Court Upholds Broad Definition of “Settlement Payments” Under Bankruptcy Code

The following post comes to us from James L. Bromley, a partner and leader of the global bankruptcy and restructuring practice at Cleary Gottlieb Steen & Hamilton LLP.

On June 28, 2011, the Court of Appeals for the Second Circuit upheld the Southern District of New York’s determination that the safe harbor provision in § 546(e) of the Bankruptcy Code protects from the bankruptcy trustee’s powers to avoid transfers made by the Debtor, Enron Corp., to redeem commercial paper prior to maturity. In re Enron Creditors Recovery Corp., Dckt. No. 09-5122-bk (L) 09-5142-bk (Con) (2d Cir. June 28, 2011). The issue before the Court was whether the payments made during the preference period constitute “settlement payments” within the meaning of § 546(e)’s safe harbor. The decision is particularly noteworthy because this is the first instance the Second Circuit has addressed the breadth of this section of the Bankruptcy Code. In recent years, courts have struggled to interpret the statutory language and legislative intent of the § 546(e) safe harbor in a consistent manner, leaving litigants and transaction planners without a clear understanding of what types of transactions will be protected from the trustee’s avoidance powers. Although the decision is limited to the facts of the case, the Second Circuit adopted a broad reading of § 546(e) which was consistent with the intent of a safe harbor and resisted placing any limitations on its plain meaning, in contrast to the dissent, as well as some other courts. This case is therefore important, not only for cases involving the “settlement payment” safe harbor, but also potentially for litigation involving all of the Code’s safe harbors for financial contracts. [1]


In the weeks leading up to its bankruptcy petition during the fall of 2001, Enron drew down on its revolving lines of credit and paid out more than $1.1 billion to retire its unsecured commercial paper prior to maturity. In November 2003, two years after Enron filed for bankruptcy, the trustee brought adversary proceedings against approximately two hundred financial institutions – including the three broker-dealers that facilitated Enron’s redemption of its commercial paper – seeking to claw back the payments made in connection with its commercial paper redemption. Enron alleged that the payments were recoverable as (1) preferential transfers under 11 U.S.C. § 547 (b), because they were made on account of antecedent debt within 90 days prior to bankruptcy, and (2) constructively fraudulent transfers under 11 U.S.C. § 548(a)(1)(B), because the redemption price exceeded the commercial paper’s fair market value.

Defendants moved to dismiss, claiming that Enron’s payments to redeem its commercial paper from the market prior to its stated maturity were exempt from avoidance because they were “settlement payments” which are protected under § 546(e). The settlement payment safe harbor, as in effect at the time of Enron’s bankruptcy, limited the trustee’s power to avoid those transfers by providing that “the trustee may not avoid a transfer that is a … settlement payment, as defined in section … 741 of this title, made by or to a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency.” [2] In turn, “settlement payment” is defined to include “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.” 11 U.S.C. § 741(8).

The Bankruptcy Court denied both motions to dismiss and for summary judgment on this issue. In denying the motion to dismiss, the Bankruptcy Court held that the phrase “commonly used in the securities trade” in § 741(8) modifies all the terms in the section’s definition and thereby limits any protected “settlement payments” to those that are common in the industry. Accordingly, the Bankruptcy Court found that discovery was necessary to determine whether Enron’s payments to redeem its commercial paper were indeed common. In re Enron Creditors Recovery Corp., 325 B.R. 671, 685-86 (Bankr. S.D.N.Y. 2005). In its denial of summary judgment, the Bankruptcy Court concluded that “the transfer of ‘ownership’ of a security is an integral element in the securities settlement process,” and held that “settlement payments” include only payments made to buy or sell securities and not payments to retire debt. In re Enron Creditors Recovery Corp., 407 B.R. 17 45 (Bankr. S.D.N.Y. 2009).

While the majority of defendants had settled with Enron prior to the Bankruptcy Court’s ultimate ruling, including two of the defendant broker-dealers which were represented by our firm, the few that remained sought and were granted interlocutory appeal of the Bankruptcy Court’s decision to deny summary judgment with respect to § 546(e). The District Court reversed the Bankruptcy Court, concluding that (1) the definition of “settlement payment” is not limited only to payments that are “commonly used” and therefore the circumstances of a particular payment do not bear on whether that payment fits within the definition; (2) that a “settlement payment” is any transfer that concludes or consummates a securities transaction, and (3) that Enron’s redemption of its commercial paper constitutes a securities transaction regardless of whether Enron acquired title to the commercial paper, because the redemption involved “the delivery and receipt of funds and securities.” In re Enron Creditors Recovery Corp., 422 B.R. 423 (S.D.N.Y. 2009).

The Second Circuit Decision

In a split two to one decision, the Second Circuit rejected all of Enron’s arguments and affirmed the decision of the District Court. The Court opted to follow courts that have endorsed a broader interpretation of the “settlement payment” definition. The Court applied the last-antecedent rule to the phrase “commonly used in the securities industry” and held that it limits only the phrase preceding it, and does not limit all the other transactions that § 741(8) defines as settlement payments. In other words, in order to be considered a settlement payment, a transfer need not necessarily be a common occurrence because the phrase “commonly used in the securities industry” is meant to act as a catchall intended not to act as a limitation but to underscore the breadth of the safe harbor.

With respect to the issue of whether redemption of Enron’s commercial paper would fall into the category of a “settlement payment,” the Court, contrary to the dissent, found that there was no limitation in the Bankruptcy Code that could be read to exclude transfers that retire debt and do not result in the acquisition of title to a security. The Court relied on the absence in the text of § 741(8) or in any other provision of the Bankruptcy Code of any support for an additional purchase or sale requirement. The Court also concluded that nothing in this decision contradicts case law permitting avoidance of payments made on ordinary loans.

In addition, the Court ruled that the absence of the involvement in the transaction of a financial intermediary, so as to implicate the systemic risks that motivated the Congress’s enactment of the safe harbor, was not a basis to deny the protection of the safe harbor. Congress enacted § 546(e)’s safe harbor in 1982 as a means of “minimiz[ing] the displacement caused in the commodities and securities markets in the event of a major bankruptcy affecting those industries.” Kaiser Steel Corp. v. Charles Schwab & Co., 29 Inc., 913 F.2d 846, 849 (10th Cir. 1990) (quoting H.R. Rep. 97-420, at 2 (1982), reprinted in 1982 U.S.C.C.A.N. 583, 583). If a firm was required to repay amounts received in settled securities transactions, it could have insufficient capital or liquidity to meet its current securities trading obligations, placing other market participants and the securities markets themselves at risk. The Court therefore held that the safe harbor limits this risk by prohibiting the avoidance of “settlement payments” made by, to, or on behalf of a number of participants in the financial markets. In the case before it, the Court concluded that undoing Enron’s redemption payments, which involved over a billion dollars and two hundred note holders, would necessarily have had a substantial negative effect on the financial markets.


[1] See, e.g., 11 U.S.C. §§ 555, 556, 559, 560, 362(b)(6), (b)(7), and (b)(17), 546(e), (f), (g), and (j).
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[2] In 2001, 11 U.S. § 546(e) provided in relevant part:

Notwithstanding sections…547 [and] 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a…settlement payment, as defined in section…741 of this title, made by or to a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency…that is made before the commencement of the case, except under section 548 (a)(1)(A) of this title.

In 2006, § 546(e) was amended to include transfers “made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant, or securities clearing agency, in connection with a securities contract….” 11 U.S.C. § 546(e) (emphasis added).
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