Enron Creditors Recovery Corp, et al. v. J.P. Morgan Securities, Inc., et al. (In re Enron Creditors Recovery Corp.), 407 B.R. 17 (Bankr. S.D.N.Y. 2009)

The bankruptcy court in Enron Creditors Recovery Corp. held that the safe harbor provided by section 546(e) of the Bankruptcy Code for settlement payments related to certain types of securities transactions does not protect the redemption of short term debt instruments known as “commercial paper” prior to maturity.  Section 546(e) of the Bankruptcy Code provides that the debtor may not avoid a transfer that is a “margin payment” or “settlement payment” made to certain enumerated participants in financial markets.

 In this case, Enron Corporation issued commercial paper prior to filing its chapter 11 petition.  According to the offering memorandum for the commercial paper, it was not redeemable or subject to voluntary prepayment by Enron prior to maturity.  Notwithstanding this prohibition, the defendants redeemed $1.1 billion of the commercial paper between October 26 and November 6, 2001.  Enron filed its chapter 11 petition on December 2, 2001.  The debtor brought this avoidance action to recover the payments the defendants received for their commercial paper as preferences under section 547(b) of the Bankruptcy Code and fraudulent transfers under section 548(a). 

 As an affirmative defense to the debtor’s attempt to recover the funds, the defendants claimed that the payments fell into the safe harbor provided by section 546(e) of the Bankruptcy Code for settlement payments and therefore could not be recovered by the debtor.  “Settlement Payment” is defined in section 101 of the Bankruptcy Code 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 debtor countered that the transfers did not fall within this exception.

 The bankruptcy court held that the transfers at issue did not fall within the safe harbor provided by section 546(e) of the Bankruptcy Code.  According to the bankruptcy court, the procedures that were followed to redeem the commercial paper were not of a type “commonly used in the securities trade,” as required in the definition of “Settlement Payment.”  It noted several specific elements of the transactions that were not commonly found in the securities trade, including: 

1. The commercial paper was extinguished as a result of the transactions at issue, as opposed to the general practice of reselling it on the secondary market.   
2. The parties to the transactions structured them in an unusual manner that was explicitly designed to avoid preference liability.  The court noted that the dealers that facilitated the redemptions intentionally tried to distance themselves from the debtor, so as not to become implicated in possible, future preference litigation.   
3. Some of the commercial paper was redeemed one or two days prior to maturity, rather than held to maturity and paid upon maturity, which would be more common in the securities trade.

 In addition to finding that the transactions at issue did not fit the definition of settlement payments, the bankruptcy court found that they were not consistent with the purpose for which the safe harbor was created.  The bankruptcy court noted that the safe harbor was designed to protect investors from risks incidental to the flow of payments in the transfer of instruments within the financial system.  The court found that there was no transfer of ownership in this case, since the result of the redemption transactions was that the commercial paper was extinguished.

Commentary: Enron Creditors Recovery Corp. is an essential case in helping define what transactions qualify for protection under section 546(e) of the Bankruptcy Code.  Among other things, it highlights that it is not sufficient for a transaction to merely involve a security to fall within the safe harbor provided by section 546(e) of the Bankruptcy Code; rather, the transaction must in substance and form fit within the intent behind that section.  The case also illustrates that structuring a transaction to specifically avoid preference liability may, in fact, backfire.