Settlement Payments Doctrine Insulates Enron’s Voluntary Repurchase of Debt Shortly before Its Bankruptcy — Majority Panel Decision in Second Circuit

From In re Enron Creditors Recovery Corp. v. Alfa, S.A.B., 2011 U.S. App. LEXIS 13177 (2d Cir. June 28, 2011):

This appeal raises an issue of first impression in the courts of appeals: whether 11 U.S.C. § 546(e), which shields "settlement payments" from avoidance actions in bankruptcy, extends to an issuer's payments to redeem its commercial paper prior to maturity. Enron Creditors Recovery Corp. ("Enron") seeks to avoid and recover payments Enron made to redeem its commercial paper prior to maturity from Appellees Alfa, S.A.B. de C.V. ("Alfa"), ING VP Balanced Portfolio, Inc., and ING VP Bond Portfolio, Inc. (collectively, "ING"), whose notes were redeemed by Enron. Alfa and ING argue that § 546(e) protects these payments from avoidance.

The Bankruptcy Court for the Southern District of New York (Arthur J. Gonzalez, Bankruptcy Judge) concluded that § 546(e)'s safe harbor does not protect Enron's payments from avoidance because they were made to retire debt, not to purchase securities, and because they were extraordinary. The District Court for the Southern District of New York (Colleen McMahon, Judge) held that Enron's payments do fall within the safe harbor, reversed the Bankruptcy Court's decision, and remanded with instructions to enter summary judgment in favor of Alfa and ING. ***

[W]e agree with the district court that Enron's proposed exclusions from the reach of § 546(e) have no basis in the Bankruptcy Code***

Between October 25, 2001 and November 6, 2001, Enron drew down on its $3 billion revolving lines of credit and paid out more than $1.1 billion to retire certain of its unsecured and uncertificated commercial paper prior to the paper's maturity. Enron redeemed the commercial paper at the accrued par value, calculated as the price originally paid plus accrued interest. This price was considerably higher than the paper's market value.

The offering memoranda that accompanied the issuance of the commercial paper provided that the "Notes are not redeemable or subject to voluntary prepayment by the Company prior to maturity." This provision prohibited calls and puts: Enron could not force investors to surrender the notes and the investors could not require Enron to prepay them.

The Depository Trust Company (the "DTC"), a clearing agency, maintained bookkeeping entries that tracked ownership of Enron's commercial paper. This is the customary tracking method in the industry. Every issuer of commercial paper has an issuing and paying agent ("IPA") within the DTC to issue commercial paper and to pay at maturity or at an early redemption.

Three broker-dealers, J.P. Morgan, Goldman, Sachs & Co., and Lehman Brothers Commercial Paper, Inc., participated in Enron's redemption. They received the commercial paper from the individual noteholders and paid them the redemption price. The mechanics of these transfers were as follows. The DTC debited the redemption price from each broker-dealer's account and credited it to the noteholder's DTC account. The broker-dealers then transferred the notes to the DTC account of Enron's issuing and paying agent, Chase IPA, and received payment from Enron through the DTC. Immediately after the broker-dealer received payment, the commercial paper Enron redeemed was extinguished in the DTC system. Confirmations of these transactions referred to them as securities trades, termed them "purchases" from the holders, and referenced a "trade date" and "settlement date." ***

Section 546(e) provides, in relevant part, that

[n]otwithstanding sections . . . 547 [and] 548(a)(1)(B) . . . of this title, [which empower the trustee to avoid preferential and constructively fraudulent transfers,] the trustee may not avoid a transfer that is a . . . settlement payment, as defined in section . . . 741 of this title, made by or to (or for the benefit of) a . . . stockbroker, financial institution, financial participant, or securities clearing agency . . . that is made before the commencement of the case, except under section 548(a)(1)(A) of this title[, which empowers the trustee to avoid transfers made with actual intent to hinder, delay, or defraud creditors].

Section 741(8) of Title 11, in turn, defines a "settlement payment" as "a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade." ***

I. Judicial Interpretation of the Safe Harbor

Congress enacted § 546(e)'s safe harbor in 1982 as a means of "minimiz[ing] the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries." Kaiser Steel Corp. v. Charles Schwab & Co., Inc., 913 F.2d 846, 849 (10th Cir. 1990) (quoting H.R. Rep. 97-420, at 2 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583). If a firm is required to repay amounts received in settled securities transactions, it could have insufficient capital or liquidity to meet its current securities trading obligations, placing other market participants and the securities markets themselves at risk.

The safe harbor limits this risk by prohibiting the avoidance of "settlement payments" made by, to, or on behalf of a number of participants in the financial markets. By restricting a bankruptcy trustee's power to recover payments that are otherwise avoidable under the Bankruptcy Code, the safe harbor stands "at the intersection of two important national legislative policies on a collision course-the policies of bankruptcy and securities law." In re Resorts Int'l, Inc., 181 F.3d 505, 515 (3rd Cir. 1999) (internal quotation marks omitted).

Section 741(8), which § 546(e) incorporates, defines "settlement payment" rather circularly as "a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade." The parties, following our sister circuits, agree that courts should interpret the definition, "in the context of the securities industry," as "the transfer of cash or securities made to complete [a] securities transaction." Contemporary Indus. Corp. v. Frost, 564 F.3d 981, 985 (8th Cir. 2009) (quoting In re Resorts Int'l, Inc., 181 F.3d at 515).

Although our circuit has not yet addressed the scope of § 741(8)'s definition, other circuits have held it to be "extremely broad." In re QSI Holdings, Inc., 571 F.3d 545, 549 (6th Cir. 2009) (quoting Contemporary Indus. Corp., 564 F.3d at 985). Several circuits, for example, have rejected limitations on the definition that would exclude transactions in privately held securities or transactions that do not involve financial intermediaries that take title to the securities during the course of the transaction. See, e.g., In re Plassein Int'l Corp., 590 F.3d 252, 258-59 (3rd Cir. 2009); In re QSI Holdings, Inc., 571 F.3d at 549-50; Contemporary Indus. Corp., 564 F.3d at 986. No circuit has yet addressed the safe harbor's application to an issuer's early redemption of commercial paper.

Alfa and ING argue that Enron's redemption payments are settlement payments within the meaning of § 741(8) because they completed a transaction involving the exchange of money for securities. The SEC and the Securities Industry and Financial Markets Association, a trade group representing the interests of securities firms, banks, and asset managers, have filed amicus briefs in support of Alfa and ING's interpretation of the statute.

Enron proposes three limitations on the definition of settlement payment in § 741(8), each of which, it argues, would exclude the redemption payments. First, it contends that the final phrase of § 741(8)--"commonly used in the securities trade"-excludes all payments that are not common in the securities industry, including, Enron argues, Enron's redemption. Second, Enron argues that the definition includes only transactions in which title to the securities changes hands. Because, Enron argues, the redemption payments here were made to retire debt and not to acquire title to the commercial paper, they are not settlement payments within the meaning of § 741(8). Finally, Enron argues that the redemption payments are not settlement payments because they did not involve a financial intermediary that took title to the transacted securities and thus did not implicate the risks that prompted Congress to enact the safe harbor.

Because we find nothing in the Bankruptcy Code or the relevant caselaw that supports Enron's proposed limitations on the definition of settlement payment in § 741(8), we reject them. We hold that Enron's redemption payments fall within the plain language of § 741(8) and are thus protected from avoidance under § 546(e).

II. "Commonly Used in the Securities Trade"

Section 741(8) defines "settlement payment" as "a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade." Enron argues that the phrase "commonly used in the securities trade" modifies all the preceding terms and thereby excludes from the definition all uncommon payments. We disagree.

First, as the district court held, the grammatical structure of the statute strongly suggests that the phrase "commonly used in the securities trade" modifies only the term immediately preceding it: "any other similar payment." Under the "rule of the last antecedent, . . . a limiting clause or phrase . . . should ordinarily be read as modifying only the noun or phrase that it immediately follows." Barnhart v. Thomas, 540 U.S. 20, 26 (2003); see also Stepnowski v. Comm'r, 456 F.3d 320, 324 n.7 (3d Cir. 2006) ("Under the last-antecedent rule of construction, . . . the series 'A or B with respect to C' contains two items: (1) 'A' and (2) 'B with respect to C.'"). Enron seizes on a corollary rule of construction under which "a modifier . . . set off from a series of antecedents by a comma . . . should be read to apply to each of those antecedents." Kahn Lucas Lancaster, Inc. v. Lark Int'l Ltd., 186 F.3d 210, 215 (2d Cir. 1999), abrogated on other grounds as recognized by Sarhank Grp. v. Oracle Corp., 404 F.3d 657, 660 n.2 (2d Cir. 2005). For example, in the phrase "no person shall be deprived of life, liberty, or the pursuit of happiness, without due process of law," the phrase "without due process of law" modifies all three terms. This rule, however, does not apply to the series in § 741(8) because the modifier is not set off from its antecedents by a comma. Because both the modifier and its immediate antecedent are set off from the preceding terms in the series, the last-antecedent rule applies. The phrase "commonly used in the securities industry" thus is properly read as modifying only the term "any other similar payment." The phrase is not a limitation on the definition of settlement payment, but rather, as our sister circuits have held, it is "a catchall phrase intended to underscore the breadth of the § 546(e) exemption." In re QSI Holdings, Inc., 571 F.3d at 550 (quoting Contemporary Indus. Corp., 564 F.3d at 986 (emphasis in original)).

Moreover, Enron's proposed reading would make application of the safe harbor in every case depend on a factual determination regarding the commonness of a given transaction. It is not clear whether that determination would depend on the economic rationality of the transaction, its frequency in the marketplace, signs of an intent to favor certain creditors-as suggested by the facts on which the bankruptcy court relied, such as the alleged coercion by Enron's commercial paper noteholders, *** or some other factor. This reading of the statute would result in commercial uncertainty and unpredictability at odds with the safe harbor's purpose and in an area of law where certainty and predictability are at a premium.

Accordingly, we hold that the phrase "commonly used in the securities industry" limits only the phrase immediately preceding it; it does not limit the other transactions that § 741(8) defines as settlement payments.

III. Redemption of Debt Securities

Enron next argues that the redemption payments are not settlement payments because they involved the retirement of debt, not the acquisition of title to the commercial paper. We find no basis in the Bankruptcy Code or the relevant caselaw to interpret § 741(8) as excluding the redemption of debt securities. Because Enron's redemption payments completed a transaction in securities, we hold that they are settlement payments within the meaning of § 741(8).***

Enron argues, and the dissent agrees, see Dissent at 11, 19-20, that applying the safe harbor to Enron's commercial paper redemption would contradict "uniform case law spanning two decades" that allows "avoidance of debt-related payments." The cases on which Enron relies, however, involve non-tradeable bank loans, not widely issued debt securities. See, e.g., Union Bank v. Wolas, 502 U.S. 151, 152-53 (1991); Ray v. City Bank & Trust Co., 899 F.2d 1490, 1491-93 (6th Cir. 1990); Breeden v. L.I. Bridge Fund, LLC, 220 B.R. 739, 740 (B.A.P. 2d Cir. 1998); CEPA Consulting, Ltd. v. N.Y. Nat'l Bank, 187 B.R. 105, 106-07 (S.D.N.Y. 1995). Concluding that the safe harbor protects payments made to redeem tradeable debt securities does not contradict caselaw permitting avoidance of payments made on ordinary loans. Interpreting the term "settlement payment" in the context of the securities industry will exclude from the safe harbor payments made on ordinary loans.

Indeed, it is not clear that a purchase or sale requirement would necessarily exclude all payments made on ordinary loans. For example, what if parties structured the early repayment of a loan evidenced by a promissory note as a repurchase of that promissory note? The note's terms could prohibit voluntary early redemption. If the borrower were to buy back the promissory note at a negotiated price, it would be difficult to characterize this transaction as a redemption rather than a repurchase in order to exclude it from the safe harbor.

The payments at issue in this case demonstrate the difficulty with and the absence of a statutory foundation for a purchase or sale requirement. Assume, for example, that the terms of Enron's commercial paper-like the terms of the hypothetical promissory note discussed above-prohibited early redemption. Enron could reacquire the paper only by agreeing with the paper holders on a particular reacquisition price. This transaction would appear to be a repurchase, cf. Sterling Precision Corp., 393 F.2d at 217 ("[A] maker's paying a note prior to maturity in accordance with its terms would not be regarded as a 'purchase.'"***), and would thus trigger safe-harbor protection under the rule Enron and the dissent espouse. It is difficult to see, however, why this transaction should warrant safe harbor protection while a transaction identical in every respect, except that the commercial paper's terms did not prohibit early redemption, should not. Avoidance of the transactions in either scenario would present the same threat of systemic risk in the marketplace, and limiting safe-harbor protection to transactions in the first scenario would not prevent an issuer from making payments to reacquire commercial paper during the preference period. Contrary to the dissent's contention, see Dissent at 18-19, a purchase or sale requirement would thus not prevent Enron from favoring commercial-paper holders over other creditors. ***

IV. Involvement of a Financial Intermediary

Enron also argues that the redemption of debt does not constitute a protected settlement payment because it did not involve a financial intermediary that took a beneficial interest in the securities during the course of the transaction. Enron argues that the redemption thus did not implicate the systemic risks that motivated Congress's enactment of the safe harbor. Although the role of the broker-dealers that participated in Enron's redemption is a disputed issue of fact, see Enron IV, 422 B.R. at 426, Enron is correct that the DTC acted as a conduit and recordkeeper rather than a clearing agency that takes title to the securities during the course of the transaction.

Nevertheless, we do not think the absence of a financial intermediary that takes title to the transacted securities during the course of the transaction is a proper basis on which to deny safe-harbor protection. The Third, Sixth, and Eighth Circuits rejected similar arguments in affirming application of the safe harbor to leveraged buyouts of private companies that involved financial intermediaries who served only as conduits. See In re Plassein Int'l Corp., 590 F.3d at 257-59; In re QSI Holdings, Inc., 571 F.3d at 549-50; Contemporary Indus. Corp., 564 F.3d at 986. In reasoning that provides an analog for us, these courts explained that undoing long-settled leveraged buyouts would have a substantial impact on the stability of the financial markets, even though only private securities were involved and no financial intermediary took a beneficial interest in the exchanged securities during the course of the transaction.3 See In re Plassein Int'l Corp., 590 F.3d at 258; In re QSI Holdings, Inc., 571 F.3d at 550; Contemporary Indus. Corp., 564 F.3d at 987. We see no reason to think that undoing Enron's redemption payments, which involved over a billion dollars and approximately two hundred noteholders, would not also have a substantial and similarly negative effect on the financial markets.

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