Hutson v. E.I du Pont de Nemours and Co., Inc. (In re National Gas Distributors, LLC), 556 F.3d 247 (4th Cir. 2009)

The Court of Appeals for the Fourth Circuit recently held in In re National Gas Distributors, LLC that a long term, fixed rate supply contact may be immune from avoidance actions on the grounds that it is a commodity forward agreement. Prior to filing its Chapter 11 petition, the debtor, National Gas Distributors LLC (National Gas), entered into supply contracts with its customers pursuant to which it sold natural gas to them at fixed rates notwithstanding market fluctuations. The trustee in the debtor’s Chapter 11 case brought avoidance actions against the debtor’s customers to recover amounts that it claimed the debtor should have charged its customers for the natural gas.

The trustee asserted that by selling natural gas at below market rates under the supply contracts, the debtor made fraudulent conveyances under Bankruptcy Code section 548. Bankruptcy Code section 548, in pertinent part, states: “The trustee may avoid any transfer . . . if the debtor voluntarily or involuntarily . . . received less than a reasonable equivalent value in exchange for such transfer or obligation…” In the avoidance actions it brought against the debtor’s customers, the trustee sought to avoid the supply contracts and recover the difference between the contract price and the natural gas market price at the time of the delivery. 

The customers moved to dismiss the trustee’s avoidance actions, arguing that the supply contracts were commodity forward agreements, which are included in the broad definition of “swap agreements” in Bankruptcy Code section 101(53B)(A)(i)(VII). Bankruptcy Code sections 546 and 548 exempt swap agreements from avoidance actions.

The bankruptcy court denied the customers’ motions to dismiss, reasoning that while the Bankruptcy Code does not define the term “commodity forward agreement,” the supply agreements did not qualify as such. It found that the supply agreements lacked two essential elements of a commodity forward agreement: (i) the open trading of the contract on an exchange or market, and (ii) non-physical delivery of the underlying commodity. The customers appealed the bankruptcy court’s decision and were permitted to file an interlocutory appeal directly to the Court of Appeals for the Fourth Circuit.

The Fourth Circuit disagreed with the two major premises of the bankruptcy court’s decision. It held that (i) commodity forward agreements need not be traded on an open market or exchange and (ii) non-physical delivery of the underlying commodity is not a necessary component of a commodity forward agreement. It noted that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) expanded the definition of “swap agreements” to include many different financial instruments, evidencing Congress’s concern about destabilizing financial markets.

In support of its position, the Fourth Circuit derived a series of conclusions from the language of the Bankruptcy Code and determined that a commodity forward agreement need not be traded on an exchange or market. First, it noted that the definition of “swap agreement” contains both “forward agreement” and “forward contract,” and because every contract is also an agreement, a forward contract is also a forward agreement. The Fourth Circuit then noted that while Bankruptcy Code section 761 states that “commodity  contracts” are contracts “on, or subject to the rules of, a contract market or board of trade,” the Bankruptcy Code’s definition of “forward contract” in section 101(25) lacks any such requirement. Thus, the Fourth Circuit concluded that a forward contract, and by extension a forward agreement (because every forward contract is also a forward agreement), need not be traded on an official market.

The Fourth Circuit also took issue with another basis for the bankruptcy court’s decision: that avoiding contracts similar to the natural gas contracts could not destabilize financial markets. It hypothesized that that a business could enter into a contract to purchase a commodity at a set price on a certain date, and, in reliance on this commitment, enter into other contracts with other market participants who in turn may enter into even broader market contracts. Thus, the Court concluded that commodity forward agreements need not be traded on an open market in order for them to affect financial markets.

Finally, the Fourth Circuit disagreed with the bankruptcy court’s holding that a commodity forward agreement cannot be a contract that is physically settled. It observed that nothing in the Bankruptcy Code precluded a “swap agreement” from being physically settled.

While the Fourth Circuit did not rule on whether the natural gas contracts at issue were commodity forward agreements, it stated that a commodity forward agreement needs to contain three elements: (i) the subject of the agreement must be a commodity; (ii) the agreement must require payment for the commodity at a price fixed at the time of contracting for delivery more than two days after the contract is entered into (the Fourth Circuit noted that the same time frame is included in the definition of “forward contract” under Bankruptcy Code section 101(25)(A)); and (iii) the quantity and time elements of the agreement must be fixed at the time of the agreement (the Court based this conclusion on case law that held this to be an integral element of a “forward agreement”). The Court remanded the matter to the bankruptcy court to determine whether the natural gas contacts were commodity forward agreements in light of its holding.

This case has significant implications for lawyers drafting supply agreements in which the price and quantity are set at the time of the contract. Drafting the contract in a manner consistent with the Fourth Circuit’s holding could protect purchasers from possible avoidance actions should the seller file for bankruptcy.