankers¶ acceptances: Probably refers to bankers¶ acceptances authorized under § 13(7) of the Federal Reserve Act. supra. lists 20 principal type obligations that qualify.S. Bankers¶ acceptances are essentially thirdparty obligations which the bank committed to honor. ‡ ‡ ± 9 Derivatives in Bankruptcy . pursuant to resolutions of the Board of Governors of the Federal Reserve System. Agency? ± Legislative History: Intended to cover entities whose obligations are eligible for purchase by federal reserve banks.

or a clearing organization (as defined in section 402 of the Federal Deposit Insurance Corporation Improvement Act of 1991). ‡ ‡ A repo is essentially a current sale and a forward contract. commodity contract. forward contracts. or at the time of the date of the filing of the petition. at the time it enters into a securities contract. swap agreement.000. swaps or master netting agreements with the debtor or any other entity (other than an affiliate) of a total gross dollar value of not less than $1. or has gross mark-to-market positions of not less than $100. has one or more securities contracts.000 in notional or actual principal amount outstanding on any day during the15month period prior to the petition date. repurchase agreement. or forward contract. repos.000.000.000 (aggregated across counterparties) in one or more such agreements or transactions with the debtor or any other entity (other than an affiliate) on any day during the 15-month period prior to the petition date.Repurchase Agreements (cont¶d) ± Protected Party ± repo participant (§ 101(46)): ‡ ‡ ‡ any entity at any time before bankruptcy has outstanding repo with the debtor ± Financial Participant (§ 101(22A)) ‡ an entity that. commodities contracts. 10 Derivatives in Bankruptcy .

J.2d 38. Caylon NY Branch v.Repurchase Agreements (cont¶d) ‡ Economically it is hard to distinguish a repo from a secured loan (underlying securities serve as collateral) since the repurchase price includes interest on the imputed loan created by the repo. Aetna. 1998). 17 F. 802-05 (Bankr. Del. 9th Cir. 513 U. American Home Mortgage Corp. Supp. Nebraska Dep¶t of Revenue v. Comark. C.4 (Bankr.N. 1982).D.A. 503 (Bankr.R. Servicing Rights: Not protected and not subject to the safe harbor provisions even if included in the repo agreement. 806.N.Y. Cal. 41 (2d Cir. ± ± Undecided: CRIIMI MAE.. Bear Stearns..R.. Md. Lowenstein. 2008). Bressler. 379 B. 503 (Bankr. 1986). Drysdale Securities.R. 785 F. D. 809 n. 2008). 145 B. S.R.R.S. ± ± Courts are split on whether non-qualified repos are sales or loans. 25 F. finding the standard repo form to be ambiguous on this point).Y.D. 1986). aff¶d. 2000) (whether a repo is a sale or a loan is a factual question. Bevill. 1992). SEC v. D. 67 B. D. but under the plain meaning cannon of interpretation a contract that meets the statutory definition will be treated is such. 134 (1994) (loans for state tax law purposes).3d 570. 123. 251 B. 23 B. 2d 275. 47 (B.D. Caylon NY Branch v. ± Sales: ‡ Granite Partners v. 1991). 796. 557.R. 11 Derivatives in Bankruptcy .R.P. 596-98 (D. Del. 1994) (loans for insurance law purposes). Loans: ‡ RTC v. Lombard-Wall. American Home Mortgage Corp. 379 B. 124 B. 165 (Bankr. 578-80 (7th Cir. 300-04 (S.N.

but not limited to: repos. article. or product or by product thereof.D. lease. Del.III. hedge. sale or transfer. deposit. reverse repos.26 (Bankr.R. swap. 336 B. 219 (Bankr. with damages subject to § 562.R. of a commodity. allocated or unallocated transaction. monthly nomination of quantities to be delivered six days before delivery date satisfies this requirement)). and security and credit enhancement agreements. loan. any option to enter into these agreements or transactions. N. consignment. service or interest which is presently or in the future becomes the subject of dealing with in the forward contract trade. 214. D. including. 2004). including any similar good. 548. Similar to the repo definition. Forward Contracts ‡ Defined in §101(25): ± ± ± a contract (not a commodity contract). ± ± ± 12 Derivatives in Bankruptcy . maturity means the due date for commencement of performance. or any other similar agreement. for purchase. option. including any combination of agreements or transactions. maturity date of more than 2 days after the contract is entered into (Mirant. master agreements. Tex. Borden Chemicals. 310 B. 565 n. 2006).

326-27 (Bankr. in commodities or other similar good. ± ‡ Note: ± ± ³swap´ is mentioned as included. service or interests. The 2006 amendments made clear that these terms do not refer to the defined term ³repurchase agreement´ The 2006 amendments made clear that the commodity contract carve-out specifically refer to commodity contract as defined in § 761(4). Financial participant (§ 101 (22A)). Entity whose business consists in whole or in part of entering into forward contracts. ± 13 Derivatives in Bankruptcy . 319. not a ³swap agreement´ ³repurchase transaction´ and ³reverse repurchase transaction´ are included. old definition used ³person´ which excludes governmental entities).R.Forward Contracts (cont¶d) ‡ Protected Party ± forward contract merchant (§ 101(26)): ± ± Federal Reserve Bank. not ³repurchase agreement´. Which presently or in the future becomes part of the forward contract trade ± Appears to overrule Mirant.D. ‡ ‡ ‡ as a merchant or with merchants. N. 303 B. 2003) (holding that governmental entities are not protected. Tex.

a forward contract merchant engaging in collection activities for gas it sold may not qualify as a forward contract merchant for settlement payment protections. it buys.D.R. 568 (Bankr. Legislative history suggests that it is a commercial trading firm that offers producers. Tex. See 124 Cong. 2004): a person that.´) ‡ ± ± 14 Derivatives in Bankruptcy . merchants. D. Borden Chemicals. 2006): a party who buys and sells gas using forward contracts qualifies as a merchant. Merchant is not one acting as the end-user or producer.R. Del. Aurora Natural Gas. 310 B. 548.D. Tex. 316 B. 14724-6 (daily ed.R. 7. or with. Rec. 214. 336 B. Sept. 1978) (comment of Senator Mathias) (³Forward contract merchants are commercial trading firms which offer to commercial customers the ability to buy or sell commodities in the physical market on a forward basis. processes it and sells the processed product to Party B ± is it a forward or a service contract? What is a forward contract merchant? ± ± Definition is descriptive Mirant. N. 2004). in order to profit. N.Forward Contracts (cont¶d) ‡ Query: What about a ³mixed´ contract ± Party A purchase gas from Party B. 225 (Bankr. 481 (Bankr. engages in forward contract trade as a. sell or trades in the market. users of commodities and other traders opportunity to buy and sell commodities on a forward basis.

L. which is a forward. L. ‡ What is ³forward contract trade´? ± ± Type of forward contracts that are traded? Type of goods or services that are commonly the subject of forward contracts? ‡ There is an active forward contract market in electricity. D. FERC. A person that has only one forward contract but is otherwise a very large business.D. 21819 (Bankr. N. 336 B. qualifies? Mirant. 214.R.C.3d 1110 (9th Cir. And in Natural Gas.3d 1042 (9th Cir. 245 F. 548 ± probably not.R. Borden Chemicals. 2001). 548 ± probably not. 2004). Mirant. Davies. v. But ± entities that do not qualify as forward contract merchants could still qualify as financial participants. 267 F. 2006). 548 (Bankr. Del.R. 310 B. Tex.R. California Power Exchange Corp. Duke Energy Trading & Marketing. 2001).Forward Contracts (cont¶d) ‡ Query: ± ± ± A person having only one asset/contract. v. 310 B. 310 B. qualifies as forward contract merchant? Mirant. ‡ 15 Derivatives in Bankruptcy .

Securities Contracts ‡ Defined in § 741(7) (not part of the regular chapter 7. the guarantee. certificates of deposit.IV. option entered on a national securities exchange relating to foreign securities. certificate of deposit. including an option to purchase or sell any such security. group or index of securities. 671. 686 (Bankr. certificate of deposit. ± ± 16 Derivatives in Bankruptcy .Y. 2005). but the sub-chapter applicable to stockbroker liquidation): ± ± Contract. Enron. including by novation. or option (whether or not such settlement is in connection with any agreement or transaction referred to in the definition of a´securities contract´). mortgage loan. group or index. or option on any of the foregoing.N. S. by or to a securities clearing agency of a settlement of cash. sale or loan ‡ (query-is redemption/prepayment in full of debt instruments qualifies as a purchase? Not clear.D. or mortgage loans. for purchase. 325 B. or interest therein (including any interest therein or based on value thereof). group or index of securities. or any option to purchase or sell any of the foregoing and any repo or reverse repo on the foregoing (whether or not the repo or reversed repo comes within the definition of a ³repurchase agreement´). certificates of deposit.R. mortgage loans or interests therein. mortgage loan or any interest in a mortgage loan. interest. or mortgage loans or interests therein (including any interest therein or based on the value thereof). securities. ± of a security.

sale or repurchase obligation under a participation in a commercial mortgage loan. option to enter into these agreements or transactions. with damages subject to § 562. Extension of credit for the clearance or settlement of securities transactions. or any total return swap transaction coupled with securities sale transaction. any prepaid forward securities transaction.Securities Contracts (cont¶d) ± ± ± ± ± any margin loan. does not include purchase. ± 17 Derivatives in Bankruptcy . the definition includes any combination of agreements or transactions. Loan transaction coupled with securities collar transaction. master agreements with all supplements and security and credit enhancement agreements. Similarly to forwards and repos. any other agreement or transaction that is similar to an agreement or transaction referred to in the section.

Securities Contracts (cont¶d)

Security defined in § 101(49) to include (not inclusive):
‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ stock, treasury stock, Note, bond, debenture, collateral trust certificate, pre-organization certificate or subscription, transferable share, voting trust certificate, certificate of deposit, certificate of deposit of a security, ‡ ‡ ‡ ‡ investment contract or certificate of interest or participation in a profit- sharing agreement or in oil, gas or mineral royalty or lease, it if is required to be registered under the Securities Act of 1933 or is exempt from registration under § 3(b) of the 33 Act, interest in a limited partnership, other claim or interest commonly known as a security, certificate of interest of participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase or sell, a security.


Derivatives in Bankruptcy

Securities Contracts (cont¶d)


‡ ‡ ‡ ‡ ‡ ‡ currency, check, draft, bill of exchange or bank letter of credit. leverage transaction (§ 761) commodity futures contract forward contracts option, warrant or right to subscribe or purchase/sell a commodity futures contract debt or evidence of indebtedness for goods sold or services rendered.


Limited liability company interests ± constitute a security of the debtor. Iridium Africa, 197 F. Supp. 2d 120, 133 (D. Del. 2002) (Mag. J.), adopted in part, rejected in part on other grounds, 2004 WL 323178 (D. Del. Feb. 13, 2004) (D. J.), and adopted in part, rejected in part on other grounds, 307 F. Supp. 2d 608 (D. Del. 2004). Short term commercial paper ± should be; but the court left it open. Enron, 325 B.R. 671, 686 (Bankr. S.D.N.Y. 2005). CLO notes (notes issued in connection with a collateralized loan obligation structure), are securities. Enron Corp. v. Int¶l Finance Corp., 341 B.R. 451 (Bankr. S.D.N.Y. 2006).




Derivatives in Bankruptcy

Securities Contracts (cont¶d)


Employee stock options are securities. Enron, 341 B.R. 141, 150 (Bankr. S.D.N.Y. 2006). Securities exempt from registration under any exemption other than § 3(b) of the 1933 Act are not securities within the Bankruptcy Code¶s definition. Basin Resources, 182 B.R. 489, 491 (Bankr. N.D. Tex. 1995) (case involved investment contracts and should probably be applied only to these instruments, not to other items listed in the definition). Margin contract where stockbroker advances loans against pledged securities in a margin account qualifies as securities contract. Weisberg, 136 F.3d 655 , 658-59 (9th Cir. 1998). The 2005 amendments specifically list margin loans as a securities contract. § 741(7)(A)(iv). Legislative history to the 2005 amendments states the intent to cover any loans known in the securities industry as margin loans, such as credit permitted under Regulation T of the Federal Reserve or where a protected party extends credit in connection with the purchase, sale, carrying or trading of securities; loans merely secured by securities are not included.





Derivatives in Bankruptcy

98 B. 2. Hamilton Taft. 2008) Protected Parties: ± ± Financial participant (§ 101(22A)) Stockbrokers (§ 101(53A)): has a customer as defined in § 741and is engaged in effecting securities transactions for the account of others or with the general public. 1997). Stewart Finance Co. 114 F. relying on its 10-Q).Securities Contracts (cont¶d) ‡ Non qualified repos for securities. Ga. 816-19 (9th Cir. Residential Resources..3d 991 (9th Cir. 69 (Bankr. 388 B. and the 2006 amendments amended section 741(7)(A) to so provide.R. from of for such person¶s account. D.3d 805. D. Lehman Brothers. The legislative history to the 2005 amendments also states the same intent. Del. 525 F. American Home Mortgage v. Repos for notes secured by mortgage loans qualify both as repurchase agreement and a securities contract. qualify as securities contracts.D. Lehman Brothers. 2008) (analyzing ³customer´ and ³stockbroker´). Securities clearing agencies (§ 101(48)) ‡ ‡ ± 21 Derivatives in Bankruptcy . supra (Lehman Brothers is a stockbroker. 1989). 2007) (Morgan Stanley is protected for a challenged payment although the debtor transferor directed the margin payment be made to an account of a third party (insider)). M. Ariz. Slatkin.R. American Home Mortgage v. 23 (Bankr. 2007 WL 1032263 (Bankr.

and the person has a claim against the broker for security received. 21. aff¶d. the 2006 amendments made clear that the definition of customer in § 741(2) is inapplicable § 741(2) defines a customer essentially as a person with whom the stockbroker acts as principal or agent. 1996) (No. 355 B. W. but noting that it acted as a mere intermediary or conduit). ‡ ‡ Query: Is a private securities transaction subject to the safe-harbor provisions merely because a financial institution is inserted to act as an agent? Munford.3d 604. such customer While customer is not defined. Dec. with a view to sale. 98 F. or as collateral. 2007 (Yes.D. held or acquired by the broker in its ordinary course of business as a broker from or for the account of the customer for safekeeping. Private LBO transaction).R. 22 Derivatives in Bankruptcy . acknowledging the involvement of a financial institution. Quality Stores. Mich. Mich. Investment companies registered under the Investment Companies Act of 1940. 2006).Securities Contracts (cont¶d) ± Financial institutions (§ 101(22)) ‡ ‡ ‡ ‡ mainly banks when a bank acts as agent for a ³customer´ in connection with a securities contract. 629 (Bankr. W. pursuant to a purchase.D. LBO transaction. 610 (11th Cir.

option. same day-tomorrow. an interest rate swap. including a rate floor. option. and basis swap. cross-currency rate swap. or forward agreement. or forward agreement. or other foreign exchange. at 895). forward.R. a spot. option future. future. option. future. weather derivative. Swaps ‡ Swap agreement is defined in § 101(53B): ± ± Any agreement (including terms and conditions incorporated by reference in such agreement). a commodity index or a commodity swap. Emissions swap. credit spread or credit swap. option. option. or Inflation swap. future. tomorrow-next. or forward agreement. or weather options. ± ± ± ± ± ± ± ± ± 23 Derivatives in Bankruptcy . or forward agreement. an equity index or equity swap. future. 369 B. rate cap. or forward agreement. option. future. precious metals or other commodity agreement. or forward agreement. a total return. a currency swap. or future agreement. rate collar. or forward agreement (is the term different from the defined term forward contract? Nat¶l Gas. option.V. a weather swap. future. a debt index or debt swap.

‡ ‡ ‡ The 2005 amendments significantly expanded the definition to specifically cover. 24 Derivatives in Bankruptcy . option or spot transaction on one or more rates. or economic or financial indices or measures of economic or financial risk or value. swap.Swaps (cont¶d) ± any agreement or transaction that is similar to any other agreement or transaction referred to in this paragraph and that ‡ ‡ is of a type that has been. among other things. or economic consequence. the subject of recurrent dealings in the swap markets (including terms and conditions incorporated by reference therein). the definition includes any combination of these agreements or transactions. commercial. is presently. and is a forward. commodities. or contingency associated with a financial. extent of an occurrence. equity and credit derivatives. debt securities or other debt instruments. quantitative measures associated with an occurrence. Similar to the other financial contracts. any option thereon. or other equity instruments. with damages subject to § 562. any master agreement and the supplements and any security or credit enhancement agreement.´ was intended to provide sufficient flexibility to avoid the need to amend the definition as the nature and uses of swaps mature. which included ³any other similar agreements. The amended definition is designed to clarify such intent. The definition applies only for Bankruptcy Code purposes and shall not be applied to challenge or affect the characterization or treatment of swaps under any other statute. The legislative history notes that the original definition. future. equity securities. currencies. regulation or rule. or in the future becomes.

898 (Bankr. ‡ 25 Derivatives in Bankruptcy . 2007) (refusing to treat a forward gas supply agreement as a swap agreement because it was a private supply agreement with no impact on financial markets). National Gas Distributors. ± Financial Participant. LLC. 369 B.Swaps (cont¶d) ‡ Protected Parties ± ³Swap participants´ (§ 101(53C)): An entity that. Legislative history also states that a forward transaction could qualify as a swap even if not qualified as a forward.D. has an outstanding swap agreement with the debtor (no timing limitations).R. 884.N.C. at any time before the bankruptcy filing. E. (§ 101(22A)) ‡ Legislative history to the 2005 amendments states that agreements are not protected just because they are documented as swaps.

ed. rights. except onions as provided in section 13-1 of this title.VI.01(f) as any person registered or required to be registered as a futures commission merchant under the CEA.´ The quoted phrase above was added to CEA in 1974 and was intended by Congress to expand ³the definition of commodity to encompass virtually anything that is or becomes the subject of futures trading.´ except for onions. 2002) (term has the same meaning in § 101(25) (forward contract exclusion)).02[1]. contained in the sub-chapter dealing with commodity broker liquidation. ± CEA § 1a(4) defines ³commodity´ to include a list of agricultural products ³and all other goods and articles. 2004). as well as other specified entities. 294 F. 741 (5th Cir. Commodity is defined in § 761(8) through cross-reference to the Commodity Exchange Act (³CEA´). including clearing organizations. as to which there is a customer. intangible as well as tangible. Commodity Contracts ‡ Defined in § 761(4).3d 737. and all services. are they applicable when the term is used in other chapters without cross-reference? Olympic Natural Gas. and interests in which contracts for future delivery are presently or in the future dealt in. ‡ ‡ ± 26 Derivatives in Bankruptcy . This drafting glitch was corrected in the 2006 amendments to section 101(25). Derivatives Regulation § 1. at 9 (1st. 1 Phillip McBride Johnson & Thomas Lee Hagen. Definitions are limited only to this sub-chapter. Commodity Broker is defined in CFTC¶s Rule 190.

" "Foreign future" is defined in section 761(11) of the Bankruptcy Code as a "contract for the purchase or sale of a commodity for future delivery on. partnership." ± (B) with respect to a foreign futures commission merchant. or other property. a contract market or board of trade. ‡ "Foreign futures commission merchant" is defined in section 761(12) of the Bankruptcy Code as an "entity engaged in soliciting or accepting orders for the purchase or sale of a foreign future or that.Commodity Contracts (cont¶d) ‡ Section 761(4) of the Bankruptcy Code defines a commodity contract as: ± (A) with respect to a futures commission merchant. and (B) in or in connection with such solicitation or acceptance of orders. ‡ "Futures commission merchant" is defined in CEA § 1a(20). or extends credit to margin. a board of trade outside the United States. foreign future." ‡ 27 Derivatives in Bankruptcy . guarantee. corporation. or secure any trades or contracts that result or may result therefrom. or trust that ± (A) is engaged in soliciting or in accepting orders for the purchase or sale of any commodity for future delivery on or subject to the rules of any contract market or derivatives transaction execution facility. as "an individual. accepts any money. which definition is incorporated by section 761(8) of the Bankruptcy Code. or subject to the rules of. association. or property (or extends credit in lieu thereof) to margin. in connection with such a solicitation or acceptance. contract for the purchase or sale of a commodity for future delivery on. a security. or subject to the rules of. or secure any trade or contract that results from such a solicitation or acceptance. accepts cash. guarantee. securities.

§ 31. or the liquidation or rescission of any such leverage contract by or to the leverage transaction merchant.C." "Leverage transaction" is defined in section 761(13) of the Bankruptcy Code as an "agreement that is subject to regulation under section 19 of the [CEA. standardized as to terms and conditions. or leverage contract." 17 C.4(x) (2004). § 31.F.R. ‡ "Clearing organization" is defined in section 761(2) of the Bankruptcy Code as "a derivatives clearing organization registered under the [CEA]." 28 Derivatives in Bankruptcy . and that is commonly known to the commodities trade as a margin account." 17 C. codified as 7 U.F. the repurchase or resale of any leverage contract. a contract market or board of trade that is cleared by such clearing organization. for the long-term (ten years or longer) purchase ('long leverage contract') or sale ('short leverage contract'). The CFTC's regulations define a leverage contract as a "contract. or commodity option traded on. margin contract.S. contract for the purchase or sale of a commodity for future delivery on. § 23]. leverage transaction. ‡ ‡ "Leverage transaction merchant" is defined in section 761(14) of the Bankruptcy Code as a "person in the business of engaging in leverage transactions. or subject to the rules of. the delivery of the leverage commodity. or subject to the rules of. a contract market or board of trade that is cleared by such clearing organization. leverage account.4(w) (2004)." The CFTC's regulations under CEA § 19 describe a leverage transaction as ³the purchase or sale of any leverage contract. ± (D) with respect to a clearing organization.R.Commodity Contracts (cont¶d) ± (C) with respect to a leverage transaction merchant.

' 'indemnity. options.³ ‡ ± The 2005 amendments expanded the definition to cover combinations of agreements and transactions. any transaction involving any commodity regulated under this chapter which is of the character of. with damages subject to § 562. a security.' 'privilege.' 'advance guaranty. 29 Derivatives in Bankruptcy . a customer of such person for the purchase or sale of an interest in a commodity option. regulation or order of the [CFTC] . .' or 'decline guaranty.' 'bid. or is commonly known to the trade as.S. master agreements and security and credit enhancement agreements. or other property from.C." "Commodity option" is defined in section 761(5) of the Bankruptcy Code as an "agreement or transaction subject to regulation under section 4c(b) of the [CEA. or that accepts cash.Commodity Contracts (cont¶d) ± (E) with respect to a commodity options dealer. an 'option." Section 4c(b) of the CEA regulates option trading: "No person shall offer to enter into." ‡ "Commodity options dealer" is defined in section 761(6) of the Bankruptcy Code as a "person that extends credit to. codified as 7 U. § 6c(b)].' 'put. .' 'call.' contrary to any rule. enter into or confirm the execution of. commodity option.' 'offer. .

VII. non-regulated contracts.3d 737. 294 F.¶ In contrast. a contract market or board of trade . 2002) The distinction is essentially between forwards. and futures (or ³commodity´ contracts). specified future date .R. are indeed forward contracts. .3d at 741 (³The term µcommodity contract¶ µencompasses purchases and sales of commodities for future delivery on. which are private. . 258 B. aff¶g Olympic Gas. Distinction Between Forwards and Commodities Contracts ‡ The terms forward contracts and commodity contracts. or subject to the rules of. Olympic Natural Gas. 740-41 (5th Cir. which are regulated by the Commodity Futures Trading Commission (³CFTC´) ± Olympic Natural Gas.¶´) (citations omitted). taken transactions´ as futures and to ³off-exchange transactions´ as forwards). specified quantity of natural gas to be delivered at some certain. 165 (³[C]ontracts for the purchase and sale of a certain. ‡ 30 Derivatives in Bankruptcy . at 163 (referring to ³on. µforward contracts¶ are µcontracts for the future purchase or sale of commodities that are not subject to the rules of a contract market or board of trade.´). . 294 F. . cover the entirety of transactions in the commodity and forward contract markets. .

Derivatives Regulation § 1. Knight Enters. Co Petro Marketing Group. ± CEA § 2 grants to the CFTC exclusive jurisdiction over.´ CEA § 1a(19). As a leading commentator notes: ‡ [T]he phrase future delivery eliminates transactions where an immediate sale occurs but where. however. Inc. and agreements to sell. ‡ ± There is no fixed definition for a futures contract.3d 766. at 23-24.2d 573. among other things. MG Refining & Marketing.02[3]. 581 (9th Cir. ³transactions involving contracts of sale of a commodity for future delivery. but on whether the contract is a futures contract. agreements of sale. the actual transfer of the commodity is deferred. CFTC v.D. 1998) (same). 182 (S. 25 F. In re Bybee. 1982) (³[N]o bright-line definition or list of characterizing elements is determinative. Inc. CFTC v. 680 F...´ The term ³contract of sale´ is defined to include ³sales. 315 (9th Cir. for the convenience of the parties or otherwise. The ³future delivery´ component.2d 309. in historical context. 772 (9th Cir. 945 F. Inc.´). these arrangements frequently are referred to as forward contracts. v. The primary focus of this exclusion.´ CEA § 1a(7). almost everything is a commodity. When the contract contemplates actual delivery.N.Y. 1995) (forward contract exception did not apply because actual delivery was not contemplated). 2d 175. ± 31 Derivatives in Bankruptcy . 67 F. The transaction must be viewed as a whole with a critical eye toward its underlying purpose. was on a common practice in agricultural trade of making binding sales with postponed delivery. Noble Metals Int¶l. is defined in the CEA only by way of exclusion: ³the term µfuture delivery¶ does not include any sale of any cash commodity for deferred shipment or delivery. 1991). Supp..Forwards and Commodities Contracts (cont¶d) ‡ The jurisdictional focus of the CEA is not on what is a commodity. but the obligation is deferred the forward contract exception applies.

Forwards and Commodities Contracts (cont¶d) ‡ The differences and similarities between forwards and futures were explained in Abrams. ± ± ‡ The ultimate determination of whether a contract is a futures contract is highly factual. 32 Derivatives in Bankruptcy . 590-92 (7th Cir. in a forward all of the sale terms are negotiated including price. quality and date of delivery. and the customer generally has no business use for the commodity. and in futures a clearing house is required to effect the sale. the use of standardized forms is significant in finding a futures contract to exist. 1984): ± ± ± forwards are privately negotiated transactions while futures are traded on an exchange. both are designed to shift risks. quantity. but futures generally are not used to obtain actual delivery and are discharged by entering into offsetting transactions while forwards often contemplate actual delivery.2d 582.02[5]. the only open term to be negotiated in a futures is the price. at 32-33. both in theory require actual delivery. 737 F. Commodities Regulation § 1. in a futures contract actual delivery of the commodity is not expected to occur. in forwards the terms are negotiated directly among the parties. The CFTC and the courts have developed certain criteria relevant to the determination: ± ± ± ± the designation of the contract as a futures or forward is not controlling.

2000). 294 F. the contract is among industry participants. 113 F. at 33-34 & n. 2002). 67 F.D. Inc. CFTC v. Fla. Supp.C. 2000). 71 F. Inc. aff¶d.2d at 313-15. 2d at 1263.D. Olympic Gas. 680 F.. Supp.3d at 772-73). and delivery cannot be deferred forever. 971 (4th Cir.3d at 741. Horton Farms. Inc. v. 1998). IBS."). courts examine the parties' objective ability to actually take delivery. 846 (W. Inc. 2d 1257. v. Inc. Salomon Forex. ADM Inv. not the general public. 1263 (S. 33 Derivatives in Bankruptcy .. Supp.02[5]. 1993). CFTC v. Servs.. 71 F. ‡ ‡ Nagel v.3d 308 (6th Cir. 2d 830. Bybee..3d 187 (4th Cir. The Seventh Circuit has refined the multi-factor test and held that if the following three factors exist. Midland Rare Coin Exchange. In reviewing the expectation of delivery element.139 (citing Petro Marketing. 8 F.3d 966.3d 436. Commodities Regulation § 1. Noble Metals. Midland. Inc. Andersons.N. and is not fungible with other contracts for the sale of the commodity. 276 F.. 945 F.2d at 581 ("The contracts here represent speculative ventures in commodity futures which were marketed to those for whom delivery was not an expectation. 166 F. Tauber.Forwards and Commodities Contracts (cont¶d) ‡ The lack of expectation of delivery is the most significant factor. quantity or other terms. 1999). 217 F. the contract is a forward contract not subject to CFTC's regulation: ± ± ± it has idiosyncratic terms regarding place of delivery. 441 (7th Cir.

Tex. or a board of trade as defined in the CEA. 548 (Bankr. ± Mirant. An exception to this general rule is provided for ± ± ± ± Securities contracts (§ 555) Forward and commodities contracts (§ 556) Repos (§ 559) Swaps (§ 560) ‡ ‡ The exception applies to a ³contractual right. multilateral clearing organization as defined in the FDIC Improvement Act of 1991. ‡ 34 The exception requires a qualified protected counter-party. 310 B. Ipso Facto Provisions Enforceable ‡ Generally. or resolution of their board.R. 541(c)(1). also known as ipso facto clauses are unenforceable in bankruptcy.C.´ which includes rights provided for in a rule or by law of a clearing organization (derivative clearing organization as defined in the CEA. 2004) ± parties assumed that Southern California Gas Company is a clearing organization. N. a national securities association. Derivatives in Bankruptcy .S. securities clearing agency). bankruptcy termination.VIII. §§ 365(e)(1). arising under common law. a derivative transaction execution facility designated under the CEA. law of merchant or by reason of usual business practice. or contract market designated under the CEA. a national securities exchange.D. 11 U.

the stockbroker entities filed chapter 11 petitions and did not become subject to SIPA proceedings. 1988. if it is the lender. 2002. ³BMA´) that SIPC would modify its standard from of order. and thereafter would lift the stay or perform the debtor¶s obligations under the transaction. In two major stockbroker failures. that it has a perfected security interest in the collateral. 559) ± At the commencement of SIPA proceeding. ± ± ± 35 Derivatives in Bankruptcy .Ipso Facto Provisions Enforceable ‡ (cont¶d) Courts may interfere with enforcement of ipso facto clauses in securities contracts and repos. including securities loans and repurchases agreements. that SIPC would act promptly to determine whether the subject securities are necessary to satisfy the claims of customers (stating 4 to 5 days after the initiation of the proceeding as a hoped-for time frame). A similar letter addressing repos was issued on February 4. while still barring the immediate close-out of securities lending transactions which would otherwise by protected under Section 555 upon written consent of SIPC and the trustee appointed in the case (thus eliminating the need for court relief). By letter dated August 29. The letter indicates that it is expected that SIPC would consent (and would urge the trustee to consent) if it received an affidavit of the counterparty attesting that it has no knowledge of fraud in the transaction and. and was made applicable to reverse repos by a letter dated June 5. Deputy General Counsel of SIPC advised counsel to The Public Securities Associations (now known as The Bond Market Association. 1986. SIPC generally seeks and obtains an order staying the close-out of at least some securities contracts. or by any statute administered by the SEC (§§ 555. by transferring their customer accounts and giving up their broker/dealer licenses prepetition (thus ceasing to be stockbrokers). Drexel Burnham and Thomson McKinnon. administered by SIPC. if authorized by the Securities Investor Protection Act of 1970.

" H.Ipso Facto Provisions Enforceable (cont¶d) ± The 2005 amendments amend Section 5(b)(2) of SIPA to block SIPC from seeking a stay of the exercise of contractual rights with respect to the various protected contracts. Rep. No. As to swaps the exception applied to the right ³to cause the termination´ of the swap.¶´). or property held with respect to such contracts. D. these sections exempt from the ipso-facto prohibition the right ³to cause the liquidation of´ the securities contracts. 77 B. ± The ³liquidation´ term used is understood to mean. but might be stayed from foreclosing on the related securities collateral. "the right to liquidate does not constitute the right to transfer cash. but also the ³termination. 4 (1982). 97th Cong.J. modified sections 555.R. securities. 448 (Bankr.. 559 and 560 by allowing not only the liquidation.R. is µthe right to close out an open position.N. But. a counterparty would be able to terminate/accelerate a securities contract (and reduce its exposure to market movements). the right to liquidate a commodity contract pursuant to Section 556. and securities lent under a securities lending agreement. 441. the termination of the contract. forwards.M. ‡ Prior to the 2005 amendments. Thus. 556. The 2005 amendments to the Bankruptcy Code. securities sold by the debtor under a repurchase agreement. 1987) (³As the legislative history makes clear. ± 36 Derivatives in Bankruptcy . In re R. except that it may seek to stay the foreclosure on or disposal of securities collateral pledged by the debtor. Cordova Int¶l. at a minimum. or acceleration´ of these contracts. except to the extent otherwise provided in this title. 420. commodities contracts and repos. 2d Sess.

Enron Corp. 306 B. Practical advice to reduce termination risks: Obtain court approval for counter-party assurance programs designed to encourage counter-parties not to terminate. 465 (Bankr. Case No. 675 (S. letters of credit.D. could provide that any party participating waives termination right based on bankruptcy filing. Ross. but see. Programs may contain variety of features: Collateral.N. U. 03-46590 (Bankr.R. 553 (D. Nat'l Westminster Bank. thus. Tex. (super) administrative expense priority.R. for reasons wholly unrelated to the counter-party's bankruptcy. 1991).R. Az.D. 549. Courts may rely on the doctrine of waiver. In re Amcor Funding Corp. prohibiting termination..Ipso Facto Provisions Enforceable ‡ (cont¶d) Unless a protected party exercises its right as soon as possible after the counter-party's bankruptcy. v. guaranties.. aff'd sub nom.D. Courts may refuse to allow termination of safe harbor contracts.Y. 347 (Bankr. Nat¶l Westminster. Mirant.Y. 130 B. S. courts may refuse to apply the safe harbors.N. 2004) (city transit authority sought to terminate cash settled swap for natural gas based on unenforceability of the agreement).R. N.g. 314 B.. 1992). N.S. a year after Amcor's filing.D. Yaeger v. Mirant. due to Drexel's bankruptcy rather than due to Amcor's bankruptcy). 2004) (late termination due to reliance on being protected by bankruptcy court¶s orders allowed). 962 F. finding that the forward contract merchant's continuing post-petition performance and failure to enforce the event of default constitute waiver. Tex. 1990) (Drexel prohibited from terminating its securities contract under section 555. 656. preferably on the first day it learns of the bankruptcy.2d 1 (2d Cir.A.) ‡ ‡ 37 Derivatives in Bankruptcy . See e. 117 B.

Application of Automatic Stay to Termination ‡ Few courts have addressed whether the automatic stay applies to a nondebtor party's right to exercise its right to terminate a contact exempt from the ipso facto prohibition. v. Those that have are split. ± The only court to address safe harbor transactions.). 319. 548. 116 B.D.IX. Siegal (In re Siegal). 2003) The Courts of Appeals for the Fifth and Ninth Circuits held that to effectuate a termination clause that is enforceable under section 365(e)(2). 440 F.D. 964. ± 38 Derivatives in Bankruptcy . Tex. 12 B. v. 1 (Bankr. 977.R. 824 F.. N. 314 B. Ariz. Tex. 2004) (forward contract).. N. "even if § 365(e)(2) allowed [the nondebtor party] to terminate the contract. Merchants Bonding Co. N. (In re Wegner Farms Co.3d 238 (5th Cir. 190 B.. 640 n. D. 1996). 730 (9th Cir. Inc. Mirant. 49 B. held the automatic stay not to stay termination. Inc. 440.2d 725. Computer Communications. 445 (Bankr. Mirant. which exempts ipso facto clauses in certain types of contracts from the general unenforceability of such clauses. 983 (Bankr. explaining its seemingly contrary decision.R. 639.R.R. 310 B. Iowa 1985). 1987) (held. Adana Mortgage Bankers. Gov't Nat'l Mortgage Corp. Tex. Wegner Farms Co. 327-28 (Bankr. Mirant.R. 564 (Bankr.R. Inc.D.). N. N.D. Ohio 1990). the nondebtor party to the executory contract must first seek relief from the automatic stay of section 362.´) ‡ Accord: Calvin v. (In re Adana Mortgage Bankers. In re Cardinal Indus. 971 (Bankr. Inc. Mirant. 1980).D. Ga. 347 (Bankr. 2006). § 362 automatically stayed termination.R. 2004) (swap). 303 B.D. S.

D. at the same time. 206 B. The law in the other circuits is not clear. (In re Alert Holdings.). 326. Smith (In re Albion Disposal. (In re Elder-Beerman Stores. 6th Circuit: Elder-Beerman Stores Corp. 776 (2d Cir. another section should not be interpreted to cause an irreconcilable conflict'"). unequivocally and without qualification. 1096 (3d Cir. disagrees. 794. Pa.R. Courts in the Sixth Circuit seem to prefer the approach of Computer Communications. 194. 982 F. 202 (Bankr. stayed under section 362 would be at worst anomalous. Slater v. W.R. 1989).). "'where one section of the Bankruptcy Code explicitly governs an issue. Inc. which covers Delaware. a state agency that had agreed to lend debtor money to avert foreclosure ceased advances upon commencement of case. Ohio 1997). but they have yet to address this specific issue.N. aff'd in part.Y.D. S. courts within the Second Circuit refer to both Computer Communications and Watts.D.Application of Automatic Stay to Termination (cont¶d) ± The Court of Appeals for the Third Circuit.D. The court held that the termination of advances did not violate stay: "Section 365(e)(2)(B).S. rev'd in part.R.R. To hold that such termination is. Thomasville Furniture Indus. 609 (S. Co.). Inc.2d 1090.N. v.R. 1982) (automatic stay did not prevent ipso facto termination of contract to make loan. 148 B. Inc.). 329 (Bankr. In Watts v. 1993).Y. For example. 250 B. 17 B. Interstate Protective Servs. ‡ 2nd Circuit: Shimer v. Alert Holdings. 142. 1992).. 154 (Bankr. Ohio 1998). 876 F. Inc. Inc. D.2d 769.. S. provides for the termination of a contract to make a loan after the commencement of a bankruptcy case. and at best an imposition of a pro forma requirement that the creditor must ask for what the Code plainly grants him. Fin. ± ± ‡ 39 Derivatives in Bankruptcy .D. 806-07 (Bankr. Fugazy (In re Fugazy Express. v. 1992).´ Accord In re New Town Mall. 152 B. Inc. Hous. Inc.

avoided. The 2005 amendments supplemented the protections by also amending section 362 accordingly (§ 362(o)) Query: Should Computer Communications be extended to contracts that require an advance termination notice? ‡ ‡ 40 Derivatives in Bankruptcy . Tex. 548. terminate or accelerate a safe harbor contract "shall not be stayed. it was not entirely clear whether the Fifth and Ninth Circuits¶ rationale should apply to safe harbor contracts.Application of Automatic Stay to Termination (cont¶d) ‡ Prior to the 2005 amendments. which was the subject of the decisions. Section 365(e)(2).D. specifically provides that the contractual right to liquidate. or otherwise limited by operation of any provision of this title or by order of the court. 554 (Bankr. N.R. provides for the enforceability of an ipso facto clause but does not specifically mention the term "stay. 2004)." The post-2005 amendments safe harbor provisions of the Bankruptcy Code. 310 B. dealing with the enforceability of ipso facto clauses.´ Accord Mirant.

at 2 (1982). ± ± Setoff allows parties to setoff obligations arising from various transactions among them.X.(7). 2004). see also id. Holyoke Nursing. 372 F. 583.S. 584. N. The prompt closing out or liquidation of such open accounts freezes the status quo and minimizes the potentially massive losses and chain reactions that could occur if the market were to move sharply in the wrong direction.3d 1. 560 (Bankr.N. Tex. Mirant. 548. recoupment is limited to the same transaction.C. 310 B. Recoupment does not apply to claims arising from post rejection/termination of the contracts. §§ 362(a)(4). Setoff/Netting ‡ Legislative Intent: Focus is on stability of financial markets: ± "[T]he stay provisions of the Code are not construed to prevent brokers from closing out the open accounts of insolvent customers or brokers. 3 (1st Cir. Rep. at 585 (specifically referring to forward contract merchants).(6).A.R. No. 97-420. reprinted in 1982 U.D.C. 553 Recoupment is generally held to be exempt from the stay.R." H. 2004). ‡ Exercise of setoff rights and other secured creditor¶s remedies are generally subject to the automatic stay. ‡ 41 Derivatives in Bankruptcy .

R. similar to § 362(b)(6). the parties assumed they were. Swaps: § 362(b)(17) Similar to § 362(b)(6). forwards and commodity contracts: § 362(b)(6) exempt the exercise of contractual right to setoff or net termination values. avoided or limited. Repos: § 362(b)(7). Forwards and commodity contracts are also subject to the exemption of § 556 -. ± ± ± 42 Derivatives in Bankruptcy . at 560. avoided or limited. master agreements with all supplements thereto. 310 B. ‡ The safe harbor provisions and certain sub-sections of § 362 exempt certain setoffs from the automatic stay: ± Securities contracts. or in connection with these contracts. payment amounts. including any security agreement or arrangement. Mirant. credit enhancement and any master agreement.protected parties¶ right to variation or maintenance margin payment received from a trustee under those contracts shall not be stayed.Setoff/Netting (cont¶d) ‡ Query: Do various confirmations under a single master deemed one transaction or several transactions? ± ± In Mirant. The 2005 amendments specifically include in the definitions of the various financial contracts. ‡ Supplemented by § 560: contractual right to offset or net-out any termination values or payment amounts shall not be stayed. or other transfer obligation arising under under.

Section 362(o): Supplements the protections by prohibiting any court or administrative agency from staying the exercise of rights exempt from the stay with respect of protected transactions. Query: What is the scope of payments due ³in connection with´ a safe harbor contract? Setoff is allowed regardless of whether the post-petition termination of a safe harbor contract is deemed to give rise to a post-petition. 1998) (affirming application of § 362(b)(6) to liquidation of collateral posted prepetition as margin to cover unanswered post-petition margin calls). Weisberg. notwithstanding § 553 requiring both claims to arise pre-petition. 657-59 (9th Cir.Setoff/Netting (cont¶d) ‡ Master Netting Agreements: § 362(b)(27) allows setoffs and netting under masternetting agreements.3d 655. or pre-petition claim. 136 F. ‡ ‡ ‡ 43 Derivatives in Bankruptcy .

accelerate or liquidate. repos or swaps. commodities contracts. liquidation. swap agreements or master netting agreements. forward contracts. ‡ Master netting agreement is defined as ± An agreement providing for the exercise of rights. it shall be deemed to be a master netting agreement only with respect to those agreements or transactions that qualify as such. If the agreement contains provisions relating to agreements or transactions that are not securities contracts. forwards. ± ± New section 561(a) specifically allows cross product netting. payment amounts or other transfer obligations arising under or in connection with one or more securities contracts. avoided or limited by operation of the bankruptcy code or by order of a court or administrative agency. repos or swaps. or any security agreement or arrangement or other credit enhancement related to one or more of the foregoing. or close out. repurchase agreements. shall not be stayed. or to offset. Section 561(a) provides that the right to terminate. under or in connection with one or more securities contracts. commodity contracts. acceleration. ± 44 Derivatives in Bankruptcy . setoff. forwards. including rights of netting.Setoff/Netting (cont¶d) ‡ Cross Product Netting ± prior to the 2005 amendments did not appear to be covered by the safe harbor provisions. commodities contracts. or net termination values. including any guarantee or reimbursement obligation related to one or more of the foregoing. termination.

D.Setoff/Netting (cont¶d) ‡ The legislative history is clear: ³The definition of µMaster Netting Agreement¶ is designed to protect the termination and closeout netting provisions of cross-product master agreements between parties. violated the stay. 657-59 (9th Cir. 310 B. 559-60 (Bankr. 2004) (reversal of a wire. (7). The legislative history is also crystal clear on this point: 45 Derivatives in Bankruptcy . 548.3d 655. but it was not clear whether realization on collateral was exempt from the stay.) ‡ ‡ The 2005 amendments specifically allow realization against pledged collateral. § 362(b)(6). (17) were drafted in terms of setoff. after the amount was deposited into the debtors¶ account. N.R. Tex. 1998) (§ 362(b)(6) applies to liquidation of collateral posted pre-petition as margin to cover unanswered post-petition margin calls).´ Foreclosure ± Prior to the 2005 amendments. ± Weisberg. 136 F. but see Mirant.

´ ± 46 Derivatives in Bankruptcy . commodity contracts. as well as in section 362(b)(6) and (7) of the Bankruptcy Code. forward contracts. are intended to refer also to rights to foreclose on. master netting agreements. of setoff or netting provisions in swap agreements and in master netting agreements and security agreements or arrangements related to one or more swap agreements or master netting agreements. Collateral may be pledged to cover the cost of replacing the defaulted transactions in the relevant market. and master netting agreements free from the automatic stay apply to collateral pledged by the debtor but that cannot technically be µheld by¶ the creditor. Because the relevant definitions include related security agreements. collateral securing swap agreements. and to collateral that has been repledged by the creditor and securities re-sold pursuant to repurchase agreements. as well as other costs and expenses incurred or estimated to be incurred for the purpose of hedging or reducing the risks arising out of such termination. Enforcement of these agreements and arrangements free from the automatic stay is consistent with the policy goal of minimizing systemic risk. forward contracts. commodity contracts. This provision parallels the other provisions of the Bankruptcy Code that protect netting provisions of securities contracts. such as receivables and book-entry securities. swap agreements. Subsection (d) also clarifies that the provisions protecting setoff and foreclosure in relation to securities contracts. the references to µsetoff¶ in these provisions. repurchase agreements.Setoff/Netting (cont¶d) ± ³Subsection (d) amends section 362(b) of the Bankruptcy Code to protect enforcement. commodity contracts. free from the automatic stay. repurchase agreements. or forward contracts. and repurchase agreements. and to set off against obligations to return. securities contracts.

American Homepatient. (§ 562(a)). In any objection to timing. Tenn. 47 Derivatives in Bankruptcy . termination or acceleration date. index or other property. 2004) (Damages for rejection of a warrant agreement to purchase debtor¶s common stock will be based on the value of the shares on the petition date. termination or acceleration) if values shifted in between these dates. or difference between derivative price and market value of the underlying security. (§ 502(g)(2)) Not clear which date controls (liquidation. If there is no way to determine the values involved in a commercially reasonable manner. ± Bank of Montreal v. the objecting party carries the burden of proof.. Inc. damages will be measured at the earliest subsequent date or dates on which values can be determined in a commercially reasonable manner. 309 B. 740-41 (M.XI. (§ 562 (c)) ± ± ± ‡ Measure of Damages: ± ± could be costs to replace the derivative. 738. the claim is a pre petition claim. The 2005 amendments to Bankruptcy Code provide that the measure of damages is determined on the earlier of rejection of the agreement or the liquidation.R. (§ 562 (b)). Damages ‡ Relevant Date ± Prior to the 2005 amendments was not clear whether it is the petition date or termination date. not rejection date).D.

LEXIS 21223 (S. Nov. 1992). at *6-*7 (Del. The commonly used ³Market Quotation´ measure of damages under the 1992 ISDA Master Agreement (Multicurrency-Cross Border) does not use the lowest bid.Y. 1989 WL 16981. Dist. 10. Drexel Burnham Lambert Products Corp. v. 23. ± ± 48 Derivatives in Bankruptcy . v.Damages (cont¶d) ‡ Swaps: ± The practice (no longer common) of denying a defaulting swap counterparty the termination value of a swap transaction (known as the ³first method´) was held enforceable in Drexel Burnham Lambert products Corp. Super.S.N.D. First method was eliminated in the 2002 ISDA Master. 1989) (Market Quotation method is a reasonable method of determining damages even though claimant did not actually enter into a replacement agreement). 1992 U.Mcorp. Feb. Midland Bank PLC. Ct. costs and loss of the bargain incurred by a counterparty) ± expressly includes the cost of unwinding hedges related to the terminated swap agreement. but uses either (i) the average of the two middle bids obtained from four reference market makers or (ii) the middle bid of three bids so obtained. The other commonly used measure of damages under the ISDA Master Agreement ± ³Loss´ (essentially losses.

2008). D. American Home Mortgage v. UCC Article 9 Inapplicable: Article 9 requirement that the secured creditor liquidate collateral in a commercially reasonable manner inapplicable to protected repos.Damages (cont¶d) ± Damages under interest rate swap agreements are not subject to disallowance as unmatured interest under § 502(b)(2).. refused to compel TXU to designate an early termination date and refused to allow Enron to ³disclaim´ the swap because the effect of which would be to re-write the terms of the swap. Del. ± ± ± 49 Derivatives in Bankruptcy . 537.R. TXU Electricity. held the contract provisions enforceable. 2003). refuses to designate an early termination event because it is ³out of the money´ at the time of bankruptcy (which prevents the bankrupt from getting the termination payment it would have been entitled to)? The New South Wales Supreme Court in Enron Australia v. Thrifty Oil Co. What if the non-defaulting party under a swap in which the parties chose not to declare automatic termination upon bankruptcy event. 69 (Bankr.D. Cal.R. 388 B. 249 B. 2000). 543-51 (S. aff¶d.3d 1039 (9th Cir.´ It involves a determination as to losses and costs incurred and gains realized in replacing the terminated transactions or providing the economic equivalent of the material terms of these transactions. 322 F. The 2002 ISDA Master adopts a single measure of damages²the ³closed out amount. Lehman Brothers. [2003] NSWSC 1169.

to.´ Note that § 546(g) dealing with swaps. The 2006 amendments to § 546(f) dealing with repos. to or for the benefit of a master netting agreement participant (defined in § 101(38B) as an entity that any time before the petition is a party to an outstanding master netting agreement with the debtor). The 2005 amendments added § 546(j) protecting from avoidance a transfer made by. or transfers made in connection with qualified contracts. Avoidance Actions Exception ‡ Except for actual fraudulent transfers. or in connection with a swap agreement but does not reference margin or settlement payments. ± While the 2006 amendments provide that § 546(e). deleted the reference to margin and settlement payment and apply to any transfer made ³in connection with a repurchase agreement. § 546(e). it is not clear that it requires that the margin or settlement payments referred to be made under a qualified contract. (g). (f). apply to transfers made under qualified contracts. or for the benefit of a protected party. financial institutions. except if such transfer is avoidable under a contract covered by the master netting agreement. ± ± ± 50 Derivatives in Bankruptcy . in connection with a master-netting agreement. protect from avoidance transfers that constitutes margin or settlement payments made by. forward contract merchant. exempt a transfer under. stockbroker. dealing with margin or settlement payments to a commodity broker. financial participant or securities clearing agencies.XII.

935. is not a margin payment." ‡ Sections 741(5) and 761(15) of the Bankruptcy Code contain similar definitions of margin payment for the securities trade and commodities trade. a security or other property.C. initial margin. In re Stewart Finance Co. prior to any trading. Biggs v. Seitter v. 402. D. (In re Yeagley). 367 B. at a time when no trades took place and no deficiency exists. constituted a margin payment. (In re David). 193 B.D. 1998) ("The term 'margin payment' is not broad enough. 51 Derivatives in Bankruptcy ."). that is commonly known in the forward contract trade as original margin. (D) providing that protected parties that receive margin or settlement payments are deemed to have provided value.N. 405 (Bankr. M.D. Kan. however.. or variation margin. including mark-to-market payments.´ H. 229. or variation payments.´) ± At least two courts suggested that an initial payment made to open a margin account. respectively. reprinted in 1990 U. Smith Barney. Ga. Farmer's Commodities Corp. C.A.R.R. No. at 7 (1990). Cal. 940 (Bankr. 220 B. maintenance margin. 2007) at *5 (³Margin payment is a broadly construed term and includes any payment by a debtor to pay for the purchase of securities or to reduce a deficiency in a margin account. to encompass payment made to open a margin account before any trading is conducted or any deficiency incurred. 1996) ("[T]he terms 'margin payments and 'settlement payment' do not include all payments into a margin account. the court would be hard-pressed to find that a payment made to open an account with a stockbroker. (C). Rep.Avoidance Actions Exception (cont¶d) ‡ Protection is supplemented by § 548(d)(2)(B)."). ‡ Margin Payments ± Margin payment for forward contract purposes is defined in section 101(38) of the Bankruptcy Code as a "payment or deposit of cash.R.C. Inc. 101-484.R. For example. 909 (Bankr. 223. ± Legislative History: ³[T]his provision exempts these types of customary setoff payments in the forward contract trade from scrutiny as to whether they are actually fair value for the amount used.S.

2007) (LBO of a private company).R.R. 655. D. 98 F. no protection from avoidance). 198 B. 321 B.R. a settlement payment on account.Y.Avoidance Actions Exception (cont¶d) ‡ Settlement Payments ± Settlement payment is defined in § 101(51A) for forward contract purposes as "a preliminary settlement payment. Healthco. Gordon. Tex.D. an interim settlement payment. 195 B. 1996) (held. 527 (Bankr. Integra Realty. Wieboldt Stores. courts. 1998) (court held that.D. 1996) (LBO).I. a partial settlement payment. but in which the actual exchange of stock and consideration therefor take place at a later date"). 131 B. 353 (N. 491-95 (Bankr. L.D. Grafton.R. even if interpreted broadly. Ohio 2003) (private sale through financial intermediary). Ill. Colo. in the securities context." Section 741(8) of the Bankruptcy Code contains a substantially similar definition of settlement payment for the securities trade. Yucaipa Capital Fund. to qualify as settlement payment for purposes of statute. 352. 348.R. Jewel Recovery. Inc.R.. 1991) (LBO).R. 2005) (redemption of equity in an LLC run as a ponzi scheme. or any other similar payment commonly used in the forward contract trade. 983 (Bankr. Grand Eagle. N. 1996) (LBO is essentially a private transaction. payment must implicate the "system of intermediaries and guarantees" of the securities industry "wherein parties use intermediaries to make trades of public stock which are instantaneously credited. 9th Cir.R. a net settlement payment.3d 604. 675-76 (D. Although the statutory definition is circular and not particularly illuminating. Munford. 288 B. a final settlement payment. 1996) (spin-off). ± 52 Derivatives in Bankruptcy . D. private stock sale not protected by the Bankruptcy Code because it "lack[s] the impact on the public market trading systems that Congress intended to protect"). not protected-not involving public markets and involving illegally unregistered securities). 367 B. 971. Zahn v.N.D. 656. v.R.P. Norstan Apparel Shops. 68 (Bankr. have held that at a minimum the payment must involve the system of intermediaries and guarantees typical of the securities industry. 664-65 (N. Mass. 196 B. 218 B. 484. 356-60 (Bankr. 609-10 (11th Cir. E.

R. 2005) (Prepayments made to retire short terms CP notes. D. Del. 2006). 1236-37 (10th Cir. W. 325 B. 1999) (LBO). Mich.R. 583-86 (Bankr. 451 (Bankr. Payment made contrary to the applicable contractual terms. 2007 (private LBO). D. 671.Avoidance Actions Exception (cont¶d) ± Other cases refuse to deny protection simply because the transaction does not impact the public markets or involve illegal securities law transactions. 750-53 (3d Cir. Del. 181 F. Resorts Int¶l.2d 1230. aff¶d 388 B. 71.Y. 2007 WL 4557855 (W. Corp. S. Int'l Finance Corp. Bevill. 2005). 2006) (private stock sale transaction). 21.Y. 83-89 (D. 324 B. 2002) (LBO).D.D. 878 F. 97 2006 (Bankr. Plassein Int¶l Corp. 355 B. Dec.D.N. Bresler.R. Pa.R.. does not qualify. Enron Corp. Quality Stores. aff¶d.N. Del. Kaiser Steel. A CLO¶s sponsor¶s purchase of CLO notes to provide credit support and to prevent investors¶ losses through financial institutions and stockbrokers. 2008) (LBOs of privately held companies).. Del. W.R. 2006).R.2d 742.3d 505. where the notes were not redeemable or prepayable pursuant to their terms and the offering document (and also at significantly above market value) are not common and thus do not qualify). 1991) (LBO). 318 (Bankr. 341 B. 46 (D.R. IT Group. Hechinger. v.D. Enron. 685-86 (Bankr. 514-16 (3d Cir. 952 F. 366 B.. S. QSI Holdings. 2007) (private LBO). 274 B. Mich. 1989) (Repo). Applies to ³private´ stock redemption. W.R. 359 B. Mich. 2007). 629 (Bankr. qualifies as a settlement payment.D. ± ± ± 53 Derivatives in Bankruptcy . Loranger Mfg.D. 575.

R. 369 B. under on-market transaction or to be cleared or settled through a centralized system. But see National Gas Distrib.3d at 742.R. Olympic Gas. at 898 (refusing to treat a forward gas supply agreement as a swap agreement because it was a private supply agreement with no impact on financial markets). 258 B. ‡ The legislative history to section 101(51A) as well as the section itself state that. 2004) (setoff of claims arising from termination of forward contract is a settlement payment). 336 B. N. Mirant. ± The Fifth Circuit expressed its agreement with precedents outside the securities area that the term should be interpreted broadly. 310 B. qualified as settlement payments under section 101(51A) as "a similar payment commonly used in the forward contract trade"). 229 (Bankr.D. at 165-66 (payments made under forward contracts were settlement payments for forward contract purposes although their avoidance "would have no impact on the securities system"). 54 Derivatives in Bankruptcy . as to forward contracts.R. Tex. 548.R. Borden Chemicals.R.Avoidance Actions Exception (cont¶d) ‡ These authorities are probably inapplicable to forwards and swaps as these transactions are typically private. aff'd." Olympic Gas. Del.3d at 742.. 563 (Bankr. 214. 294 F. 2006) (payments made under the contract following delivery of gas are settlement payments). at 166 (net payments exchanged monthly among the parties on account of forward contracts for natural gas. aff'g 258 B. a settlement payment includes a "similar payment commonly used in the forward contract trade. and in the context of forward contracts does not require the payment to be made on a financial derivative. 294 F. D.

S. Jonas v. 993 (9th Cir.Y. 195. ‡ ‡ ‡ 55 Derivatives in Bankruptcy . Bevill.R. N. & Loan Ass'n. Payment obtained through attachment did not qualify as a protected payment under a swap under the pre-2005 amendments version of section 546(g). Hamilton Taft. but does qualify post 2005 amendments.2d 742. Exercise of setoff to recover erroneous payments. 971 F. N. 2004) (forward). 477 (Bankr. Bresler & Schulman Asset Management Corp. and the return of additional margin posted in connection with the repo.D. 1989) (interpreting the term settlement payment to fit the settlement process applicable to repurchase agreements). 595 (Bankr.D. 2004) (forward). 240 B. 114 F. 1992) (party's withdrawal from a repurchase transaction. GPR Holdings. 751-53 (3d Cir. v.R. 326 (9th Cir. Casa de Cambio. 481 (Bankr. Resolution Trust Corp.2d 322. Payment for gas purchased after initial failure to pay and collection activities by the seller.D. 1999).Avoidance Actions Exception (cont¶d) ‡ Courts applied this definition to repos.8 (Bankr. Aurora Natural Gas. 390 B. Ill. 1997) (reverse repo). may not qualify. Interbulk.N. 316 B. 878 F. 201 n. is a settlement payment).3d 991.D.R. Tex. N. Spencer Sav. 316 B. may not qualify. 2008). (In re Comark). Tex.R.

98 B.. Residential Resources Mortgage Invs. Section 105 ‡ ‡ Allows courts to issue any order to carry out the provisions of Bankruptcy Code. except that courts may temporarily enforce the stay or prevent close-outs of protected transactions to enable the courts to decide whether all of the necessary elements are satisfied. D. 2. Ariz. v..XIII. 56 Derivatives in Bankruptcy . 1989) (staying broker-dealer from liquidating repurchase agreement to enable the court to first determine whether the contract was in fact a repo).R. It would appear that § 105 should not be used to override the specific provisions protecting safe harbor transactions. 20-24 (Bankr. Inc. See Thomson McKinnon Sec.

L. Recharacterization Issues ‡ Bankruptcy courts generally have the power to recharacterize transactions based on their economic substance. 251 B. rather than based on their form. 249 B. 537 (S. Stearns & Co. Bear. 2d 275. D. aff'd.P.3d 1039 (9th Cir. 322 F. 147. Cal. 800-05 (Bankr. Granite Partners.N.D. 298-99 (S. Courts in the Ninth Circuit refused to recharacterize a swap and floating rate loan as one transaction representing in substance a fixed rate loan.R. 1997). based on a counter-party's post-hoc view as to their alleged economic substance.R. In re Thrifty Oil Co. v. 2000) (same).D. aff'd..Y. In re CRIIMI MAE.XIV. 2000). Repos have the economics of a secured loan and carry a significant recharacterization risks. 212 B. Supp.R. 17 F.D.. Courts seem less than willing to recharacterize sophisticated financial products. 1998) (question of fact whether a repo is "true" repo or disguised financing). ‡ ‡ 57 Derivatives in Bankruptcy . 150-53 (Bankr S.. 796. Inc. Cal. 2003). Md.

D. the rejection of any agreement is a breach of the contract which gives rise to damages. 134 B. Purchase includes claims for the failure to issue securities or options under employment agreements or termination agreements. 256 (2d Cir. at *20 (D. Del. 921 (Bankr. Med Diversified. 2008). 642 (Bankr. then any holder of a note issued by the debtor or an affiliate may be subordinated. 2008 WL 114864 (Bankr. in that case. the investors filed claims based on the unpaid amounts outstanding on the debtor's notes. . Id. Del. 272 B. 384 B. 2006). Del. 19. not damages). 718-18 (Bankr. 1996 WL 148533. D. D. 1996). D. 836. Wyeth.R. repos or securities contracts where the underlying security is a security of the debtor or its affiliates. Wireless. 91 B. 713.3d 251.XV. Mar. ‡ ‡ ‡ 58 Derivatives in Bankruptcy . sale or issuance of the debt instrument. Montgomery Ward. Damages: It is not entirely clear what the term means.R. .C. Washington Bancorporation. at 640. see also NationsRent..S. W. Mo.´). ± ± Technically. But.H.R. 639.N. a result that makes no sense as held by Blondheim. 1988)."). . 461 F. 341 B. § 510(b) does not apply to a claim seeking recovery of an unpaid debt due upon a promissory note. This section may subordinate claims under forwards. at 151. such claims represent the bargained for sales price. U. swap. D. 2001) (absent an allegation of fraud in the purchase. Mandatory Subordination Issues ‡ Section 510(b) of the Bankruptcy Code requires mandatory subordination of damage claims arising from purchase of sale of a security of the debtor or its affiliates. If that what it means.R.R.D. 2008) (make whole claims not subordinated. Enron. 1991) (³[T]he term 'damages' implies more than a simple debt . 920. 844-45 (Bankr.

NAL. the investment was an equity investment and the damages resulted from the debtor's failure to pay under the stock purchase agreement). Vista Eyecare. 2003) (claimant who sold shares in a third company to the debtor in exchange for debtor's cash and stock was subordinated. courts did apply the more comprehensive meaning of damages. fraudulent retention or breach of contract). Ga. Response USA." but generally.R.Mandatory Subordination Issues (cont¶d) ± In other contexts. 1999) (breach of best efforts to register securities. S. ± Section 510(b) does not mention the term "breach. the argument for it constituting a breach and damages is straightforward. If the contract by its terms refers to it as a credit event type default. 2002) (debtor's refusal to repurchase shares. S. 613. 225. 283 B. Fla. 231-32 (Bankr. 141 (Bankr. 288 B.Y. damages equal the repurchase price minus shares' value).N. question is whether a change in the formulation would make a difference.J. 237 B.R. A related question may be whether a claim resulting from the acceleration of a safe harbor contract upon bankruptcy filing.D.R.R.D. N. breach of contract yields claim for damages). constitutes a claim for damages resulting from a breach of the safe harbor contract. ‡ Breach. 341 B.N. damages can result either from tort type claim or from a breach of contract. 627-28 (Bankr. Enron. 88 (D. 2006) (claims of employees on account of their stock options subordinated whether framed in terms of fraudulent inducement.D. ± 59 Derivatives in Bankruptcy .

Del. the non-debtor party may take the risk of a creditor. however.R. Wireless. Some courts.3d 133.R. it was held to be ambiguous. contra Cybersight. 384 B. is broad and the recent trend is to apply it liberally. claimant's intent to fix the value discounted. Mobile Tool. 281 F. holding no difference between a judgment and equity exchanged for notes) It is arguable. 240 F. Alta+Cast. that when the debtor's or its affiliate's securities are used as the underlying property in swaps.3d 823 (9th Cir. no rewards upon stock's appreciation or loss upon failure. held that when a former equity¶s holder¶s claim is based on a money judgment for the value of the shares. 281 F. forwards and securities contracts. D. it had the right not to put and the debtor didn't have a call). and had the ability not to sell).R.R. such claim would be subordinated under section 510(b). 782 (Bankr. Telegroup. except that the underlying property used in the transaction is debtor's or affiliate's securities. Ariz. 778. 2004) (section 510(b) does not apply when notes are issued in exchange for equity).Mandatory Subordination Issues (cont¶d) ‡ Nature of Risk Assumed by Investors.e. 2002). 508 (Bankr.. they were equity investors). U. ± ± Acknowledging that section 510(b) is not a model of clarity. or the re-sale of the security back to the debtor is mandatory through one mechanism or another. Telegroup. however. courts attempt to capture the risk associated with the transaction. ± ± 60 Derivatives in Bankruptcy . 2001) (claims of shareholders resulting from merger agreement subordinated.e. Del. The literal language of section 510(b). while if the claim was converted pre-petition to a debt instrument. Vista Eyecare.R. 150. and in effect is not taking a position of an equity investor. D. 138 (3d Cir. That may be especially so if the debtor has a call against the put. 152-53 (Bankr. 2003 (same). Einstein/Noah Bagel. especially in Delaware. they covenanted for the ability to register the stock so they can freely sell it enjoying any appreciation.S. Del. section 510(b) would not be applied.R. 301 B. 2004 WL 2713098 (D. 2008) (money judgment on account of value of shares due under breached employment agreement subordinated). at 625-28 (put option on debtor's common stock subordinated. the non-debtor party is not intending to. D. 306 B. Del. 713 (Bankr. did the claimant take an equity or creditor type risk. D. 499. 2004) (refusing to subordinate claim based on a judgment entered for breach of employment agreement to issue stock. 2000). 306 B. i. Relying on the legislative history. 257 B. 283 B. Betacom. i.3d at 142 (dismissing claimants' argument that they didn't intend to retain their investment.

± An issue that has not been explored is what role should the rationale for section 510(b) play in this context. Vista Eyecare. in bankruptcy a debtor may not repurchase its own equity securities and thus the claim can be disallowed in its entirety under section 502(b)(1) of the Bankruptcy Code. L&H.R. 275 B. 264 B. VF Brands. 61 Derivatives in Bankruptcy . "installment" tests). Del. ± A subsidiary issue may involve a determination whether (i) the underlying corporate obligation to repurchase or acquire its equity securities was valid when made and thus valid or not at the time an actual payment must be made ("outset" vs. 283 B. D. The VF Brands court gave to this notion a short shrift by stating that section 510(b) makes no distinction between the debtor's and affiliates' stock. 2002) (claims against parent resulting from sale of its subsidiary stock subordinated to unsecured creditors of parent). not parent's creditors). 2001) (claims of shareholders of the parent with respect of the subsidiary stock subordinated only to subsidiary's creditors. 725 (Bankr.R.Mandatory Subordination Issues (cont¶d) ‡ Corporate Law Principles: If the contract is deemed to be a contract for the debtor to purchase its own equity securities. Del. and (ii) how do bankruptcy courts treat the applicable state law.R. ‡ Affiliate's Securities: Very few cases have addressed the application of section 510(b) in such a situation. at 620-25. D. 336 (Bankr.

Hechinger. 2005). 592 (D. Del.D. 2003) (illegal redemption). v. 2002) (unjust enrichment).3d 94. even if creditors assigned the claims to the trustee). No: Enron Corp. 291 B. 291 B. 1991).XVI. a prohibited distribution to shareholders ± is state law preempted? ± ± ± Yes: PHP.R. Preemption/Chapter 11 Plan Conflict ‡ If the safe harbor transaction is in violation of a state corporate law provision. i. 2003) (creditors assigned claims to liquidating trust. 857 (Bankr. 1241 (10th Cir.R. 102 (2d Cir. Maybe Not: Kaiser Steel.R. Bear Stearns Int¶l Ltd. Del.e. 323 B. 592 (D.N. 274 B. S. 62 Derivatives in Bankruptcy .. 336 F.. But See Bennett Funding Group.2d 1230.R. ‡ Can a chapter 11 plan avoid § 546? ± ± Yes: PHP. 71. Del.Y. 2003) (Trustee may not pursue claims belonging to creditors. 95-98 (D. 952 F. § 546(e) is inapplicable as it applies to trustee/debtor in possession).

applicable. 63 Derivatives in Bankruptcy . 3 and 5 apply in chapter 7. in appeared that these sections were not applicable to an ancillary proceeding. 12 and 13 cases. ± ± The 2005 amendments to the Bankruptcy Code make these provisions. and 559-562 apply to cases under chapter 15. 559 and 560 were not incorporated into chapter 9 (municipal bankruptcies) under § 901(a). as well as new sections 561 and 562.Y. adopted new chapter 15 entitled Ancillary and Other Cross-Border Cases. 269 B.XVII. Orange County sued one debtor (Namura) as a test case but withdrew its complaint. 11. Ancillary proceedings are neither as they are governed by § 304.. sections 555. In the Orange County case several counterparties closed out positions.R. 556.D. of Directors of Compañia General de Combustibles S.A. ‡ The 2005 amendments abolished § 304. Accord Petition of Bd. ± Section 103(a) provides that chapters 1. 104 (Bankr. ‡ Prior to the 2005 amendments. Section 103 was amended to provide that sections 555557.N. S. 2001) (§ 560 not applicable to a swap entered with Argentinean debtor). Applicability to Chapter 9/Ancillary Proceedings ‡ Prior to the 2005 Amendments.

to purchase (in the call of a call) or sell (in the case of a put) a specified number of ounces of Bullion at a specified strike price. with both rates reset periodically. A transaction in which one party grants to the other party (in consideration for a premium payment) the right. to purchase (in the case of a call) or sell (in the case of a put) a bond of an issuer. A transaction in which one party grants to the other party (in consideration for a premium payment) the right. or floor transactions in respect of Bullion. The option may be settled by physical delivery of Bullion in exchange for the strike price or may be cash settled based on the difference between the market price of Bullion on the exercise date and the strike price. A transaction in which one party pays periodic amounts of a given currency based on a floating rate and the other party pays periodic amounts of the same currency based on another floating rate. The bond option can be settled by physical delivery of the bonds in exchange for the strike price or may be cash settled based on the difference between the market price of the bonds on the exercise date and the strike price. Cravath. Glossary of Commonly Used Terms* ‡ Basis Swap. at a specified strike price. Bullion Option. Bullion Swap. On the Enforceability of the Termination. ‡ ‡ ‡ * 64 Derivatives in Bankruptcy . all calculations are based on a notional amount of the given currency. collar. Swaine & Moore. but not the obligation. Bullion swaps include cap. Bond Option.XVIII. A transaction in which one party pays periodic amounts of a given currency based on a fixed price or a fixed rate and the other party pays periodic amounts of the same currency or a different currency calculated by reference to a Bullion reference price (for example Gold-COMEX on the New York Commodity Exchange) or another method specified by the parties. 1998). but not the obligation. Close-out and Multi-branch Netting Provisions of the 1987 and 1992 ISDA Master Netting Agreements (March 12.

and in the case of silver. on the difference between the agreed forward price and the prevailing market price at the time of settlement. The payment calculation is based on the quantity of the commodity and is settled based.Glossary of Commonly Used Terms (cont¶d) ‡ Bullion Trade. a fine troy ounce. of a specified floating rate (in the case of an interest rate cap) or commodity price (in the case of a commodity cap) in each case that is reset periodically over a specified per annum rate (in the case of an interest rate cap) or commodity price (in the case of a commodity cap). among other things. silver. Cap Transaction. A collar is a combination of a cap and a floor where one party is the floating rate or floating commodity price payer on the cap and the other party is the floating rate or floating commodity price payer on the floor. a troy ounce. A transaction in which one party agrees to buy from or sell to the other party a specified number of Ounces of Bullion at a specified price for settlement either on a "spot" or two-day basis or on a specified future date. "Bullion" means gold. Collar Transaction. platinum and palladium. Commodity Forward. platinum or palladium and "Ounce" means. Bullion Options and Bullion Swaps. A transaction in which one party pays a single or periodic fixed amount and the other party pays periodic amounts of the same currency based on the excess. A Bullion Trade may be settled by physical delivery of Bullion in exchange for a specified price or may be cash settled based on the difference between the market price of Bullion on the settlement date and the specified price. in the case of gold. ‡ ‡ ‡ ‡ 65 Derivatives in Bankruptcy . if any. For purposes of Bullion Trades. A transaction in which one party agrees to purchase a specified quantity of a commodity at a future date at an agreed price and the other party agrees to pay a price for the same quantity to be set on a specified date in the future.

Glossary of Commonly Used Terms (cont¶d) ‡ Commodity Option. The option can be settled either by physically delivering the quantity of the commodity in exchange for the strike price or by cash settling the option. A transaction in which one party pays periodic amounts of a given currency based on a fixed price and the other party pays periodic amounts of the same currency based on the price of a commodity. in which case the seller of the option would pay to the buyer the difference between the market price of that quantity of the commodity on the exercise date and the strike price. such as natural gas or gold. The amount payable by the credit protection seller is typically determined based upon the market value of one or more debt securities or other debt instruments issued. A credit protection transaction may also refer to a "basket" or two or more Reference Entities. or a futures contract on a commodity. Credit Protection Transaction. all calculations are based on a notional quantity of the commodity. guaranteed or otherwise entered into by a third party (the "Reference Entity") upon the occurrence of one or more specified credit events with respect to the Reference Entity (for example. bankruptcy or payment default). Commodity Swap. credit default swaps or credit default options. to purchase (in the case of a call) or sell (in the case of a put) a specified quantity of a commodity at the specified strike price. and the other party (the credit protection seller) pays either a fixed amount or an amount determined by reference to the value of one or more loans. Some market participants may refer to credit protection transactions as credit swaps. debt securities or other financial instruments (each a "Reference Obligation") issued. ‡ ‡ 66 Derivatives in Bankruptcy . guaranteed or otherwise entered into by the Reference Entity. but not the obligation. A transaction in which one party grants to the other party (in consideration for a premium payment) the right. A transaction in which one party pays either a single fixed amount or periodic fixed amounts or floating amounts determined by reference to a specified notional amount. Credit protection transactions may also be physically settled by payment of a specified fixed amount by one party against delivery of specified Reference Obligations by the other party.

A transaction in which one party pays periodic amounts in one currency based on a specified fixed rate (or a floating rate that is reset periodically) and the other party pays periodic amounts in another currency based on a floating rate that is reset periodically. Such swaps may involve initial and or final payments that correspond to the notional amount. but not the obligation.Glossary of Commonly Used Terms (cont¶d) ‡ ‡ Credit Spread Transaction. Cross Currency Rate Swap. to purchase (in the case of a call) or sell (in the case of a put) a specified amount of a given currency at a specified strike price. Currency Swap. All calculations are determined on predetermined notional amounts of the two currencies. Currency Option. Payments are calculated on a notional amount. often such swaps will involve initial and or final exchanges of amounts corresponding to the notional amounts. A transaction in which one party grants to the other party (in consideration for a premium payment) the right. A transaction in which one party pays fixed periodic amounts of one currency and the other party pays fixed periodic amounts of another currency. ‡ ‡ 67 Derivatives in Bankruptcy . A transaction involving either a forward or an option where the value of the transaction is calculated based on the credit spread implicit in the price of the underlying instruments.

Glossary of Commonly Used Terms (cont¶d) ‡ Equity Forward. A transaction in which one party pays periodic amounts of a given currency based on a fixed price or a fixed rate and the other party pays periodic amounts of the same currency or a different currency based on the performance of a share of an issuer. A transaction in which one party pays a single or periodic amount and the other party pays periodic amounts of the same currency based on the excess. Equity Index Option. The payment calculation is based on the number of shares and can be physically-settled (where delivery occurs in exchange for payment) or cash-settled (where settlement occurs based on the difference between the agreed forward price and the prevailing market price at the time of settlement). Equity or Equity Index Swap. a basket of shares of several issuers or an equity index at a future date and the other party agrees to pay a price for the same quantity of shares of an issuer to be set on a specified date in the future. such as the Standard and Poor's 500 Index. A transaction in which one party agrees to pay an agreed price for a specified quantity of shares of an issuer. ‡ ‡ ‡ 68 Derivatives in Bankruptcy . of a specified per annum rate (in the case of an interest rate floor) or a specified price (in the case of a commodity floor) over a specified floating rate (in the case of an interest rate floor) or commodity price (in the case of a commodity floor). if any. a basket of shares of several issuers or an equity index. A transaction in which one party grants to the other party (in consideration for a premium payment) the right to receive a payment equal to the amount by which an equity index either exceeds (in the case of a call) or is less than (in the case of a put) a specified strike price. Floor Transaction.

Glossary of Commonly Used Terms (cont¶d) ‡ ‡ Foreign Exchange Transaction. Interest Rate Swap. A transaction in which one party pays periodic amounts of a given currency based on a specified fixed rate and the other party pays periodic amounts of the same currency based on a specified floating rate that is reset periodically. A transaction in which one party agrees to pay a fixed rate for a defined period and the other party agrees to pay a rate to be set on a specified date in the future. The payment calculation is based on a notional rate and is settled based. A transaction providing for the purchase of one currency with another currency providing for a settlement either on a "spot" or two-day basis or a specified future date. such a the London inter-bank offered rate. to receive a payment equal to the amount by which an interest rate either exceeds (in the case of a call option) or is less than (in the case of a put option) a specified strike rate. at a fixed or floating price for actual delivery on one or more dates. Interest Rate Option. on the difference between the agreed forward rate and the prevailing market rate at the time of settlement. but not the obligation. electricity or gas. Forward Rate Transaction. ‡ ‡ ‡ 69 Derivatives in Bankruptcy . A transaction in which one party grants to the other party (in consideration for a premium payment) the right. Physical Commodity Transaction. all calculations are based on a national amount of the chosen currency. such as coal. among other things. A transaction which provides for the purchase of an amount of a commodity.

dividend and fee payments and any appreciation in the market value of each Reference Obligation. A transaction in which one party pays either a single amount or periodic amounts based on the total return on one or more loans. which may include measurements of heating. but not the obligation. floor or some combination thereof. structured in the form of a swap. precipitation and wind. cooling. A transaction in which one party agrees to sell securities to the other party and such party has the right to repurchase those securities from such other party at a future date.Glossary of Commonly Used Terms (cont¶d) ‡ ‡ Repurchase Transaction. to enter into a swap with certain specified terms. Securities Lending Transaction. In some cases the swap option may be settled with a cash payment equal to the market value of the underlying swap at the time of the exercise. collar. Weather Index Transaction. and the other party pays either a single amount or periodic amounts determined by reference to a specified notional amount and any depreciation in the market value of each Reference Obligation. A transaction in which one party grants to the other party the right (in consideration for a premium payment). calculated by reference to interest. ‡ ‡ ‡ 70 Derivatives in Bankruptcy . A transaction. between two parties in which the underlying value of the transaction is based on a rate or index pertaining to weather conditions. guaranteed or otherwise entered into by a third party (the "Reference Entity"). A transaction in which one party transfers securities to a party acting as the borrower in exchange for a payment or a series of payments from the borrower and the borrower's obligation to replace the securities at a defined date with identical securities. Total Return Swap. Swap Option. cap. debt securities or other financial instruments (each a "Reference Obligation") issued.

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