Defending the Preference and Fraudulent Transfer Safe Harbor

The bankruptcy court had accepted Enron'fs argument that “the safe harbor [of Code '' 546(e)] only extends to qualifying 'epurchases'f and 'esales'f of securities, not to the payment or retirement of debt.” Enron I, at 682. Conceding that the definition of “settlement payment” in ” 741(a) is “unhelpfully circular” and disagreeing with the bankruptcy court, the district court in Enron III agreed with five circuits who held that “741(a) does not limit the definition of 'esettlement payment'f to payments commonly used in the securities trade.” Enron III, at *6.

Indeed, appellate courts have broadly interpreted “settlement payment” as “the completion [or conclusion] of a securities transaction.” Kaiser I, 913 F.2d at 849 (internal quotations omitted). To impose additional non-statutory requirements on the plain language of ”” 741(8) and 546(e), as Enron and the bankruptcy court did, would constitute an “act of judicial legislation.” Id. at 850. The breadth of ” 546(e)'fs safe harbor has been explicitly adopted by five circuits. Kaiser I, 913 F.2d at 849 (held, completion of leveraged buyout constitutes “settlement payment” and is thus protected from avoidance under ” 546(e)); Kaiser Steel Corp. v. Pearl Brewing Co. (In re Kaiser Steel Corp.), (10th Cir. 1991) (“Kaiser II“), 952 F.2d at 1239 (10th Cir. 1991) (“[t]here is no reason to narrow the plain concept of 'esettlement.'f 'c .); In re Bevill, Bresler & Schulman Asset Mgmt. Corp. (“Bevill”), 878 F.2d 751-52 (3d Cir. 1989) (” 'c 'esettlement payment'f does not only mean payment of cash to the dealer by the purchaser, but also encompasses transfer of the purchased securities to the purchaser from the dealer.”); In re Resorts Int'fl, Inc., (“Resorts“); 181 F.3d at 515 (same); In re QSI Holdings, 571 F.3d at 548-50 (6th Cir. 2009) (transfers made to holders of non-public securities entitled to safe harbor protection, rejecting effort to import publicly traded securities limitation; “nothing in the text of
” 546(e) precludes its application to settlement payments involving privately held securities.”); Contemporary Inds. Corp. v. Frost 564 F.3d at 986 (8th Cir. 2009) (“We agree with our sister circuits that ” 741(a) was intended to sweep broadly 'c [T]he term 'c encompasses most transfers of money or securities made to complete a securities transaction.”); In re Hamilton Taft & Co., 114 F.3d 991, 993 (9th Cir. 1997) (“[W]e have broadly construed the term 'esettlement payment'f to 'einclude 'c a transfer of securities that completes a securities transaction'f.”).

According to Enron and the bankruptcy court, “there was sufficient indicia of extremely unique circumstances presented in this case that set it apart and called into question whether, indeed, a 'esettlement payment'f as contemplated by ” 546(e) was at issue.” Enron II, at 31 n.14. They thus assumed that the phrase “commonly used in the securities trade” in ” 741(8) modified all of the proceeding definitions of “settlement payment.”

The 'Doctrine of the Last Antecedent'f

Judge McMahon disagreed. “Conventions of statutory interpretation, including the rule of the last antecedent, convinced me that the holdings of [five] sister circuits are correct.” Enron III, at *6. The “doctrine of last antecedent” thus governed the interpretation of ” 741(8). When, as in this case, “no contrary intention appears, the 'erule of the last antecedent'f provides that a limiting clause or phrase should ordinarily be read as modifying only the noun or phrase that it immediately follows.” Enron III, at *10, citing J.P. Morgan Chase Bank, N.A. v. Baupost Group LLC, 380 B.R. 307, 319 (S.D.N.Y. 2008); Barnhart v. Thomas, 540 U.S. 20, 27-28 (2003). The limiting phrase in ” 741(8) ” “commonly used in securities trade” ” cannot, according to Judge McMahon, be read to modify “anything other than the last antecedent that precedes it ” 'eother similar payment'f” Id., at *10. Instead, “the phrase 'esettlement payment'f as used in section 546(e), includes any payment in settlement of a securities transaction.” Id. Accord, Barnhart, 540 U.S. at 26 (under doctrine of last antecedent, when applied to construing statutes, “a limiting clause or phrase 'c should ordinarily be read as modifying only the noun or phrase that it immediately follows.”).

The Enron Transfers Were Settlement Payments

The bankruptcy court had also accepted Enron'fs argument “that the
” 546(e) safe harbor does not apply to a redemption of commercial paper,” reasoning that the “legislative history and the case law imply that redemption of commercial paper at maturity is not covered by the safe harbor.” Enron II, at 40 n.23. Because the defendants here had sold their Enron commercial paper to their stockbroker one day prior to maturity, the bankruptcy court reasoned that the defendants had assumed “the related preference risk associated with the payment of a loan.” Id., at *40.

Rejecting Enron'fs arguments, the district court first held that the commercial paper here was a security. Enron III, at *11-12. Congress defined the term “security” in ” 101(49) to include “notes,” such as commercial paper, which constitutes “unsecured, short-term promissory notes issued by commercial entities.” SEC Inds. Ass'fn v. Bd. of Governors, 468 U.S. 137, 140 n.1 (1984). Thus, “commercial paper 'c falls within the general meaning of the term 'enotes'f.” Id., at 149. When one appellate court, for example, determined that a limited liability company membership interest was protected by the safe harbor of ” 546(e), it relied on the definition of a security in Code ” 101(49). In re Grafton Partners, L.P., 321 B.R. 527, 531-532 (9th Cir. B.A.P. 2005).

Rejecting the bankruptcy court'fs holding that “there was neither a purchase nor a sale” of the Enron commercial paper because “Enron never acquired title to the notes,” Judge McMahon held that the confirmations issued to ING and Alfa “explicitly referred to the 'esettlement date,'f suggesting an industry understanding that payments made and received on that date were 'esettlement payments.'f“ Enron III, at *12. Moreover, “because the redemption of the notes (a security) involved 'ethe delivery and receipt of funds and securities,'f 'c it qualifies as a 'esecurities transaction'f for safe harbor purposes, regardless of whether Enron, itself, or through an agent, acquired title to the notes.” Id., at *12, citing Kaiser I, 913 F.2d at 850.

The SEC, a participant in the bankruptcy court litigation and on appeal, also argued that Enron'fs prepayment was a settlement payment. In its brief, the SEC reasoned that “whether a payment qualifies as a 'esettlement payment'f does not turn on other circumstances of the payment or on the circumstances of the transaction at which the payment is made.” Moreover, “the confirmations for the transaction describe them as settlements of securities trades, referring to 'epurchases'f from the holders, a 'etrade date'f and a 'esettlement date'f'c .” As the Third Circuit explained in the Resorts case, ” 'c the 'eextremely broad'f 'c statutory definition of 'esettlement payment'f [in '' 741(8)] is consistent with Congress'f intent 'c that a 'esettlement payment'f may be the deposit of cash by the purchaser or the deposit or transfer of the securities by the dealer, and that it includes transfers which are normally regarded as part of the settlement process, whether they occur on the trade date, the scheduled settlement date, or any other date in the settlement process for the particular type of transaction at hand.'f” Resorts, 181 F.3d at 515 (quoting Bevill, 878 F.2d at 752).

Moreover, reasoned Judge McMahon, the funds here had actually been “transferred by Enron to redeem the notes. The money was clearly paid out in exchange for the return of the securities — or, to use the appealingly simple language of Kaiser I, there was 'ethe delivery and receipt of funds and securities.'f” Enron III, at *12, citing Kaiser I, 913 F.2d at 850.

Code ” 546(e) Eliminated Any Need for Judicial Review of Extrinsic Facts

The bankruptcy court'fs reliance on extraneous facts cited by Enron surrounding the payments to the defendants was thus unnecessary, given the broad statutory definition of settlement payment. “Nowhere are judges asked to distinguish transactions based on their subject matter. Protection is extended to any 'c 'esettlement payment'f under a securities contract.” Morrison, 13 Am. Bankr. Inst. L. Rev. at 662. There was simply no reason for the bankruptcy court to accept Enron'fs argument that a court must review the general context of the transaction when a stockbroker makes a settlement payment for its purchase of the debtor'fs commercial paper.

Congress enacted ” 546(e) to insulate transfers that would otherwise have been subject to avoidance as preferences or as constructively fraudulent transfers. As the Enron commercial paper litigation showed after six years, judicial scrutiny of the transactional context of the transfer here was lengthy and expensive. See Morrison, 13 Am. Bankr. Inst. L. Rev. at 664 (“Judges are discouraged from engaging in 'esubstance over form'f analysis. The new definitions [of the Code] are pure form; they protect transactions that fit within formal definitions developed in the marketplace. The role of the judge is to identify these industry definitions. If the contract fits the form, it'fs protected.”).

Conclusion

The Enron fact-intensive analysis would make few, if any, transactions sufficiently “common” to be protected by ” 546(e). Litigants could always cite some trivial unique aspect of the transaction, thus creating a fact issue for trial. This approach could not only create unnecessary chaos in the securities marketplace and in the courts, but also make the ” 546(e) safe harbor meaningless. Indeed, Congress has already provided protection for: 1) preferential transfers that occur “in the ordinary course of business or financial affairs” of the debtor and its transferees (Code ” 547(c)); and 2) constructively fraudulent transfers made in “good faith.” Code ” 548(c). There would be no need for a separate safe harbor in ” 546(e) if parties had to litigate extensively to protect transfers that would already be protected by ” 547(c) and ” 548(c). Despite Enron'fs recovery motive here, the Code provided no basis for turning a purely legal dispute into a prolonged factual dispute.

Michael L. Cook, a member of this newsletter'fs Board of Editors, is a partner at Schulte Roth & Zabel LLP in New York. He represented Alfa S.A.B. de C.V., a defendant in the Enron commercial paper litigation and the plaintiff trustee in the Seligson litigation discussed in Part One of this article.

Last month, we discussed the fact that the The Bankruptcy Code (“Code”) has at least nine so-called “safe harbor” (i.e., bankruptcy insulating) provisions for financial contracts. As we showed in Part One, some lower courts have inconsistently enforced those safe harbor provisions in the preference and fraudulent transfer context, generating costly litigation for the asserted cause of creditor recovery. We continued by discussing the legislative history of the safe harbor.

In discussing the history of Enron , we pointed out that District Judge Colleen McMahon succinctly summarized the relevant legislative history, noting that it had first been “enacted in 1978 in response to a” decision holding that a bankruptcy trustee was not barred “from recovering [on fraudulent transfer grounds] a margin payment made to a commodities clearinghouse.” Seligson v. New York Produce Exchange , 394 F. Supp. 125, 128-36 (S.D.N.Y. 1975). Enron III, at *5. By 1982, explained the court, ” 546(e) “broadened the safe harbor by extending its scope to include the securities markets 'c 'ebeyond the ordinary course of business to include margin and settlement payments to and from brokers, clearing organizations, and financial institutions'f.” Enron III, at *5-6, quoting Kaiser Steel Corp. v. Charles Schwab & Co., (10th Cir. 1990) (“Kaiser I“), at 849, and citing H.R. Rep. 97-420, at *2 (1982). “This broad protection was designed to ensure settlement finality, and therefore market stability.” Enron III, at *6. The discussion concludes herein.

The Code Does Not Impose an 'eOrdinary Course'f Requirement on the Definition of Settlement Payments

The bankruptcy court had accepted Enron'fs argument that “the safe harbor [of Code '' 546(e)] only extends to qualifying 'epurchases'f and 'esales'f of securities, not to the payment or retirement of debt.” Enron I, at 682. Conceding that the definition of “settlement payment” in ” 741(a) is “unhelpfully circular” and disagreeing with the bankruptcy court, the district court in Enron III agreed with five circuits who held that “741(a) does not limit the definition of 'esettlement payment'f to payments commonly used in the securities trade.” Enron III, at *6.

Indeed, appellate courts have broadly interpreted “settlement payment” as “the completion [or conclusion] of a securities transaction.” Kaiser I, 913 F.2d at 849 (internal quotations omitted). To impose additional non-statutory requirements on the plain language of ”” 741(8) and 546(e), as Enron and the bankruptcy court did, would constitute an “act of judicial legislation.” Id. at 850. The breadth of ” 546(e)'fs safe harbor has been explicitly adopted by five circuits. Kaiser I, 913 F.2d at 849 (held, completion of leveraged buyout constitutes “settlement payment” and is thus protected from avoidance under ” 546(e)); Kaiser Steel Corp. v. Pearl Brewing Co. (In re Kaiser Steel Corp.), (10th Cir. 1991) (“Kaiser II“), 952 F.2d at 1239 (10th Cir. 1991) (“[t]here is no reason to narrow the plain concept of 'esettlement.'f 'c .); In re Bevill, Bresler & Schulman Asset Mgmt. Corp. (“Bevill”), 878 F.2d 751-52 (3d Cir. 1989) (” 'c 'esettlement payment'f does not only mean payment of cash to the dealer by the purchaser, but also encompasses transfer of the purchased securities to the purchaser from the dealer.”); In re Resorts Int'fl, Inc., (“Resorts“); 181 F.3d at 515 (same); In re QSI Holdings, 571 F.3d at 548-50 (6th Cir. 2009) (transfers made to holders of non-public securities entitled to safe harbor protection, rejecting effort to import publicly traded securities limitation; “nothing in the text of
” 546(e) precludes its application to settlement payments involving privately held securities.”); Contemporary Inds. Corp. v. Frost 564 F.3d at 986 (8th Cir. 2009) (“We agree with our sister circuits that ” 741(a) was intended to sweep broadly 'c [T]he term 'c encompasses most transfers of money or securities made to complete a securities transaction.”); In re Hamilton Taft & Co., 114 F.3d 991, 993 (9th Cir. 1997) (“[W]e have broadly construed the term 'esettlement payment'f to 'einclude 'c a transfer of securities that completes a securities transaction'f.”).

According to Enron and the bankruptcy court, “there was sufficient indicia of extremely unique circumstances presented in this case that set it apart and called into question whether, indeed, a 'esettlement payment'f as contemplated by ” 546(e) was at issue.” Enron II, at 31 n.14. They thus assumed that the phrase “commonly used in the securities trade” in ” 741(8) modified all of the proceeding definitions of “settlement payment.”

The 'Doctrine of the Last Antecedent'f

Judge McMahon disagreed. “Conventions of statutory interpretation, including the rule of the last antecedent, convinced me that the holdings of [five] sister circuits are correct.” Enron III, at *6. The “doctrine of last antecedent” thus governed the interpretation of ” 741(8). When, as in this case, “no contrary intention appears, the 'erule of the last antecedent'f provides that a limiting clause or phrase should ordinarily be read as modifying only the noun or phrase that it immediately follows.” Enron III , at *10, citing J.P. Morgan Chase Bank, N.A. v. Baupost Group LLC , 380 B.R. 307, 319 (S.D.N.Y. 2008); Barnhart v. Thomas , 540 U.S. 20, 27-28 (2003). The limiting phrase in ” 741(8) ” “commonly used in securities trade” ” cannot, according to Judge McMahon, be read to modify “anything other than the last antecedent that precedes it ” 'eother similar payment'f” Id., at *10. Instead, “the phrase 'esettlement payment'f as used in section 546(e), includes any payment in settlement of a securities transaction.” Id. Accord, Barnhart, 540 U.S. at 26 (under doctrine of last antecedent, when applied to construing statutes, “a limiting clause or phrase 'c should ordinarily be read as modifying only the noun or phrase that it immediately follows.”).

The Enron Transfers Were Settlement Payments

The bankruptcy court had also accepted Enron'fs argument “that the
” 546(e) safe harbor does not apply to a redemption of commercial paper,” reasoning that the “legislative history and the case law imply that redemption of commercial paper at maturity is not covered by the safe harbor.” Enron II, at 40 n.23. Because the defendants here had sold their Enron commercial paper to their stockbroker one day prior to maturity, the bankruptcy court reasoned that the defendants had assumed “the related preference risk associated with the payment of a loan.” Id., at *40.

Rejecting Enron'fs arguments, the district court first held that the commercial paper here was a security. Enron III, at *11-12. Congress defined the term “security” in ” 101(49) to include “notes,” such as commercial paper, which constitutes “unsecured, short-term promissory notes issued by commercial entities.” S EC Inds. Ass'fn v. Bd. of Governors , 468 U.S. 137, 140 n.1 (1984). Thus, “commercial paper 'c falls within the general meaning of the term 'enotes'f.” Id., at 149. When one appellate court, for example, determined that a limited liability company membership interest was protected by the safe harbor of ” 546(e), it relied on the definition of a security in Code ” 101(49). In re Grafton Partners, L.P., 321 B.R. 527, 531-532 (9th Cir. B.A.P. 2005).

Rejecting the bankruptcy court'fs holding that “there was neither a purchase nor a sale” of the Enron commercial paper because “Enron never acquired title to the notes,” Judge McMahon held that the confirmations issued to ING and Alfa “explicitly referred to the 'esettlement date,'f suggesting an industry understanding that payments made and received on that date were 'esettlement payments.'f“ Enron III, at *12. Moreover, “because the redemption of the notes (a security) involved 'ethe delivery and receipt of funds and securities,'f 'c it qualifies as a 'esecurities transaction'f for safe harbor purposes, regardless of whether Enron, itself, or through an agent, acquired title to the notes.” Id., at *12, citing Kaiser I, 913 F.2d at 850.

The SEC, a participant in the bankruptcy court litigation and on appeal, also argued that Enron'fs prepayment was a settlement payment. In its brief, the SEC reasoned that “whether a payment qualifies as a 'esettlement payment'f does not turn on other circumstances of the payment or on the circumstances of the transaction at which the payment is made.” Moreover, “the confirmations for the transaction describe them as settlements of securities trades, referring to 'epurchases'f from the holders, a 'etrade date'f and a 'esettlement date'f'c .” As the Third Circuit explained in the Resorts case, ” 'c the 'eextremely broad'f 'c statutory definition of 'esettlement payment'f [in '' 741(8)] is consistent with Congress'f intent 'c that a 'esettlement payment'f may be the deposit of cash by the purchaser or the deposit or transfer of the securities by the dealer, and that it includes transfers which are normally regarded as part of the settlement process, whether they occur on the trade date, the scheduled settlement date, or any other date in the settlement process for the particular type of transaction at hand.'f” Resorts, 181 F.3d at 515 (quoting Bevill, 878 F.2d at 752).

Moreover, reasoned Judge McMahon, the funds here had actually been “transferred by Enron to redeem the notes. The money was clearly paid out in exchange for the return of the securities — or, to use the appealingly simple language of Kaiser I, there was 'ethe delivery and receipt of funds and securities.'f” Enron III, at *12, citing Kaiser I, 913 F.2d at 850.

Code ” 546(e) Eliminated Any Need for Judicial Review of Extrinsic Facts

The bankruptcy court'fs reliance on extraneous facts cited by Enron surrounding the payments to the defendants was thus unnecessary, given the broad statutory definition of settlement payment. “Nowhere are judges asked to distinguish transactions based on their subject matter. Protection is extended to any 'c 'esettlement payment'f under a securities contract.” Morrison, 13 Am. Bankr. Inst. L. Rev. at 662. There was simply no reason for the bankruptcy court to accept Enron'fs argument that a court must review the general context of the transaction when a stockbroker makes a settlement payment for its purchase of the debtor'fs commercial paper.

Congress enacted ” 546(e) to insulate transfers that would otherwise have been subject to avoidance as preferences or as constructively fraudulent transfers. As the Enron commercial paper litigation showed after six years, judicial scrutiny of the transactional context of the transfer here was lengthy and expensive. See Morrison, 13 Am. Bankr. Inst. L. Rev. at 664 (“Judges are discouraged from engaging in 'esubstance over form'f analysis. The new definitions [of the Code] are pure form; they protect transactions that fit within formal definitions developed in the marketplace. The role of the judge is to identify these industry definitions. If the contract fits the form, it'fs protected.”).

Conclusion

The Enron fact-intensive analysis would make few, if any, transactions sufficiently “common” to be protected by ” 546(e). Litigants could always cite some trivial unique aspect of the transaction, thus creating a fact issue for trial. This approach could not only create unnecessary chaos in the securities marketplace and in the courts, but also make the ” 546(e) safe harbor meaningless. Indeed, Congress has already provided protection for: 1) preferential transfers that occur “in the ordinary course of business or financial affairs” of the debtor and its transferees (Code ” 547(c)); and 2) constructively fraudulent transfers made in “good faith.” Code ” 548(c). There would be no need for a separate safe harbor in ” 546(e) if parties had to litigate extensively to protect transfers that would already be protected by ” 547(c) and ” 548(c). Despite Enron'fs recovery motive here, the Code provided no basis for turning a purely legal dispute into a prolonged factual dispute.

Michael L. Cook, a member of this newsletter'fs Board of Editors, is a partner at Schulte Roth & Zabel LLP in New York. He represented Alfa S.A.B. de C.V., a defendant in the Enron commercial paper litigation and the plaintiff trustee in the Seligson litigation discussed in Part One of this article.