This alert has been prompted by a recent decision of the U.S. Court of Appeals that has a potentially huge impact on the treatment under U.S. bankruptcy law of contracts that entail a physical delivery of commodities. The decision is a positive development for those that had entered into a physically settled transaction with an entity which has subsequently become subject to a U.S. bankruptcy procedure as such transactions may qualify as a "swap agreement" and therefore fall within the "safe harbor" provisions of the U.S.

On February 11, 2009, the United States Court of Appeals for the Fourth Circuit, addressing an apparent issue of first impression, ruled that a series of gas supply contracts might constitute “commodity forward agreements” and, in turn, “swap agreements,” exempt from the court-appointed trustee’s avoidance actions.1 The Court reversed and remanded the decision from the United States Bankruptcy Court for the Eastern District of North Carolina, which had held that the commodity supply contracts at issue were insufficiently tied to financial markets to be considered protected “commodity forwar

The U.S. Court of Appeals for the Fourth Circuit recently issued a decision that has the potential to have a major impact on how contracts that provide for physical delivery of commodities are treated under U.S. bankruptcy law.  

In Hutson v. E.I. du Pont de Nemours & Co.

The Commodity Futures Trading Commission is proposing to amend its Bankruptcy Rules to permit the trustee for a bankrupt futures commission merchant to continue to operate the business of the commodity broker in the ordinary course for a limited period of time.

On December 16th, the CFTC published for comment amendments to its regulations concerning the operation of a commodity broker in bankruptcy. The amendments would permit a bankruptcy trustee to operate, with the written permission of the CFTC, the commodity broker in the ordinary course, including the purchase or sale of new commodity contracts on behalf of the customers of the commodity broker under appropriate circumstances, as determined by the Commission.

During the past 18 months, the world has felt the impact of derivatives on financial markets. Many businesses have for years used derivative contracts such as currency or interest rate swaps or forward contracts for the purchase of oil, gold, natural gas, wheat or other commodities to hedge their exposure to an unexpected rise or fall in values, interest rates or prices. However, the scope and extent of trading in derivative instruments exploded during the past 10 years, causing profound effects on the world’s financial markets.

The US Court of Appeals for the Second Circuit recently held that redemptions of commercial paper made through the Depositary Trust Company (DTC) are entitled to the “safe harbor” protections afforded to settlement payments under Bankruptcy Code Section 546(e), and are, therefore, not preferential transfers, even though such payments were made prior to maturity.1 The Second Circuit is the first Circuit Court of Appeal to address the issue, which arises out of the Enron bankruptcy case.

Legal Framework

The past several years have not been kind to commodities exploration companies.  The price of gold dropped to $1,051/oz. in November 2015, a level that had not been seen since 2009.  Although the price of gold rebounded somewhat in January and February 2016 to just over $1,200/oz., the price has steadily decreased after peaking at $1,921/oz. in August 2011.  The price of silver has also decreased dramatically, with its price off 60% from the 2011 highs.  Copper has not escaped this trend, and was recently selling for just over half of its 2011 price.

"Safe harbors" in the Bankruptcy Code designed to insulate nondebtor parties to financial contracts from the consequences that normally ensue when a counterparty files for bankruptcy have been the focus of a considerable amount of scrutiny as part of evolving developments in the Great Recession. One of the most recent developments concerning this issue in the courts was the subject of a ruling handed down by the New York bankruptcy court presiding over the Lehman Brothers chapter 11 cases. In In re Lehman Bros. Holdings, Inc., Judge James M.