Enron opened the door a bit for Section 546(e) safe harbor!
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ENRON CREDITORS RECOVERY CORP.
Barely two months afterward, the Second Circuit Court of Appeals issued an opinion in Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V. (In re Enron Creditors Recovery Corp.), 651 F.3d 329 (2d Cir. 2011), that has had the effect of overruling MacMenamin's Grill.
Prior to filing for chapter 11 on December 2, 2001, in New York, Enron paid more than $1.1 billion to retire certain of its unmatured, unsecured, and uncertified commercial paper at an accrued par value (original purchase price plus interest) significantly higher than its actual market value. Enron later sought to avoid the redemption payments in bankruptcy court as preferential transfers under section 547(b) of the Bankruptcy Code and constructive fraudulent transfers under section 548(a)(1)(B) of the Bankruptcy Code.
The transferees of the payments filed for summary judgment, arguing that the payments were protected by section 546(e)'s safe harbor. The bankruptcy court denied the motion, concluding that the definition of "settlement payments" in section 741(8) of the Bankruptcy Code includes only payments made to buy or sell securities and not payments to retire debt and that Enron's payments were therefore not protected by the safe harbor. The district court reversed, and Enron appealed to the Second Circuit Court of Appeals.
The Second Circuit's Ruling
Enron argued that the redemption payments were not "settlement payments" under section 546(e) of the Bankruptcy Code because: (i) the payments were not "commonly used in the securities trade," as required by the definition of "settlement payment" in section 741(8) of the Bankruptcy Code; (ii) the redemption payments were made to retire debt and not to acquire title to commercial paper, meaning no title to the securities changed hands, as required for a transaction to be considered a "settlement payment"; and (iii) the payments did not involve a financial intermediary that took title to the securities, and therefore they did not create the risks to the financial markets that prompted Congress to enact the safe-harbor provisions. Broadly interpreting the plain language of section 546(e), a three-judge panel of the Second Circuit rejected each of Enron's arguments and held that the redemption payments were "settlement payments" entitled to the protection of the safe-harbor provision.
Consistent with MacMenamin's Grill, the Second Circuit rejected Enron's argument that the phrase "commonly used in the securities trade" in subsection 741(8)'s definition of "settlement payment" applied to each preceding term, thus limiting the definition of "settlement payment" to transactions that are commonly performed in the securities trade. Applying the "last antecedent" rule of construction, the court held that the phrase "commonly used in the securities trade" modifies only the term immediately preceding it, i.e., "any other similar payment." The phrase, therefore, was intended to be a catchall underscoring the breadth of section 546(e), and not a limitation. The court also expressed concern that adopting Enron's reasoning would require courts in future safe-harbor cases to make factual determinations regarding the commonness of any given transaction, causing uncertainty and unpredictability.
The Second Circuit found no other basis for restricting the scope of section 546(e)'s protections. In particular, the Second Circuit found no support for the requirement that titleto securities must change hands for a payment to qualify as a "settlement payment," and the court refused to read such a requirement into the statute.
In addition, the Second Circuit rejected Enron's argument that the payments at issue were not "settlement payments" because the transaction lacked a financial intermediary that took a beneficial interest in the securities. Citing the legislative history of section 546(e), Enron argued that, absent such a financial intermediary, the transaction did not pose any systemic risk to financial markets and therefore should not benefit from the protections of the safe harbor.
The Second Circuit disagreed, citing to opinions in several other circuits where similar arguments in the context of leveraged buyout transactions were rejected because, regardless of whether a financial intermediary took a beneficial interest in the exchanged securities, undoing settled leveraged buyouts would have a substantial impact on the stability of financial markets. The Second Circuit found that avoiding Enron's debt-retirement payments would have a similarly negative effect on the financial markets. As a result, applying the safe harbor to these payments, the court concluded, would further congressional intent regarding section 546(e).
Dissent
District judge John G. Koeltl, sitting by designation, dissented. In his dissent, Judge Koeltl argued that the majority's expansive reading of the term "settlement payment" and its accompanying legislative intent would bring virtually every transaction involving a debt instrument within the safe harbor of 546(e). Indeed, his prognostication may have hit the mark. One month after Enron was decided, a New York bankruptcy court, in In re Quebecor World (USA) Inc., 453 B.R. 201 (Bankr. S.D.N.Y. 2011), examined the application of section 546(e) in the context of a debtor's repurchase and subsequent cancellation of privately placed notes. Relying heavily on Enron, the bankruptcy court concluded that courts no longer need: (i) to consider conflicting evidence about usage of the term "settlement payment" within the private-placement sector of the securities industry; or (ii) to decide whether prepetition transfers of value to the defendants should be characterized as a redemption of private-placement notes rather than a repurchase. Instead, the court ruled, any transaction involving a transfer of cash to complete a securities transaction is a "settlement payment" and thus cannot be avoided.
OUTLOOK
Enron and MacMenamin's Grill demonstrate the exacting scrutiny with which courts are increasingly called upon to construe the Bankruptcy Code's financial-contract provisions in an innovative and quickly evolving global financial-products industry. The quick pace of industry change can be expected to continue.
In Enron, the Second Circuit joined the Third, Sixth, and Eighth Circuits in ruling that section 546(e) and the Bankruptcy Code's definition of "settlement payment" should be broadly interpreted to cover a wide array of financial transactions. See In re Plassein Int'l Corp., 590 F.3d 252 (3rd Cir. 2009); In re QSI Holdings, Inc., 571 F.3d 545 (6th Cir. 2009); Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009). Thus, the ruling does much to clarify the scope of section 546(e)'s protections by resolving the tension between the plain language of the provision and the related legislative history.
As predicted by the dissent in Enron and demonstrated in Quebecor, Enron may make it substantially more difficult for plaintiffs to maintain a viable cause of action for avoidance of many transactions involving the prepetition transfer of a security. Still, although Enron construes the safe harbor in section 546(e) to protect transactions involving a far-reaching list of debt and equity instruments, the ruling's impact is hardly unlimited. For example, the decision should have no effect on preference litigation involving trade creditors because, by definition, the term "security" excludes "debt or evidence of indebtedness for goods sold and delivered or services rendered."
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