Don’t Forget the Forward Contract Defense

You have probably given the preference defense speech countless times to unsecured trade creditor clients that 90-day payments are likely preferences, but may be covered by one of the typical § 547(c) defenses: subsequent provision of new value, ordinary course of business and contemporaneous exchange for new value. The standard defenses are so prevalent, it is easy to virtually ignore the § 546 limitations on avoiding powers (other than the two-year statute of limitations). While the vast majority of trade creditor preference cases are defended based on one or more of the typical § 547 defenses, once in a while a trade creditor comes along with a commodity supply contract, potentially bringing the case within the forward-contract limitation on a trustee’s avoidance powers set forth in § 546(e).

Forward contracts are not always obvious. An attorney who is not familiar with the concept might easily miss a relevant fact pattern and neglect to raise a potential complete defense to an avoidance action. Section 546(e) prohibits a trustee from recovering any transfer that is a margin payment or settlement payment made by or to a commodity broker, forward contract merchant, stockbroker, financial institution, financial participant or securities clearing agency. There is a good chance that even if you have read all of § 546, you probably got to the words “margin payment” and your eyes glazed over and skipped the rest of subsection (e).

A “forward contract merchant” is defined in 11 U.S.C. § 101(26) as, among other things, an entity the business of which consists in whole or in part of entering into forward contracts as or with merchants in a commodity or any similar good which is or becomes dealt with in the forward contract trade. A “forward contract” is defined in 11 U.S.C. § 101(25) as, among other things, “a contract (other than a commodity contract, as defined in § 761) for the purchase, sale, or transfer of a commodity, as defined in § 761(8) of this title, or any similar good, article, service, right, or interest which is presently or in the future becomes the subject of dealing in the forward contract trade, or product or byproduct thereof, with a maturity date more than two days after the date the contract is entered into.”

While the definitions of “forward contract merchant” and “forward contract” conjure images of commodities brokers, futures contracts and speculative investing, they also apply to many more routine commodity supply contracts. In In re Olympic Natural Gas Co.,[1] the Fifth Circuit Court of Appeals explained that the entire commodities market is divided into two broad categories of transactions: (1) on-exchange futures transactions and (2) off-exchange forward contracts. The takeaway from In re Olympic Natural Gas Co. is that on-exchange transactions constitute “commodity contracts,” which are excepted from § 546(e), while off-exchange contracts for future delivery of a commodity are “forward contracts,” exempted from avoidance by § 546(e).

Federal courts have applied the forward contract defense of § 546(e) to contracts for the purchase and sale of various commodities including natural gas.[2] Commodity sellers are in many respects the same as any other unsecured trade creditor. As a result, it is easy to jump straight to the standard § 547(c) preference defenses and forget to evaluate a possible forward contract defense. The key red flags for a potential forward contract defense are a purchase and sale contract for future delivery of a commodity. Whenever these elements are present, do not forget the forward contract defense.