Enron: Second Circuit Decides Issue of First Impression in Favor of Investors
The Second Circuit Court of Appeals, in a 2-1 decision entered on June 28, 2011 affirming the district court’s earlier reversal of the bankruptcy court in the Enron bankruptcy case, determined that the “safe harbor” provision of section 546(e) of the Bankruptcy Code (which provides an exemption for “settlement payments” from preference and fraudulent transfer actions) insulated sellers of Enron Corporation’s commercial paper from a lawsuit seeking to recoup Enron’s pre-bankruptcy redemption of such securities. In Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., __ F.3d __, 2011 WL 2536101 (2d Cir. June 28, 2011) the Second Circuit has seemingly scored a victory for investors who, among others,sell the commercial paper of distressed or insolvent companies in the secondary market and, in this case, the defendant noteholders will not as a result of the Second Circuit’s decision have to return payments they received from their stockbrokers from Enron’s redemption.
In what the Second Circuit characterized as an issue of first impression in the court of appeals, it held that section 546(e) which shields “settlement payments” from avoidance actions in bankruptcy, extends to Enron’s payments to redeem its commerical paper prior to maturity. As such, the Court determined that the Enron litigation trust’s preference and fraudulent transfer action against certain of the former noteholders of Enron commercial paper, and the institutions who initially received Enron’s redemption payments, had to be dismissed.
The Second Circuit disagreed with Enron, as well as the bankruptcy court, on their point that “redemption payments are not settlement payments” allegedly because, among other things, they retired debt and were not [used] to acquire title to the commercial paper. Instead, the Second Circuit emphasized that the Bankruptcy Code does not impose a “purchase or sale” requirement for purposes of falling within the safe harbor provision of section 546. Therefore, the Court determined that the redemption payments at issue “completed a transaction in securities” and were, as a result, settlement payments. Most notably, the Second Circuit appears to have adopted the view of other circuits that the definition of “settlement payments” protected by the safe harbor provision is extremely broad, or, as the district court first determined, include any transfer that concludes or consummates a securities tansaction, thereby furthering an essential basis for the safe harbor as a means of minimiz[ing] the displacement caused in the commodities and securities market in the event of a major bankruptcy affecting those industries.
The dissent in the Enron decision picked up on the majority’s broad definition of “settlement payments” and cautioned that the breadth of that definition threatens routine avoidance proceedings in bankruptcy courts.
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