Restructuring

Contributed by Erika del Nido
In DeGirolamo v. McIntosh Oil Co. (In re Laurel Valley Oil Co.), No. 05-64330, slip op. (Bankr. N.D. Ohio Mar. 5, 2013), the court provides guidance on a slippery subject — whether the safe harbor provisions of the Bankruptcy Code apply to certain contracts for the purchase of petroleum products.   As a result of the decision, transfers made under what might ordinarily be considered contracts by a debtor to supply fuel to a customer were protected from avoidance by the safe harbor provisions of section 546(e) of the Bankruptcy Code, which are applicable to “forward contracts.”
BACKGROUND
Prior to the commencement of its chapter 7 case, the debtor, a buyer and seller of petroleum products, entered into contracts to sell diesel fuel to a customer, who intended to resell the fuel to end-users at a profit, on a prepaid basis.  The debtor had been experiencing cash shortages and had agreed to sell the fuel at an amount below cost.
The chapter 7 trustee subsequently filed a complaint against the customer seeking to avoid and recover transfers made under the contracts as preferential and fraudulent.  The customer, however, argued that the transfers under the contracts were prepetition “settlement payments” made to a “forward contract merchant” in connection with a “forward contract” and were, therefore, protected from avoidance claims by the safe harbor provisions of section 546(e) of the Bankruptcy Code.  To determine whether the transfers in question were safe-harbored from avoidance, the court examined (i) whether the contracts were forward contracts, (ii) whether either or both parties were forward contract merchants within the definition of section 101(26) of the Bankruptcy Code, and (iii) whether the delivery of diesel fuel constituted a settlement payment under section 101(51A) of the Bankruptcy Code.  Only a finding that all three criteria are satisfied would slide the fuel contract into safe-harbored waters.
FORWARD CONTRACT
Under section 101(25)(A) of the Bankruptcy Code, a contract for the purchase, sale or transfer of a commodity is a “forward contract” if its maturity date is more than two days after the parties entered into the contract.  The parties did not dispute that diesel fuel is a commodity within the meaning of the definition.  Instead, the parties disputed whether the contracts had “a maturity date more than two days after the date the contract is entered into.”  The trustee argued that the maturity date was the date the customer paid for the fuel, which occurred on the date of entry into the contracts.  The customer, however, argued that the maturity date was the date that the fuel was delivered, which occurred more than two days after entry into the contracts.
Because the Bankruptcy Code does not define “maturity date,” the bankruptcy court considered the purpose and intent of the safe harbor provisions of section 546(e) of the Bankruptcy Code in developing a definition.   It reasoned that one purpose of section 546(e) is to protect against the destabilizing effect that a bankruptcy could have on parties to a forward contract.  In the court’s view, the “risk/benefit aspect of the forward contract is not realized at the time of payment, but rather at the time of delivery of the commodity.”  Accordingly, the court held that the “‘maturity date’ is the date on which the benefit and detriment of the contract will be realized by the parties based upon the market price at the time of delivery,” and the supply contracts constituted “forward contracts.”
FORWARD CONTRACT MERCHANT
Because the supply contract was a “forward contract,” the bankruptcy court then had to consider whether the debtor-supplier or the customer was a “forward contract merchant.”  Section 101(26) of the Bankruptcy Code defines “forward contract merchant” to include an entity whose business “consists in whole or in part of entering into forward contracts as or with merchants in a commodity.”
The parties disputed whether the business of the customer “consists in whole or in part of entering into forward contracts.”  The bankruptcy court acknowledged that courts have reached differing conclusions as to the breadth of the definition.  Citing a decision from the Mirant bankruptcy court, the court noted that under the narrowest definition “a forward contract merchant is a person that, in order to profit, engages in the forward contract trade as a merchant or with merchants” and that a “merchant” is “one that is not acting as either an end-user or a producer.”  The court held that even under the narrowest definition, the customer, who intended to sell the fuel to end-users at a profit, is a “forward contract merchant” because it was neither a producer nor an end-user of the diesel fuel.  Instead, the court found that the customer entered into its contracts with the debtor to make a profit.  Having found that at least one of the parties was a forward contract merchant, the court did not consider whether the debtor was also a forward contract merchant.
SETTLEMENT PAYMENT
Turning to the last prong of the analysis, the bankruptcy court considered whether the debtor’s transfer of the diesel fuel to the customer constituted a “settlement payment,” or whether a “settlement payment” necessarily implies a transfer of cash.  The tautological definition of “settlement payment” contained in section 101(51)(A) provides little guidance — a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, a net settlement payment, or any other similar payment commonly used in the forward contract trade.  Nevertheless, the court found that other courts have interpreted the definition of “settlement payment” broadly, and nothing limits the concept of settlement payments to payments made in cash or to only those payments that are given at market value.  As such, a transfer of diesel fuel below market value constitutes a “settlement payment” for the purposes of a forward contract.
CONCLUSION
The court concluded that the transfer of diesel fuel was a settlement payment made to the customer, a forward contract merchant, in connection with forward contracts, because the contracts matured more than two days after entry into the contracts.  The court granted summary judgment in favor of the customer and held that the transfer of diesel fuel to the customer could not be avoided as a preferential or fraudulent transfer.