Source: https://www.chapman.com/insights-publications-Bankruptcy_Forward_Contract_Merchant_Safe_Harbor.html
Timestamp: 2019-04-21 13:06:12+00:00

Document:
In a case of particular significance to parties that enter into forward contracts as means of hedging the future price of commodities used in their business, the U.S. Bankruptcy Court for the Northern District of Ohio has found that a “forward contract merchant” must be in the business of entering into forward contracts in order to generate a profit, not merely as a hedge. The Court also refused to enforce a contractual provision–common in many power purchase agreements–that each party was a “forward contract merchant.” The Court found that a party that terminated a power purchase agreement had violated the automatic stay and was not entitled to the protections of the “safe harbor” protections for forward contracts in the Bankruptcy Code. The Court ultimately adopted the narrow interpretation of “forward contract merchant” set forth in the Mirant case from the U.S. Bankruptcy Court for the Northern District of Texas, and rejected the broader interpretation adopted by the U.S. Bankruptcy Court for the District of Delaware in the Borden Chemicals case. While the Court has yet to decide what sanction to apply, this case serves as a warning for parties that hedge their exposure to various commodities that they may be unable to terminate or renegotiate unfavorable contracts when their counterparty files for bankruptcy.
Section 365(e) of the Bankruptcy Code generally makes defaults that are conditioned on a bankruptcy filing unenforceable. In most cases, the automatic stay also prevents a counterparty from unilaterally terminating contracts with the debtor. 11 U.S.C. §362(a). However, in order to preserve the proper functioning of the commodities markets, Congress has preserved the right to terminate certain contracts, such as forward contracts, upon a counterparty’s bankruptcy. 11 U.S.C. §556. Section 556 is among the “safe harbor” provisions in the Bankruptcy Code. Under the “safe harbor” provisions, the right to terminate certain contracts and exercise certain other remedies is not stayed. 11 U.S.C. §362(b)(6).
The Bankruptcy Code defines a “forward contract merchant” to mean “a Federal reserve bank, or an entity the business of which consists in whole or in part of entering into forward contracts as or with merchants in a commodity (as defined in section 761) or any similar good, article, service, right, or interest which is presently or in the future becomes the subject of dealing in the forward contract trade." 11 U.S.C. §101(26)(emphasis added).
After FES filed for bankruptcy, Meadville sent a letter on April 17, 2018, stating that it was terminating the CSA. On April 27, 2018, Debtors’ counsel wrote to Meadville’s counsel, asserting that the termination of the CSA was a violation of the automatic stay and that the parties’ agreement to “forward contract merchant” status was unenforceable.
The Court concluded that Meadville’s “business” did not consist, even in part, of entering into forward contracts as or with merchants in electricity. The Court looked to a ruling in the Mirant case that defined a “merchant” as “one that is not acting as either an end-user or a producer…rather…is one that buys, sells or trades in a market.”7 The Court also noted that the Mirant court concluded that a “business” is something one engages in to generate a profit.8 Putting these terms together, the Court concluded that in order to be a forward contract merchant, the party’s “business” must consist, in whole or in part, of entering into forward contracts for the purchase and sale of electricity to generate a profit.9 Entering into supply contracts as a hedge as an end user is not sufficient.
It is well-established that the automatic stay and §365(e) prevent a non-debtor counterparty from terminating an ordinary executory contract as a result of the bankruptcy filing. It is also generally accepted that parties cannot privately agree to confer forward contract merchant status so that it will bind the Bankruptcy Court. However, more controversial is the conclusion that parties that enter into hedging contracts may not be entitled to the safe harbor protections. While the FirstEnergy court concluded that Meadville must enter into forward contracts to generate a profit, it is unclear how a contract whose goal is to minimize the cost of a good that is required to produce a company’s products is not entered into to make a profit. Every dollar that Meadville saves on electricity is additional profit from its business. Even if Meadville lost its “bet” and electricity prices at the time of delivery were lower than in the CSA, this would not change the fact that it intended that the CSA would lower its costs and enhance its profits. The FirstEnergy court appears to require that the profit come from the trade itself. Also, the Court seemed concerned that all goods or services contracts would be entitled to the safe harbor protections, but the definition of a “forward contract merchant” is limited to commodities or similar goods and services that are the subject of dealing in the forward contract trade, such as electricity.17 It will always be difficult to draw the line of where a company’s business is in part to enter into forward contracts. The ruling suggests that whether a party is a forward contract merchant will be a fact intensive inquiry, and that counterparties should carefully assess the application of the safe harbor provisions before terminating a forward contract with a bankrupt counterparty.
In re FirstEnergy Solutions Corp., 2019 WL 211801, *3 (Bankr. N.D. Ohio Jan. 15, 2019).
FirstEnergy, 2019 WL 211801, *4.
FirstEnergy, 2019 WL 211801, *3.
See In re Olympic Natural Gas Co.,294 F.3d 737, 741 (5th Cir. 2002).
Mirant Americas Energy Marketing, L.P. v. Kern Oil & Refining Co. (In re Mirant Corp.), 310 B.R. 548, 567 (Bankr. N.D. Tex. 2004).
FirstEnergy, 2019 WL 211801, *8.
BCP Liquidating LLC v. Bridgeline Gas Marketing, LLC (in re Borden Chemicals and Plastics Operating, L.P.),336 B.R. 214, 225 (Bankr. Del. 2006)(quoting 5 Collier on Bankruptcy §556.03 at 556-6 (15th ed. Rev. 2001).
In re Clear Peak Energy, Inc., 488 B.R. 647, 660 (Bankr. D. Ariz. 2013).
FirstEnergy, 2019 WL 211801, *10-11.

References: §362
 §556
 §362
 §101
 §365
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 §556