Is the purchaser under a five-year wood pellet supply agreement a “forward contract merchant” entitled to terminate the contract under the protection of the Section 556 safe harbor?
We won’t know, because Bankruptcy Judge Robert Summerhays of Lafayette, La., ruled that the purchaser waived its rights, even assuming it was a forward contract merchant.
Despite the automatic stay, Section 556 allows a “forward contract merchant” to terminate and liquidate a “commodity contract” or “forward contract” based on the bankruptcy or insolvency of a counterparty.
Originally, the supply contract contained an ipso facto clause allowing the purchaser to terminate the contract if the producer filed bankruptcy. Later, the purchaser agreed to a modification allowing the producer to pledge the contract to its lenders as additional collateral security.
The amendment also provided that the purchaser could not terminate the contract if the producer were “fully performing its obligations.”
The bankrupt producer wanted to enforce the contract because the price for wood pellets had fallen. For the same reason, the purchaser wanted to terminate the contract.
Confronted with the amendment, the purchaser argued that it retained termination rights under Section 556. Judge Summerhays disagreed in his July 22 opinion, saying that the purchaser no longer had the contractual right to terminate on the producer’s bankruptcy. Consequently, termination rights protected by Section 556 never came into play, he said.
Citing circuit court authority, it otherwise seemed as though the purchaser might win. Judge Summerhays said that an agreement qualifies as a forward contract if it deals with a commodity, maturity is more than two days after the contract date, the price and other terms are fixed, and “the contract has a relationship to the financial markets.”