Enron’s Prematurity Redemptions of Commercial Paper

The U.S. Court of Appeals for the Second Circuit held in In re Enron Creditors Recovery Corp. v. Alfa., No. 09-5122-bk (2d Cir. June 28, 2011) that prematurity redemptions of commercial paper made by Enron Corp. before it filed bankruptcy were protected from avoidance by 11 U.S.C. § 546(e)’s safe harbor for securities transaction settlement payments.

Background case facts: To respond to market speculation about Enron’s viability, the company redeemed its commercial paper between October 25, 2001 and November 6, 200 by drawing down its credit lines to retire over $1.1 billion of its unsecured commercial paper before the paper’s maturity. The company redeemed the paper at the accrued par value. This was calculated as the purchase price plus accrued interest, an amount above the price at which the paper had been trading. Broker-dealers executed the redemptions and the commercial paper was not detailed in bookkeeping entries of Enron’s clearing agent, the Depository Trust Company. Enron did not take title to the paper. Enron filed Chapter 11 bankruptcy on December 2, 2001.

Around 2003, Enron initiated adversary proceedings against financial institutions from which it redeemed commercial paper. Enron tried to avoid and recover the redemption payments pursuant to 11 U.S.C. § 547(b) arguing they were (1) made on account of an antecedent debt within 90 days before bankruptcy and (2) constructively fraudulent transfers under 11 U.S.C. § 548(a)(1)(B). The redemption price exceeded the commercial paper’s fair market value.

The financial institutions filed motions to dismiss Enron’s complaint based on the redemptions being settlement payments protected from avoidance by 11 U.S.C. § 546(e)’s safe harbor. Section 546(e) says “the trustee may not avoid a transfer that is a . . . settlement payment, as defined in section . . . 741 of this title.” Section 741(8) defines a settlement payment 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 Bankruptcy Court denied the financial institutions’ motion to dismiss and ruled the Section 546(e) safe harbor did not apply to Enron’s redemptions. The court interpreted “commonly used in the securities trade” in Section 741(8) to limit settlement payments to payments commonly used in the securities industry.

On appeal, the court observed Section 741(8) defines “settlement payment” 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 phrase “commonly used in the securities trade” was read to modify only the immediately preceding phrase “any other similar payment,” and not the entire definition of a settlement payment. There was nothing in the Bankruptcy Code requiring that a settlement payment involve either a purchase or a sale. The Second Circuit addressed Section 546(e)’s safe harbor to preserve the finality of transactions involving tradable commercial paper.

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