ENRON: A REPORT FROM THE FRONT
David M. Bennett
Thompson & Knight LLP
1700 Pacific Street, Suite 3300
Dallas, Texas 75201
Fax: 214-969-1751
Telephone: 214-969-1700
bennettd@tklaw.com
Independent Petroleum Association of America (IPAA)
Law Committee Meeting
March 21, 2002
N
555555 008268 DALLAS 1412676.1
TABLE OF CONTENTS
I.
INTRODUCTION. ............................................................................................................................ N-1
II.
THE VENUE FIGHT - WHY THE ENRON CASE IS NOT IN HOUSTON. ................................. N-1
A. An inability to file an involuntary. ............................................................................................. N-1
B. An inability to obtain an expedited hearing on the motion to transfer. ...................................... N-1
C. The legal standard applicable to venue issues............................................................................ N-2
D. The Venue Facts in the Enron Case. .......................................................................................... N-3
E. Applying the Venue Facts to the Enron Case. ........................................................................... N-3
F. The bank debt and bondholder debt, and the Debtors' choice of forum. .................................... N-5
G. The court's 30 days of involvement with the case at the time of the hearing. ............................ N-5
III. THE CASH MANAGEMENT SYSTEM FIGHT B WHY AND HOW ENRON
NORTH AMERICA'S CASH IS FUNDING THE ENRON BANKRUPTCY CASE. .................... N-5
A. The problem: Enron North America's cash is being used to fund Enron's
chapter 11 proceeding. ............................................................................................................... N-6
1. Facts Adduced at the Cash Management Hearing. ............................................................ N-7
2. The ENA Creditors Argument in Favor of a Firewall Around ENA Cash ........................ N-9
a. Whether the Postpetition Sweep of ENA Cash Violates the Code ............................. N-9
b. Debtors' actions are prohibited by Section 345(b)...................................................... N-9
c. The Debtors' loans are outside the ordinary course of its business. ............................ N-9
d. The Court's Cash Management Order did not authorize the loans at issue here. ...... N-10
e. The Cash Committee is insufficient to protect ENA. ............................................... N-11
f. The Debtors' current cash management system is riddled with conflicts
of interest. ................................................................................................................ N-11
g. Debtors Use Of ENA's Assets To Fund The Operations Of Other
Enron Entities B Debtors And Nondebtors B Without Adequate
Protection Should Not Be Permitted. ....................................................................... N-12
B. The continuing problem........................................................................................................... N-13
C. The attempted solutions. .......................................................................................................... N-14
1. The preferred solution: A "firewall" around Enron North America's cash. ..................... N-14
2. A separate Enron North America Creditors Committee. ................................................. N-15
3. A trustee for Enron North America.................................................................................. N-16
D. The Bankruptcy Court=s Choice of Solution........................................................................... N-16
IV. ISSUES UNIQUE TO THE WORLD'S LARGEST ENERGY TRADING COMPANY:
HEDGES, COLLARS, SWAPS, AND FINANCIAL CONTRACTS. ........................................... N-17
A. Termination of Commodity and Forward Contracts Under 11 U.S.C. ' 556 .......................... N-17
1. Definitions ....................................................................................................................... N-17
2. Enumerated Commodities of the Commodity Exchange Act ........................................... N-17
B. Interpretation ........................................................................................................................... N-18
1. Who is Protected? ............................................................................................................ N-18
2. The protections afforded by section 556 apply to more than liquidation. ........................ N-19
C. Case Law ................................................................................................................................. N-19
D. Similar Provisions / Other Protections ..................................................................................... N-20
1. Section 362 (b) (6) provides an exemption from the automatic stay for
setoffs of margin payments or settlement payments. ........................................................ N-20
2. Section 546 (e) prohibits any preference action by the trustee related to
a margin payment or settlement payments. ...................................................................... N-20
3. Section 560 allows a swap agreement participant to terminate, net out,
or setoff the contract without lifting the stay or fear of an avoidance. ............................. N-20
E. Analysis of the rights of a forward contract merchant under contract and
bankruptcy law. ....................................................................................................................... N-20
F. Whether there is one contract or multiple contracts? ............................................................... N-21
N-i
G.
H.
What "should" the swap counterparty do? ............................................................................... N-21
Conclusion ............................................................................................................................... N-22
N-ii
N-iii
ENRON: A REPORT FROM THE FRONT1
I.
of New York. In the weeks preceding December 2,
2001, at least two creditors of Enron Corp. were
willing to file an involuntary but the parties could
not find a third. Thus, the absence of a third
petitioning creditor as to Enron Corp. was a
substantial part of the reason why venue is not in
Houston.
INTRODUCTION.
The fall of Enron Corporation and its resulting
chapter 11 proceeding has affected thousands, if
not millions, of Americans. Corporate finance may
take decades to recover and, in some ways, may
never be the same again. For the insolvency
specialist, the Enron case presents special issues
for consideration, some unique to Enron and some
merely unusual for the size of the case. As chapter
11 cases go, Enron is still in its infancy. The end is
not only not in sight, it is not even clear that the
beginning has gotten a good start. Nonetheless, it is
never too early to take stock of what has happened,
what lessons have been learned, and what the
future may hold in store. In this paper, we will
address some, though certainly not all, of the issues
that Enron has brought to the forefront of
bankruptcy practice.
B.
In the week following the filing on Sunday,
December 2, 2001, a substantial number of
creditors filed motions to transfer the Enron cases
to the Southern District of Texas. Twenty-one
debtors whose principal offices and assets are
located in Houston, Texas, justified filing their
cases in the Southern District of New York on the
sole fact that the principal office of one of its
minor alleged affiliates B Enron Metal and
Commodity Corp. B is located in that district.
Debtor Enron Metal and Commodity Corp.,
("EMCC") a Delaware corporation, is entirely
owned by Enron Trade Holdings, a Delaware
Corporation, which is an indirect subsidiary of
Enron Corp. Only by stretching the relationship
between EMCC and the other debtors nine degrees
(of intermediate subsidiaries) were the Debtors
able to make any possible connection between the
two and justify an "affiliates" filing.
II. THE VENUE FIGHT - WHY THE
ENRON CASE IS NOT IN HOUSTON.
The first and most obvious Enron issue, and the
one directly affecting the Houston bankruptcy bar,
is the question of venue. Why, with its many
demonstrable ties to the Houston community, is the
Enron case pending in the Southern District of
New York instead of the Southern District of
Texas? There is no easy answer to this question
and, from the author's perspective, the answer is (at
least in part) "not for lack of trying." Much of what
follows is taken from the briefing and the argument
of the motion to transfer the case from New York
to Houston.
A.
An inability to obtain an expedited hearing
on the motion to transfer.
A thoughtful review of the "weight" of venue facts
demonstrated that the great weight of the case
ought to have compelled transfer to the Southern
District of Texas. Among those relationships were
the following ties to Houston: (a) a majority of the
Debtors' headquarters, (b) the documents and
records critical to these cases, (c) the Debtors'
auditors and financial advisors, (d) the majority of
witnesses, including all senior management, (e) the
majority of the Debtors' assets, including the
trading floor, (f) the majority of creditors,
including a majority of laid off employees, and (g)
the majority of the Debtors' remaining employees.
An inability to file an involuntary.
A substantial part of the reason the Enron case was
the inability of certain parties to locate three
unsecured creditors of Enron Corp. who were
willing to file an involuntary in the weeks leading
up to December 2, 2001. Enron Corp., an Oregon
corporation, could not justify venue in Delaware or
New York. If an involuntary had been filed against
Enron Corp. in the Southern District of Texas, it is
arguable that the consolidated Enron case could
not have been transferred to the Southern District
1David
M. Bennett, Rhett G. Campbell and
Judith W. Ross were all substantial contributors to
this paper.
N-1
On December 5, 2001, Thompson & Knight
L.L.P., on behalf of a number of movants, filed a
Motion to Change Venue to the Southern District
of Texas (the "Motion") on the grounds that the
doctrine of forum non conveniens and the interest
of justice supported such transfer of the Debtors'
cases to Houston, Texas. Simultaneously with
filing the Motion, the movants filed a motion for
expedited consideration of the Motion. The next
day, December 6, 2001, the court set the Motion
for hearing on January 7, 2002. The same day,
December 6, 2001, the clerk of the court called
local counsel and asked that the motion for
expedited hearing be withdrawn. As the court
requested, the local counsel for movants sent a
letter to the court withdrawing the motion for
expedited consideration. Thereafter, the parties
undertook discovery, principally through creating a
stipulation dealing with venue facts. The Motion
was heard January 7, 2002.
the development and delivery of bandwidth
communication applications.
The Debtors' prepetition relationship to the
Southern District of New York was limited to the
office of Enron Metals & Commodity Corp. and
borrowing from New York financial institutions
(and presumably their brief relationship with New
York bankruptcy counsel).
The Debtors principal assets are by far located in
the Southern District of Texas. In each of the
Debtors' voluntary petitions is a disclosure of the
location of its assets. Attached to each Debtors'
voluntary petition is an Attachment A To
Voluntary Petition (the "Attachments"). The
Attachments indicate the value of all the Debtors'
assets. The Debtors' petitions and Attachments
reflect that of the Debtors' $45 billion in assets,
only $265 million (about 0.5%) are located in the
Southern District of New York. Debtor Enron
Metal & Commodity Corp. is the sole debtor with
disclosed assets located in New York.
The Debtors are all corporations organized and
existing under the laws of either the States of
Oregon, Texas or Delaware. None of the Debtors
are incorporated in New York. With the exception
of Debtor Enron Metal and Commodity Corp., the
Debtors' principal place of business for a
substantial number of years has been and continues
to be in the Southern District of Texas. Only
Debtor Enron Metals & Commodity Corp. has an
office located in New York. Debtor Metals and
Commodity Corp., however, is completely owned
by Enron Trade Holdings Inc., a Delaware
corporation. It is the location of the offices of
Debtor Enron Metals & Commodity Corp. that
forms the sole legal basis for the Debtors' choice of
forum.
A majority of the Debtors' creditors are located in
Texas. The Debtors have prepared a Consolidated
List of Creditors, listing all known creditors of the
Debtors. Of the creditors listed, 816 are located in
Texas, compared to 96 in New York. Additionally,
the Debtors' largest unsecured creditor and largest
trade creditor are located in the Southern District
of Texas.
C.
The legal standard applicable to venue
issues.
Transfer of the Debtors' cases to the Southern
District of Texas is supported by law and equity.
Although a debtor may initially pick its forum, a
transfer motion under section 1412 of Title 28 of
the United States Code requires the balancing of
several factors. In re Ocean Properties of
Delaware, Inc., 95 B.R. 304, 305 (Bankr. D. Del.
1988). See also In re Ernst Home Center, Inc.,
Case No. 96-1088 (PJW), transcript at 2, Walsh, J.
(Bankr. D. Del. Aug. 28, 1996).
Debtor Enron Corp. is in the business of providing
products and services related to natural gas,
electricity and communications to wholesale and
retail customers. Debtor Enron Corp.'s operations
are largely conducted through its subsidiaries and
affiliates, the other debtors in the bankruptcy.
Together, the Debtors are principally engaged in:
(1) the transportation of natural gas through
pipelines to markets throughout the United States;
(2) the generation, transmission and distribution of
electricity to markets in the northwestern United
States; (3) the marketing of natural gas, electricity
and other commodities and related risk
management and finance services; (4) the delivery
and management of energy commodities and
capabilities to end-use retail customers in the
industrial and commercial business sectors; and (5)
Pursuant to the venue statute, 28 U.S.C. ' 1412,
the moving party has the burden of demonstrating
that the transfer of venue is supported by a
preponderance of the evidence. Gulf States
Exploration Co. v. Manville Forest Products Corp.
(In re Manville Forest Products Corp.), 896 F.2d
1384, 1390 (2nd Cir. 1990). "Adjudications of
motions for transfer are within the discretionary
authority of the courts, according to 'an
N-2
individualized, case by case consideration of
convenience and fairness.'" Id. at 1981 (quoting
Stewart Org. Inc. v. Ricoh Corp., 487 U.S. 22
(1988)).
In deciding whether to transfer venue, courts will
typically consider the factors in the
Commonwealth
Oil
Refining
Case:
Commonwealth of Puerto Rico v. Commonwealth
Oil Refining Co. (In re Commonwealth Oil
Refining Co.), 596 F.2d 1239 (5th ir. 1979), cert.
denied, 444 U.S. 1045 (1980):
Houston. Morever, one of the Debtors' most prized
assets is a 40-story high rise currently being
constructed in Houston. To date, the Debtors have
paid over $180 million towards construction of this
building, with another $40 million expected to be
expended to complete the project. When completed
in January 2002, the building is expected to be the
Debtors' world headquarters. This Houston asset is
of such importance that at its first day hearings, the
Debtors immediately sought permission to
continue paying their contractors.
(a) the proximity of creditors of every kind to the
court;
(b) the proximity of the debtor to the court;
(c) the proximity of the witnesses necessary to the
administration of the case;
(d) the location of the assets;
(e) the economic administration of the estate; and
(f) the necessity of ancillary administration if
liquidation should result.
Most of the witnesses that may be necessary to the
administration of the estate are located in Texas.
Almost all of the Debtors' employees, including its
managers and advisors, and a large number of its
creditors are located in Texas. In the event
appraisal testimony or other testimony is required
with respect to the valuation of the Debtors' assets,
these witnesses will most likely come from Texas.
At present, there are no known witnesses from
New York who might potentially be involved in
this case. Nearly all of the potential witnesses that
may be in this case will come from the Southern
District of Texas, not from New York.
In re FRG, 107 B.R. at 471 (citing Commonwealth
Oil, 596 F.2d at 1247). See also Ocean Properties,
95 B.R. at 304; In re Pope Vineyards, 90 B.R. 252,
255 (Bankr. S.D. Tex. 1988); Ernst Home Center,
transcript at 2-3.
Of considerable importance is whether the transfer
will promote the interest of justice. "The standards
for determining the 'interest of justice' [or]
'convenience for the parties overlap.'" In re FRG,
Inc., 107 B.R. 461, 471 (Bankr. S.D.N.Y. 1989).
While the two components are separate under the
disjunctive term of the statute, "as a practical
matter, in most cases . . . if the convenience of the
parties and witnesses will be served by transfer, it
usually follows that justice will also be served by
transfer." In Pinehaven Associates, 132 B.R. 982,
990 (Bankr. E.D.N.Y. 1991).
D.
E.
Applying the Venue Facts to the Enron
Case.
Applying these standards, it seemed clear that
venue should be transferred from the Southern
District of New York to the Southern District of
Texas. The Debtors, their assets and creditors are
primarily located in Texas.
With the exception of the bank debt and the
bondholder debt, the Debtors' creditors are more
closely tied to Texas than New York. With regard
to the proximity of creditors of every kind, the vast
majority of the creditors (by number, albeit not by
dollars of debt) are located in Texas. Moreover,
prior to filing their bankruptcies, the Debtors
employed more than 7,000 employees in their
Houston, Texas offices. Recently, the Debtors have
significantly reduced their work force. As a result,
a number of the Debtors' former employees, most
of which reside in the Southern District of Texas,
are now creditors of these estates, not included in
the list of creditors previously filed with the Court.
Should these creditors be forced to bear the
expense of traveling to New York or obtaining
The Venue Facts in the Enron Case.
According to the papers filed by Debtors with their
petitions, a large portion of the Debtors' assets are
located in the Southern District of Houston.
Disclosures attached to the Debtors' petitions
reflect that of the Debtors' $45 billion in assets,
only $265,622,903 (less than 1%) are located in
New York. In fact, the Debtors' petitions reflect
that with the exception of those assets held by
Enron Metal & Commodity Corp., virtually all of
the Debtors' assets are located in Texas. The
Debtors' assets include a significant amount of
Texas real estate, including a large amount of
commercial real estate located in downtown
N-3
local counsel to protect their interest, it is likely
many will be unable to do so.
With one exception, the Debtors are primarily, if
not exclusively, located in the Southern District of
Texas. Except for Enron Metals and Commodity
Corp, all of the Debtors are headquartered in
Houston. The Debtors' control group, its advisors
and, until recently, a majority of its attorneys, are
located in the Southern District of Texas. Most of
the Debtors' employees and virtually all of its
senior management are located in Houston. The
Debtors' close ties to the Southern District of Texas
support the transfer of venue.
It would be economical to administer the
estate in Florida. The greater portion of
applicable non-bankruptcy law is that of
Florida. The disputed claims will undoubtedly
result in litigation. The collateral for those
claims is in Florida. Witnesses other than the
Debtors' president and perhaps others who are
related to the Debtors and who may be
insiders, are located in Florida. There would
be the cost of bringing witnesses to Delaware
and difficulties with service of process.
When considering whether to transfer venue, the
economic administration of the estate is considered
to be the most important factor. Commonwealth
Oil, 596 F.2d at 1247; In re Garden Manor
Associates, 99 B.R. 551, 554 (Bankr. S.D.N.Y.
1988); In re HME Records, Inc., 62 B.R. 611, 613
(Bankr. M.D. Tenn. 1986); In re One-Eighty
Investments, 18 B.R. 725, 729 (Bankr. N.D. Ill.
1981). This critical factor is, of course, "not
independent of the other factors since proximity of
the parties, witnesses and location of the assets
certainly effects the economy and efficiency of the
administration." Pinehaven Associates, 132 B.R. at
989. "This final criteria . . . is 'actually a summary
of the previous four [factors].'" Id. (quoting In re
Consolidated Pier Deliveries, Inc., 34 B.R. 327,
329 (Bankr. E.D.N.Y. 1983)).
Moving these cases through a Delaware court
would result in not only a waste of judicial
time and becoming acquainted with Florida
law but also a waste of Debtors' resources.
There would be the expense of paying two or
more sets of counsel. Local rules require local
counsel. Local counsel must sign all
pleadings and stay in charge with certifying as
to their content. This, even if local counsel
did not actively participate in litigation, would
result in duplication of attorney time and
expenses.
Ocean Properties, 95 B.R. at 306.
Finally, transfer of these cases from Texas to New
York would not result in prejudice. First, if the
court had transferred this cases to Texas, the
Debtors would not be forced to incur considerable
expense or travel a great distance. In fact, since the
Debtors are located in Texas, transfer of this case
would actually lessen the Debtors' burden. Second,
transfer would not result in delay or a waste of this
Court's resources. This case is in its infancy. From
the filing of the petition to the hearing date, there
had been minimal involvement by the court. The
court heard one day of hearings regarding first day
matters and nothing more. The court granted no
use of cash collateral and limited DIP Financing.
The entry of other "first day" relief is generally
routine and does not constitute a significant
involvement by the Court in the case. Ernst Home
Center, transcript at 9. Thus, this court had not
been required to become familiar with the facts
underlying this case.
The Debtors' estates would be more economically
and efficiently administered if the case had been
transferred to the Southern District of Texas. First,
transferring venue to Texas would alleviate the
considerable time and expense that will be incurred
by both the Debtors and their creditors if forced to
travel from Texas to New York. Second, transfer
of venue to Texas will promote judicial economy.
The Debtors, their assets and creditors are located
in Texas. The Debtors have numerous contracts
containing Texas choice of law provisions.
Questions governing these contracts and the
operation of the Debtors' assets will be governed
by Texas law, including but not limited to, Texas'
law of oil and gas, mortgages, and oil and gas
contractor's liens. Transfer of theses cases to Texas
will prevent the Court from having to immerse
itself in the complexities of Texas law. As a sister
court recognized in the Ocean Properties case,
where the court transferred a case involving
Delaware corporations which owned Florida real
estate to the Southern District of Florida:
As in Ernst Home Center, the balance of harms
clearly weighs in favor of transferring venue.
N-4
In summary, here is how I view this issue: If
venue is not transferred, there is a serious
possibility, indeed, a probability, that a large
body of non-major players with substantial
claims on the West Coast will be seriously
disadvantaged because of the substantial, if
not prohibitive, time and cost of defending
their interests on the East Coast in contested
matters and adversary proceedings.
been heard on an expedited basis. In the end, the
failure to have the venue motion heard
immediately seems to have been fatal.
The Movants argue that since they timely
filed their motions to transfer venue, the
"learning curve" should not be considered.
However, the importance of maintaining
stability in these bankruptcy cases required
the Court to direct its immediate attention to
the proper administration of these cases. . . .
Maintaining the stability of these cases and
ensuring their proper administration had to
take precedence over the request for an
expedited venue hearing. This is especially
true in light of the fact that these cases were
properly venue (sic) pursuant to 28 U.S.C.
Sec. 1408. Thus, although the Movants filed
a timely request for the transfer of venue,
diverting the Debtors= and Committee=s
attention to the motion for transfer of venue
would have been counterproductive to the
needs and interests of these cases during the
initial stages of these cases. Moreover,
although certain of the Movants initially
requested a shortened time frame for notice of
a hearing, that request was subsequently
withdrawn while certain Movants pursued
discovery. Thus, while the Movants were not
dilatory, the necessities of this case resulted in
an accrual of knowledge by the Court.
If the cost of overcoming that disadvantage is
some additional administrative expense to the
estate, then that is a small price to pay for an
even playing field.
Ernst Home Center, at 16.
When one considers all the facts set forth in
Commonwealth Oil, the authors submit it was clear
that venue should have been transferred from the
Southern District of New York to the Bankruptcy
Court for the Southern District of Texas.
F.
The bank debt and bondholder debt, and
the Debtors' choice of forum.
All the bank creditors and virtually all the
bondholder creditors opposed the motion to
transfer. They were and are owed many billions of
dollars. Their attorneys and many of the banks are
located in New York. They believed that it would
be more convenient to hear the case in New York
and in any event believed that the debtors' choice
of forum should not be disturbed.
In re Enron, 2002 Bankr. LEXIS 77, pp. 17-18.
III. THE CASH MANAGEMENT SYSTEM
FIGHT B WHY AND HOW ENRON
NORTH
AMERICA'S
CASH
IS
FUNDING THE ENRON BANKRUPTCY
CASE.
G. The court's 30 days of involvement with
the case at the time of the hearing.
In the end, and reviewing the court's decision, In re
Enron Corp., Case No. 01-16034-AJG, 2002
Bankr. LEXIS 77 (January 11, 2002), it is clear
that the court believed that its 30 days of
involvement in the case were the focal point of the
decision to retain the case in New York. The
bankruptcy court believed that it would disrupt the
ongoing reorganization of Enron to move the case
to another bankruptcy court. The court focused
briefly on the fact that the venue motion had not
A short time into the case, creditors of Enron North
America began a series of attempts to learn the
value of the "trading book" of business of ENA,
and how much cash it was generating and could be
expected to generate. Based upon initial reports
from the company representatives, it was believed
that the ENA book could generate perhaps as much
On the first business day of Enron's bankruptcy,
the court entered an order authorizing Enron to
continue to use its existing "cash management
system." No notice was given and little thought
was given to the meaning of this, seemingly
innocuous, order.
as $8 billion of cash if liquidated appropriately.
The same ENA creditors also were of opinion that
substantial amounts of cash should be coming in
from ENA customers who did not have rights of
offset and who otherwise had no reason to refuse
to pay amounts owed on hedges that were "in the
money" with respect to ENA contracts. Based on
N-5
this information and this understanding, an early
goal of the ENA creditor group was to learn the
amount of postpetition cash being generated and
what was happening to that cash. The answers to
those questions, as the information filtered out in
drips and drabs, was disturbing.
A.
1. Made hundreds of millions of dollars of
unauthorized inter-company loans, without notice,
mostly with ENA cash, with inadequate controls
and no assurance of repayment;
2. Transferred property of the Debtors'
bankruptcy estate to non-debtors without notice to
the Court, the office of the United States Trustee or
any creditor or party in interest, and in violation of
Bankruptcy Code Sections 345, 363 and 549
among others;
The problem: Enron North America's
cash is being used to fund Enron's chapter
11 proceeding.
A group of ENA creditors in an informal alliance
began pressing ENA for information regarding the
postpetition cash flow of ENA and Enron as a
whole. The group learned that the "cash
management system" (herein "CMS") was, in fact,
being used to advance all ENA cash, on a daily
basis, to Enron Corp. In return, ENA received a
postpetition account receivable that was unsecured
and bore zero interest. Enron Corp., in turn,
disbursed the funds to whatever business unit
happened to need the funds and could justify it the request being made to the Enron Cash
Committee (herein "ECC") and the business
justification being assessed, if at all, by the Risk
Assessment Committee ("RAC").
3. Continued unabated Enron's now infamous
pre-petition self-dealing practices on and after the
Petition Date by purporting to 'represent' both sides
of the undisclosed lending transaction between the
ENA bankruptcy estate and the Enron Corp. estate
without the participation of even a single
independent, representative of ENA. In the first
eight weeks after the Petition Date alone, ENA
advanced more than $500 million to Enron Corp.
without protection of any kind; and
4. Failed to install any meaningful control
mechanism to (i) control the staggering rate of
depletion of the Debtors' estates in general (and the
ENA estate in particular) or (ii) monitor and
manage the business of, and expenditures in
connection with, the thousands of as yet unfiled
Enron entities, many of which are beyond the
jurisdiction of this Court.
Upon learning this, the group of ENA creditors
filed a motion to stop the CMS from sweeping the
ENA cash daily, and to force ENA to operate
under its own cash management system, without
regard to the cash needs of other Enron business
units. This generated a fight that culminated in an
evidentiary hearing, a series of interim orders, and
in substance, a fight that continues at the present
writing. Much of the text that follows comes from
the briefing of those issues by the ENA creditors.
The Debtors urged that this conduct was
authorized by that certain Order Authorizing
Continued Use of Existing Bank Accounts, Cash
Management System, Checks and Business Forms
dated December 3, 2001, (the "Cash Management
Order").
On Friday, February 8, 2002, the ENA Creditors
presented evidence of (i) unauthorized postpetition loans by ENA to a chapter 11 debtor, at
zero interest, with no collateral, without court
authority, in blatant violation of 11 U.S.C. '
345(b); (ii) the re-lending of ENA's funds to other
debtors and non-debtors, many of whom are
beyond the jurisdiction of this Court, also in
violation of 11 U.S.C. ' 345(b); (iii) substantial
flaws in Enron Corp.'s current cash management
system in general, and (iv) of the multi-billion
dollar risk to ENA and its creditors of ENA's
continued participation in this alleged "cash
management system". The uncontroverted
evidence showed that the Debtors have:
At a status conference on Monday, February 4,
2002, the Debtors announced to the Court that the
Debtors would propose an interim solution that
would include the pledge of Enron Corp.'s
dwindling unencumbered assets to secure ENA's
intercompany advances to Enron Corp. The
Committee also agreed that the Debtors'
centralized cash management system was
inadequate and proposed various changes to the
original cash management order via a proposed
revised cash management order attached to its
response.
1.
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Facts Adduced at the Cash Management
Hearing.
From the first day of the bankruptcy case, ENA
cash was being "swept" daily to Enron Corp. Both
ENA and Enron Corp. treat these sweeps as
"loans" or "advances" from ENA to Enron Corp.,
creating an account receivable from Enron Corp.
payable to ENA. From the date of filing, December
2, 2001, through January 23, 2002, the gross
dollars advanced from ENA to Enron Corp. are
$579 million, which after disbursements allegedly
in favor of ENA-related entities, nets to
approximately $320 million. The loans are
subordinate to the Court-approved Debtor-InPossession financing ("DIP Loan") in the amount
of $1.5 billion, which is secured by a first lien on
all of the Debtors' assets.
larger, depending on the rate of collections from
the liquidation of the ENA trading book.
The consolidated Enron budget prepared for
purposes of the DIP Loan estimated total cash
advances from the cash-generating debtor
subsidiaries to Enron Corp. at the end of 18
months (utilizing the current cash management
system) at approximately $3.6 billion, of which
ENA is projected to provide $3 billion. The budget
also projects that Enron Corp.'s net cash balance at
the end of the 18 month period will be $2.8 billion,
net of DIP drawings of $912 million for that same
period. Thus, even if the Debtor's preliminary
budget is correct, there will be an $800 million
shortfall to these entities.
The cash swept from ENA and loaned to Enron
Corp. were primarily the proceeds of the
liquidation of the ENA book of business, which is
liquidating over time. These are, in essence, the
proceeds of the sale of assets and non-recurring
income items. The post-petition ENA loans have
been made without Court authority for Enron
Corp. to borrow under 11 U.S.C. ' 364. A loan to
another Chapter 11 debtor is not a permitted
investment for ENA, pursuant to the guidelines
established by the United States Trustee for
investment of debtor funds.
The Debtors established the Cash Committee to
implement the cash management system. The Cash
Committee has no member who is responsible only
to ENA. The Cash Committee's only function is to
review cash requests for (a) proper documentation,
(b) propriety with respect to first day orders and
the DIP Loan order, and (c) to make
recommendations as to whether an expenditure
may be appropriate for a Chapter 11 debtor.
Although it has sent back some requests for cash
based on insufficient documentation, and some of
those requests have never resurfaced, there has
been no occasion when the Cash Committee
rejected a request as improper.
Enron Corp. offered no evidence of any ability to
repay the ENA loans other than prospective sale of
assets: (1) the stock of Portland General, expected
to net $1.5 billion, which is reduced to a contract,
but subject to regulatory approval and perhaps
other due diligence; (2) Enron Wind, an asset
being auctioned off, and as to which a current bid
of $300 million has been received; and (3) EOGIL
(Enron India), expected to generate $350 million,
which is the subject of a pending motion. There
was no testimony or evidence of the likelihood of
these sales occurring, what the payment terms are,
or, in the case of Enron Wind, whether the offer is
cash or some other terms. There was no evidence
of the ability of the purchasers to pay. These sale
proceeds, if forthcoming, of course, would be
subject to DIP liens securing a line of credit
presently capped at $1.5 billion. The Debtors'
existing DIP budget predicts that ENA will provide
$3 billion of the estimated $3.5 billion of loans to
Enron Corp. in the next eighteen months, although
the actual, total amount of the ENA loans to Enron
Corp. during that period actually could be much
The business judgment as to whether to make a
cash expenditure is exercised by the Chief
Financial Officers of the various business units
(each subsidiary) and, occasionally, by the Risk
Assessment & Control Group ("RACG"), a
member of which sits on the Cash Committee.
The Cash Committee has never received any
written instructions from anyone as to how to
conduct its business; it has no formal protocol or
guidelines for approving or rejecting cash
expenditures. No one on the Cash Committee has
ever raised the issue of whether ENA can be repaid
the amounts it is advancing to Enron Corp.
The Cash Committee considers itself to be acting
for the "Debtors" as a global group and not for any
particular debtor. Decisions are made for the
benefit of the "group" and not for the benefit of
any particular debtor.
All cash of all Debtor entities is swept daily to a
Cash Concentration Account ("CCA") at Enron
Corp. All disbursements are directly or indirectly
made from the CCA. When these disbursements
N-7
are made for the benefit of an Enron Corp.
subsidiary, this generates an account receivable
from that subsidiary payable to Enron Corp. The
majority of ENA's funds loaned to Enron Corp.
have been re-invested in this manner. Much of it,
$134 million gross and $4 million net, was
advanced by Enron Corp. to non-debtor
subsidiaries. Some of it was advanced to JEDI, one
of the off-balance sheet partnerships discussed in
the Powers Report. No one at Enron knows what
assets, if any, JEDI had that would be available to
repay these advances. Neither does anyone at
Enron know the solvency of the other non-debtor
subsidiaries receiving cash. All of these advances
are unsecured loans. One of the non-debtor
subsidiaries filed Chapter 11 the day after
receiving a cash advance.
certainly totaled in the hundreds of millions of
dollars in the first eight weeks of the Debtors'
bankruptcy cases. These advances consisted of (i)
more than $90 million of payroll costs paid from
the CCA to employees of non-debtor subsidiaries
of Enron Corp., which are not in the ownership
chain of the other debtors, (ii) approximately $50
million in extraordinary advances to non-debtors,
not including a $90 million payment to correct a
purportedly mistaken sweep of the operating
account of Enron Wind, and (iii) hundreds of
millions of dollars in advances to subsidiaries of
non-Enron Corp. subsidiaries of Debtor entities;
both the exact, aggregate amount of those
advances, the beneficiaries of those advances and
the ability of the hundreds non-debtor subsidiaries
of non-Enron Corp. debtor entities to repay are
unknown.
No analysis is done by the Cash Committee, by
Enron Corp., or by the RACG as to the solvency or
net worth of any of the entities receiving funds.
There was no evidence that it would be possible to
do so. The record firmly established that Enron
Corp. consumes assets and cash at a remarkable
rate. In the two months leading up to the
bankruptcy case, Enron Corp. and its subsidiaries
consumed $5.5 billion in advances and, essentially,
all of its own billions in collections during that
period. Yet, on the Petition Date, Enron Corp. was
essentially out of cash B broke, at least in the
liquidity sense. In the first eight weeks after the
Petition Date, despite being relieved from
repayment of over $40 billion in pre-petition
indebtedness, Enron Corp. 'swept' more than a
billion dollars from the other Debtors and their
subsidiaries. The rate of Enron Corp.'s depletion of
its thousands of non-debtor subsidiaries is
unknown and apparently, for now, unknowable.
ENA has, in essence, become the "bank" for Enron
Corp., and is making substantial unsecured loans.
The Cash Committee is functioning as the "loan
committee" except that the lender and the borrower
are on both sides of the table, negotiating terms
with themselves. Thus, the interest rate is zero, the
collateral is zero, the documentation is nonexistent, the reporting requirements are zero, and
the creditworthiness of the borrower and the
purpose are never discussed. ENA is in
liquidation, a fact that negates any business reason
for entering into such loan transactions.
The interest rate charged on the current DIP Loan
is a range between 7.25% and 5.3%. There was
testimony that market interest (to reflect the risk
undertaken) for the postpetition ENA lending
would require an interest rate much higher than the
DIP Loan rate of interest, probably prime plus 46%.
No one knows the aggregate amount of advances
from the Debtors to the thousands (apparently
somewhere between three thousand and forty-five
hundred) of its non-debtor subsidiaries, affiliates
and special purpose entities. Those advances
The hundreds of millions of dollars that Debtors
have transferred from ENA to other Debtors and to
non-debtor affiliates of Enron Corp. have been
transferred without the authority of the court. The
post-petition lending that has occurred thus far is
illegal because it is not in the ordinary course of
Enron's business and was effectuated without court
approval. Despite Debtors' arguments to the
contrary, the Cash Management Order entered by
the court on December 3, 2001 did not authorize
the loans. Alternatively, even if the court's Cash
2.
The ENA Creditors Argument in Favor of
a Firewall Around ENA Cash
Management Order were somehow construed as
having authorized the loans at issue: (1) the only
alleged controls in place at Enron (in the form of
the Cash Committee) does not (a) exercise
independent business judgment nor (b) engage in
any analysis of the creditworthiness of the subject
Enron entity or of that borrower's ability to repay
debt; and (2) ENA's interests are not being
represented by any individual officer whose sole
purpose is to protect the interests of ENA. Finally,
in any event, we argued that the entire process
N-8
should not be permitted to continue without the
Debtors being required, at a minimum, to provide
the ENA estate adequate protection for the use of
its cash. The Debtors, however, failed to prove that
they could provide such adequate protection.
a.
(iii) faithful performance of duties as a
depository; or
(2) the deposit of securities of the kind
specified in section 9303 of title 31.
Whether the Postpetition Sweep of ENA
Cash Violates the Code
Clearly, ENA has none of the above protections
available to it in this case. Further, Section
363(c)(1) prohibits the debtor in possession from
using property of the estate unless that use is in the
ordinary course of the debtors' business.
The Code is clear on the subject of when postpetition lending may occur. Section 364 authorizes
post-petition lending in only certain instances,
none of which are applicable here.
c.
b.
Debtors' actions are prohibited by Section
345(b).
The Debtors' loans are outside the
ordinary course of its business.
Sections 363 and 364 authorize a debtor to incur
post-petition debt (or use cash) without court
authority in only one instance: in the ordinary
course of its business. See 11 U.S.C. ' 364(a) and
11 U.S.C. ' 363(c)(1). The Bankruptcy Code does
not define "ordinary course of business." Courts
have generally applied a two-part test to determine
whether a transaction is in the "ordinary course of
business," such that a debtor-in-possession may
engage in the transaction without first securing
bankruptcy court approval: (1) a "horizontal
dimension" test under which the court must
determine whether the transaction is of type which
other similar businesses would engage in as
ordinary business, and (2) a "vertical dimension"
test, under which the court analyzes the transaction
from the vantage point of a hypothetical creditor
and inquires whether the transaction subjects the
creditor to economic risks that are of a nature
different from those he initially accepted. See In re
Lavigne, 114 F.3d 379, 384 (2nd Cir.1997); In re
Leslie Fay Companies, Inc., 168 B.R. 294,303
(Bankr. S.D.N.Y. 1994); In re Drexel Burnham
Lambert Group, Inc., 157 B.R. 532, 537
(S.D.N.Y.1993); In re Johns-Manville Corp., 60
B.R. 612, 616 (S.D.N.Y. 1986).
ENA's activities are prohibited by Section 345(b),
which permits a debtor to make a deposit or
investment of its money only under certain
circumstances. Section 345(b) provides:
(b) Except with respect to a deposit or
investment that is insured or guaranteed by the
United States or by a department, agency, or
instrumentality of the United States or backed by
the full faith and credit of the United States, the
trustee shall require from an entity with which such
money is deposited or invested B
(1) a bond B
(A) in favor of the United States;
(B) secured by the undertaking of a corporate
surety approved by the United States trustee for the
district in which the case is pending; and
(C) conditioned on B
(i) a proper accounting for all money so
deposited or invested and for any return on such
money;
(ii) prompt repayment of such money and
return; and
If either prong of the test is not satisfied, the
disputed transaction is not in the ordinary course of
business. See In re Leslie Fay Companies, Inc.,
168 B.R. at 304. ("Some transactions either by
their size, nature or both are not within the
day-to-day operations of a business and are
therefore extraordinary"). See also In re Lavigne,
114 F.3d at 385; In re Johns-Manville Corp., 60
B.R. at 617. Although the primary focus is on the
debtor's pre-petition business practices and
conduct, the court must "consider the changing
circumstances inherent in the hypothetical creditor
expectations." See In re Roth American, Inc, 975
F.2d 949, 952 (3rd Cir. 1992). As recognized by
one court, some issues that arise in a Chapter 11
case are such that "creditors . . . should have an
opportunity to be heard, . . . before . . . payments
are formally authorized by a Bankruptcy Court .
N-9
Such an opportunity would ensure that the facts
alleged by the debtor in possession are at least
colorably supported, and would avoid preferential
payments that may be commercially unsupportable
or downright fraudulent." In re James A. Phillips,
Inc., 29 B.R. 391, 395 (S.D.N.Y. 1983).
lend hundreds of millions of dollars from one
debtor estate to another, let alone authorize the
Debtors to make advances to nondebtor parties.
Debtors suggested that because the Cash
Management Order approved the Debtors' prepetition cash management system, and because one
facet (albeit an undisclosed one) of that prepetition system contemplated lending by one Enron
entity to others, then post-petition loans are
permissible. The record adduced at the February
8th hearing failed to sustain this story. The Debtors
did not 'maintain' anything post-petition, but
established a new, radically different and
ultimately flawed cash management system on and
after the Petition Date. Indeed, the evidence
presented demonstrated significant changes in the
Debtors' cash management system were made postpetition, including: 1. partial segregation of debtor
and nondebtor funds; 2. use of only debtor funds to
make intercompany loans; 3. deletion of the
automatic disbursement system; 4. implementation
of the Cash Committee; and 5. establishment of a
new system of bank accounts with the DIP Lenders
and closure of most of those pre-petition accounts.
In other words, whereas pre-petition the funds of
all Enron entities were swept to Enron Corp. and
used to fund the activities of the other entities,
post-petition, ENA is the Debtors' primary (if not
exclusive) source of capital.
The Debtors' conduct did not satisfy either the
vertical or horizontal dimensions test. Without a
doubt, ENA's lending of hundreds of millions of
dollars to Enron Corp. and its subsidiaries with no
terms of or prospect of repayment (and without
even disclosing which entities, if any, are obligated
to repay the hundreds of millions of dollars in
ENA advances) is an act which requires more
notice and judicial scrutiny than has taken place in
this instance. Certainly, ENA creditors did not
foresee, nor would they reasonably expect, the
Debtors to engage in such conduct in derogation of
the rights and interests of the ENA estate and its
creditors.
d.
The Court's Cash Management Order did
not authorize the loans at issue here.
The second circumstance where Section 364 of the
Code authorizes post-petition lending is after
notice and a hearing, and entry of a court order
approving the loan. See 11 U.S.C. ' 364(c) and
(d). The Debtors and the Committee alleged that
this Court's Cash Management Order authorized
the transactions at issue. A simple review of the
Cash Management Order and the pleadings served
on the first day belie this argument. The words
"lend" or "lending" never appear in the Debtors'
Motion for Order Authorizing Continued Use of
Existing Bank Accounts, Cash Management
System, Checks and Business Forms (the "Cash
Management Motion") (See Exhibit "B", attached
hereto). Nothing in either the Cash Management
Motion or the Cash Management Order can be
reasonably interpreted to authorize the Debtors to
The Cash Committee, established for the purported
purpose of controlling the Debtors' cash
disbursements, has been little more than a rubber
stamp for the diffuse and unsupervised business
judgment of apparently hundreds of 'chief
accounting officers' at various Enron debtor and
non-debtor entities. The evidence indicated that
Enron's centralized Cash Committee does not (i)
exercise independent business judgment regarding
the necessity or appropriateness of a particular
expenditure, nor (ii) make any determination of the
creditworthiness of the subject Enron entity, nor
any judgment about that borrowing entities' ability
In short, the Debtors' establishment of a new cash
management system and the use of ENA as its defacto DIP lender for the benefit of other debtors
and non debtors was: 1) never disclosed to anyone
in this case; and 2) never explicitly authorized by
the court.
e.
The Cash Committee is insufficient to
protect ENA.
to repay the funds advanced (regardless of the
amount of the proposed advance). On the watch of
the Cash Committee, estate funds have been
advanced to non-debtor subsidiaries of Enron
Corp., one of which filed bankruptcy after the loan
was made. The Debtors have continued to make
loans to the Debtors' various special purpose
entities, including the now notorious Jedi entity.
Indeed, a member of the Cash Committee was
unable to quantify the total amount of the hundreds
of millions of dollars in post-petition estate loans to
the thousands of non-debtor Enron Corp.
subsidiaries. Further, the Cash Committee operates
N-10
without the knowledge or benefit (or even a
discussion) of a rudimentary controlling operating
budget for Enron Corp. and its subsidiaries. On the
watch of the post-petition Cash Committee,
executive jet use has continued and luxury boxes
for the coming baseball season have been paid for
with Debtors' cash.
risk in respect of the Debtors' post-petition lending
activities, ENA literally has no independent voice
in the amount of the loans from its estate, or the
manner in which those funds are spent and/or
loaned to Enron Corp.'s bankrupt and nonbankrupt subsidiaries. In the "Powers Report", the
Debtors' own board of directors criticizes the
Debtors' handling of pre-petition conflicts of
interest in respect to a number of 'special purpose'
transactions in which management of Enron Corp.
purported to represent both Enron as capital
provider and various special purpose entities which
were the recipients of those funds. See, e.g.,
Powers Report, pp. 19 and 42. The Powers Report
goes on to conclude that, because of the lack of
independent representation of both sides of the
transactions in question, the transactions resulted
in the improper depletion of Enron assets for the
benefit of various Enron Corp. executives with
personal stakes in the special purpose entities
which were the counter-parties to these
transactions. See, e.g., Powers Report, pp. 16-17,
28, 166.
At the hearing, Debtors attempted to justify their
post-petition lending to non-debtor subsidiaries by
maintaining that the RACG purports to make credit
decisions on behalf of the Debtor entities by
determining whether the funds advanced by
Debtors to non-debtors is of benefit to the Debtors'
estates or can ever be repaid. Ironically, the day
before the hearing, the existing head of the
Debtors' RACG invoked his rights under the Fifth
Amendment of the United States Constitution and
refused to answer a single question of a
Congressional Committee investigating Enron and
its business affairs.
Even more to the point, it is abundantly clear that
no one performed a meaningful solvency analysis
of the thousands of non-debtor Enron entities - the
borrowers of bankruptcy estate funds under
Enron's post-petition lending scheme - nor
exercised any meaningful business judgment about
their ability to repay what, in the case of the nondebtor Enron borrowers, are pre-petition,
unsecured, non-priority loans. In fact, the latest
balance sheet which the Debtors could produce for
ENA in connection with the hearing on the Motion
is four months old. In at least one case, an Enron
Corp. subsidiary filed bankruptcy subsequent to
receiving estate cash, leaving the Debtors in the
position of being nothing more than a pre-petition,
non-priority, unsecured creditor of the borrower of
those funds. With the potential for hundreds B if
not thousands B of future bankruptcy filings,
hundreds of millions (soon to be billions) of dollars
of ENA estate funds are at risk.
f.
History repeated itself in the guise of the Debtors
maintenance of their pre-petition cash management
system. Based entirely on an essentially unnoticed
technical first day order, Enron Corp. caused ENA
(which as of September 30 was balance sheet
solvent with mostly unencumbered assets with a
total value exceeding $13 billion) in the first few
weeks of the case to advance hundreds of millions
of dollars of ENA funds to Enron Corp. Enron
Corp. in turn advanced those funds to its thousands
of debtor and non-debtor subsidiaries, some of
which were established, according to Enron Corp.'s
own board of directors, fraudulently to hide losses
of the company. During the course of ENA's
ongoing lending relationship with Enron Corp., not
a single independent ENA representative had any
input into the amount, or use, post-petition, of the
ENA intercompany loans. Indeed, Enron's witness
on the subject testified unequivocally that the
decisions being made about disbursements of
Enron cash were being made by executives
concerned with the debtors as a whole, not with
just the singular interests of ENA in mind.
The Debtors' current cash management
system is riddled with conflicts of interest.
Despite the fact that ENA, a liquidating debtor, is
by far the Debtors' largest cash provider and has
borne, and continues to bear, the lion's share of the
Highlighting the detriment to ENA's estate of the
post-petition use of its moneys is the circumstances
of the post-petition DIP loan approved on the first
business day of this bankruptcy case. Purportedly
under emergency circumstances, Enron Corp.
obtained a first day $1.5 billion credit line from a
consortium of third-party capital providers, which
loan had many of the usual lending protections of a
post-petition third-party loan: post-petition liens
on the Debtors' assets, an extraordinary interest
rate, controls, reporting and budgeting features,
hundreds of thousands of commitment fees, and
N-11
many other protections in favor of the post-petition
lending group designed to ensure, among other
things, repayment of the funds advanced. Despite
having been requested and approved on the first
business day of the bankruptcy case, two months
later Enron Corp. had not drawn a single dollar on
the DIP line. Why? Because Enron Corp. obtained,
in the guise of 'maintaining' its cash management
system, a much cheaper alternative: a non-arms
length, uncollateralized, non-interest bearing,
unsecured loan from the ENA estate, without any
controls over the disbursement of those funds
which Enron Corp. in turn advanced, in conduitlike fashion, to debtors and non-debtors alike. To
add insult to injury, Enron Corp. caused ENA to
co-sign and pledge its assets to secure the nascent
third -party DIP line, even though ENA will never
need any of the DIP moneys; ENA in fact will
have, based on current projections, positive cash
flow of at least $3 billion over the next eighteen
months.
g.
new cash management system segregating and
separating subsidiaries funds and halting
intercompany loans). By the Debtors' own
admission, ENA presently is in liquidation. Its
remaining material assets are (i) the self-liquidating
ENA trading book, an asset which according to the
Debtors may be worth $2 billion or more, (ii) a
one-third cost-bearing 'royalty' from the trading
business which is in the process of being
transferred to UBS, but so far has not restarted, and
(iii) various interests in miscellaneous assets,
mostly commercial loans and power projects in
various stages of completion which at present
apparently do not cash flow. The circumstances of
ENA and its subsidiaries changed radically after
the Petition Date and ENA's continued
participation in the Enron Corp. cash management
system, which, in practice, resulted in ENA being
an involuntary, uncompensated DIP lender, is
unjustifiable. Dr. Ramsey testified that while the
risk to ENA in connection with its loans is much
greater under the circumstances than the risk to the
third party DIP lenders, the terms of ENA's
involuntary DIP loans are radically more
unfavorable than the terms of the existing thirdparty DIP loan.
Debtors Use Of ENA's Assets To Fund The
Operations Of Other Enron Entities B
Debtors And Nondebtors B Without
Adequate Protection Should Not Be
Permitted.
Should ENA's assets continue to be taken for the
benefit of the other Enron entities, ENA, at a
minimum, is entitled to adequate protection. Yet,
Debtors have failed entirely to demonstrate how or
in what form ENA will be adequately protected.
See 11 U.S.C. ' 363(o)(1)(debtor's burden to
establish adequate protection); Raleigh v. Illinois
Dept. of Revenue, 120 S.Ct. 1951(2000) (noting
debtor's burden under 11 U.S.C. ' 363(o)(1) to
establish adequate protection).
The Debtors' cash management system did not
adequately protect the interests of ENA creditors.
Debtors maintained that such intercompany
activity between bankrupt entities, without
adequate protection and little (if any) procedural
safeguards in place, is routine. This is not the case.
For example, in The Charter Company v. The
Prudential Ins. Co. (In re The Charter Company),
778 F.2d 617 (11th Cir. 1985), the debtors' prepetition cash management system, which allowed
for intercompany loans between debtor and
nondebtors entities, was significantly curtailed
post-petition. Similarly, in Amdura National
Distribution Company v. Amdura Corp., Inc. (In re
Amdura Corp.), 75 F.3d 1447 (10th Cir. 1996), the
debtors' pre-petition practice of co-mingling and
loaning funds to and between its subsidiaries came
to a halt. There, the bankruptcy court at one point
stopped the intercompany loans entirely. The court
later allowed the practice to continue only on the
approval of the parties and adherence to strict
reporting requirements, with separate and
independent representation of each of the debtor
entities. See also In re Cardinal Industries, Inc.,
116 B.R. 964 (Bankr. S.D. Ohio 1990) (where, on
parent's filing of bankruptcy, debtor implemented
B.
The continuing problem.
The suggestion of the Committee that ENA should
continue to advance its depleting funds to Enron
Corp. under the circumstances was unthinkable,
even on a super-priority basis. The pre-petition
liens, security interest, constructive trust assertions
and potentially unasserted ownership interests in
Enron Corp's unpledged $500 million in
unencumbered assets, under the historic and tragic
circumstances, are unknown and unknowable. It is
conceivable that the hundreds of millions of dollars
in post-petition advances to date will never be
repaid, to say nothing of future advances.
N-12
Even if the terms of ENA's loans to Enron Corp.
were altered to reflect market terms, the
Committee's proposed mechanism for Enron's
readvancement of funds from the Concentration
Account to the thousands of debtor and non-debtor
cash users, under the Committee's proposal is
unworkable. Adequate protection requires the
Debtors to provide sufficient and accurate
information. See In re O.P. Held, Inc., 74 B.R. 777
(Bankr. N.D.N.Y. 1987) (granting creditor relief
from stay where debtor failed to provide sufficient
data to determine whether creditor was adequately
protected). Here, Debtors have failed to provide
crucial information. A pre-funding 'fair value'
analysis of all of the assets of the thousands of
debtor and non-debtor Enron entities required
under the Committee's proposal, is not
forthcoming. The PWC representative testified that
PWC has not been asked to undertake a 'fair value'
analysis of the assets and liabilities of the debtor
nor the non-debtor Enron entities. The RACG,
which has purportedly undertaken the underwriting
responsibilities in respect of the hundreds of
millions of dollars in Enron Corp. conduit loans on
as 'as needed' basis to Enron Corp.'s subsidiaries,
cannot even produce a current balance sheet for
ENA, apparently the most valuable of all of the
debtor entities, much less evaluate the
creditworthiness of the thousands of Enron entities
and special purpose entities. Weighed down by the
criminal problems of its leadership, the Enron
RACG certainly could not perform the
underwriting responsibilities of the Committee's
proposed modified cash management order.
and non-debtor subsidiaries. The Committee's
proposal for a horizontal claim in favor of ENA
and the ultimate cash providers, if adopted, would
result in nothing more than an accounting and
financial morass, improvable perhaps with an
arbitrary tracing mechanism (first in first out?; last
in first out?) but which in the end could not be
assured of producing anything close to adequate
protection for the ENA estate and its creditors.
C.
The attempted solutions.
1.
The preferred solution: A "firewall"
around Enron North America's cash.
The record adduced at the hearing on Debtor's cash
management motion, reflects the Debtor's
remarkably presumptuous and risky post-petition
business practices which have continued in the
guise of 'maintaining' the Debtor's pre-petition cash
management system. In fact, the Debtor's did not
'maintain' anything, but established a new,
radically different and ultimately flawed cash
management system on and after the petition date.
This flawed system resulted in more than a billion
dollars of loans ($570 million from ENA alone)
from various bankruptcy estates to Enron Corp.
in the first seven weeks after the Petition Date.
The record firmly establishes that Enron Corp.
consumes assets and cash at a remarkable, epic
rate. In the two months leading up to the
bankruptcy case, Enron Corp and its subsidiaries
consumed $5.5 billion in advances and essentially
all of its own billions in collections during that
period and yet was essentially out of cash - broke,
at least in the liquidity sense - on the Petition Date.
In the first eight weeks after the Petition Date,
despite being relieved from payment of reportedly
greater than $40 billion in pre-petition
indebtedness, Enron Corp. 'swept' more than a
billion dollars from the coffers of the other Debtors
and their subsidiaries. The rate of Enron Corp's
depletion of it thousands of non-debtor subsidiaries
is unknown and apparently, for now, unknowable.
Finally, the Committee's proposal that an Enron
debtor 'cash provider' receive a super-priority claim
against the Enron debtor or non-debtor which is
the net recipient of those funds would be
impossible to administer. In the first instance, all of
the funds which are swept into the Enron Corp.
centralized cash concentration account are
irrevocably commingled; in the absence of a
tracing mechanism, it would is impossible to
determine which debtor entity is the source of
Enron Corp.'s downstream lending to its debtor
Even more pernicious than the intercompany
lending activity between the Debtors various
bankruptcy estates is the rate of outflow of cash to
non-debtor entities. While the aggregate amount of
advances from the Debtors to the thousands
(apparently somewhere between three thousand
and forty-five hundred) of its non-debtor
subsidiaries, affiliates and special purpose entities,
presently is unknown, those advances certainly
totaled in the hundreds of millions of dollars in the
first eight weeks of the Debtors bankruptcy cases.
These advances consisted of (i) more than $90
million of payroll costs paid from the Enron Corp.
Concentration account to employees of non-debtor
subsidiaries of Enron Corp., which are not in the
ownership chain of the other debtors. (ii)
approximately $50 million in extraordinary
advances to non-debtors, not including a $90
N-13
million payment to correct a purported mistaken
sweep of the operating account of Enron Wind and
(iii) hundreds of millions of dollars in advances to
subsidiaries of non-Enron Corp. subsidiaries of
Debtor entities; both the exact, aggregate amount
of those advances, the beneficiaries of those
advances and the ability of the hundreds nondebtor subsidiaries of non-Enron Corp. debtor
entities to repay are unknown and, for now at least,
apparently unknowable.
state and local criminal and civil investigations
together with likely criminal and civil liability in
jurisdictions around the world. Enron's own board
of directors has issued a report admitting
systematic mismanagement, improper and
unethical financial reporting and fraud on the
capital markets. It is certain that a century from
now business students will be studying Enron as a
turn-of-the century, technology driven financial
scandal - probably the largest financial scandal in
the history of the free market - and will have taken
its place above the Teapot Dome and the Utility
scandals of the 1930's as examples of private
enterprise gone horribly, tragically and irrevocably
awry. Indeed, five Enron executives (some of
whom were still active and on the payroll) took the
Fifth Amendment in Congress. The chief executive
of Enron three months prior to the bankruptcy
case, while showing personal courage in waiving
for now his Fifth Amendment rights, offered a
days' worth of testimony which was the
financial/corporate equivalent of Nuremberg
testimony in his denial of knowledge of fraudulent
activities which have caused tens of billions of
dollars of harm to innocent third parties, to say
nothing of the unquantifiable damage to the
financial markets.
By the Debtors' own admission, ENA presently is
in liquidation. Its remaining material assets are (i)
the self-liquidating ENA trading book, an asset
which according to the debtor may be worth $5
billion or more (ii) a one-third cost-bearing 'royalty'
from the trading business which is in the process of
being transferred to UBS, but so far has not
restarted and (iii) various interests in miscellaneous
assets, mostly commercial loans and power
projects in various stages of completion which at
present apparently do not cash flow. The
circumstances of ENA and its subsidiaries have
changed radically since the petition date and
ENA's continued participation in the Enron Corp.
cash management system which in practice has
resulted in ENA being an involuntary,
uncompensated DIP lender is unjustifiable. Dr.
Ramsey testified that while the risk to ENA in
connection with its loans is much greater under the
circumstances than the risk to the third party DIP
lenders, the terms of ENA's involuntary DIP loans
are radically more unfavorable than the terms of
the existing third-party DIP loan.
2.
A separate Enron
Creditors Committee.
North
America
An alternative solution, albeit only a partial one,
would be a separate creditors committee for Enron
North America.
The Debtor has acknowledged the insufficiencies
of the existing cash management system and orally
suggested certain improvements in the system. The
Committee has gone a step further by offering a
form of modified cash management order which
purports to afford ENA certain protections in
respect of its intercompany loans.
Section 1102 provides for the appointment of
additional committees where needed to adequately
represent all creditors. Without doubt, in a case
such as this B the largest bankruptcy case in history
B with 51 debtors, over $40 billion in assets, debt
greater than $40 billion and millions of creditors,
one committee can not adequately represent the
interest of all creditors. The appointment of an
examiner, a disinterested party without the ability
to advocate on behalf of ENA's creditors, does not
change this fact.
Moreover, Enron Corp. is the subject of no fewer
than thirteen Congressional Congressional
investigations, criminal investigations by the
Justice Departments and the SEC, accusations of
income tax evasions, to say nothing of innumerable
An examiner's duties are limited. Pursuant to 11
U.S.C. ' 1106, an examiner's role consists
primarily of conducting an investigation into the
debtor's affairs and rendering a statement of its
investigation. See 11 U.S.C. '' 1106(b)(a)(3)(a)(4). An examiner is not an adversary. An
examiner is "first and foremost disinterested and
nonadversarial." See In re Baldwin United Corp.,
46 B.R. 314 (Bankr. S.D. Ohio 1985). In fact, the
Bankruptcy Code requires a disinterested
examiner. See 11 U.S.C. ' 1104(c). While the
fruits of an examiner's investigation flow to the
debtor, its creditors and shareholders, the examiner
does not answer to creditors, but solely to the
N-14
court. See In re Baldwin, 46 B.R. at 316. An
examiner "constitutes a Court fiduciary and is
amendable to no other purpose or interested party."
In re Hamiel & Sons, Inc., 20 B.R. 830, 832
(Bankr. S.D. Ohio 1982).
1992) (appointing multiple committees and
examiner); See In re Southmark Corp., 113 B.R.
280 (Bankr. N.D. Tex. 1990) (multiple committees
and examiner); In re White Motor Credit Corp., 50
B.R. 885, 901-02 (Bankr. N.D. Ohio 1985)
(involving multiple committees and examiner); In
re Carnegie Int'l Corp., 51 B.R. 252 (Bankr. S.D.
Ind. 1984) (multiple committees and examiner). In
Southmark, where there existed both an examiner
and multiple committees, the bankruptcy court
recognized the dual, but separate roles played by
each:
In contrast, a committee is not disinterested but is a
fierce advocate for the creditor constituency it
represents. A committee does not answer to the
court, but instead is a fiduciary to its constituents
and is obligated to exercise its powers as necessary
to protect its constituents' interests. See 7 L. KING,
COLLIER ON BANKRUPTCY, & 1103.05[2] (15th ed.
1987). A committee plays a vital role in the
reorganization process and its views are given
significant weight. Negotiation of a plan of
reorganization is expected to take place among the
debtor and all committees. See In re McLean
Indus., Inc., 70 B.R. 852, 860 (Bankr. S.D.N.Y.
1987). "Each committee is also to be given notice
of, and is expected to respond to, various requests.
These include highly significant matters on which
committee position is crucial, such as sales of
property outside the ordinary course of business,
post-petition
financing
agreements,
and
settlements." Id. (citations omitted).
the best interest of the estate may dictate that
the creditors and equity holders devote their
resources to the active pursuit of a viable plan of
reorganization. In a complex mega-case the task of
reorganization may be so substantial that the
committees conclude they should request the
appointment of an examiner to conduct an
investigation of a debtor's activities while they
concentrate on the reorganization effort.
Id. at 282 (citations omitted).
This is just the type of case that supports the
appointment of additional committees. As is
typical, the role of the ENA examiner is strictly
limited. The examiner's duties are largely limited to
performing an impartial investigation of the
Debtors' affairs. The examiner is not given the
authority to manage the Debtors' businesses or to
prosecute claims on behalf of the estate. The
examiner, unlike a committee, is (1) unable to
formulate a plan of reorganization, (2) negotiate on
behalf of ENA in the reorganization process, or (3)
represent the interest of ENA's creditors. Quite
simply, the examiner is not a fiduciary of ENA's
creditors. Despite the fact that ENA was uniquely
solvent pre-petition and serves as the Debtors'
exclusive source of capital, ENA does not have a
separate body to advocate on its behalf. While the
appointment of an ENA examiner is a step in the
right direction, it is wholly inadequate to represent
the interest of ENA's creditors in the Debtors'
reorganization process.
An individual creditor is simply unable to
participate in the debtor's reorganization in the
same manner that a committee may participate. No
better example exists than in this case. With little
justification, the Committee refused to agree to
give individual creditors access to discovery
instrumental in investigating creditors' claims.
Because an examiner may not always find interest
in the same information that would interest
creditors and the Committee is likely to continue
with this type of behavior, only the appointment of
separate ENA Committee will insure that ENA's
creditors have access to information.
The appointment of an examiner does not alleviate
the need for additional committees. Presumably, in
recognition of this fact, a number of bankruptcy
cases have included both an examiner and multiple
committees. See In re Ionosphere Clubs, 156 B.R.
414 (Bankr. S.D.N.Y. 1993) (appointing multiple
committees after appointment of examiner); In re
Interco, Inc., 135 B.R. 631 (Bankr. E.D. Mo.
Moreover, Movants submit that an examiner,
alone, cannot adequately investigate the Debtors'
affairs. This is an astounding task involving (to
date) fifty-one debtors. The size and complexity of
this case, alone, strongly suggests the need for
additional committees. See In re Becker Indus.
Corp., 55 B.R. 945, 949(Bankr. S.D.N.Y. 1985).
Indeed, since commencement of this case, Debtors,
the Committee, and their vast number of
professionals have been unable to unravel the
mystery surrounding the Debtors' financial affairs.
N-15
The addition of an ENA creditors' committee will
only aid the examiner in this endeavor.
A paper on the Enron bankruptcy would be
deficient if it did not contain a brief discussion of
the Bankruptcy Code's special provisions dealing
with financial and physical trade contracts, often
known as hedges, collars and swaps. Relatively
recent amendments to the Bankruptcy Code have
put counterparties to such contracts (that are almost
certain executory contracts and governed by Sec.
365 of the Code) in a favored position over other
parties, including the debtor.
The concern for creditor representation is
heightened where the U.S. Trustee appoints one
committee for jointly administered cases. See In re
McClean, 70 B.R. 862. That concern is justified
here. Neither the Committee nor the examiner
adequately represent the interests of ENA's
creditors. The examiner, by nature, is unable to
fully represent ENA's creditors. And the
Committee, overloaded with creditors of other
debtors to the detriment of the representational
needs of ENA's creditors, refuses to do so. For
these reasons, a separate ENA creditors' committee
is warranted.
3.
Termination of Commodity and Forward
Contracts Under 11 U.S.C. ' 556
1.
Definitions
Section 556 addresses the rights of commodities
brokers and forward contract merchants.
A trustee for Enron North America.
11 U.S.C. ' ' 556. Contractual right to
liquidate a commodities contract or forward
contract.
Finally, another alternative is the appointment of a
separate trustee for Enron North America. This is
probably the cleanest and most logical solution to
the problem.
D.
A.
The contractual right of a commodity
broker or forward contract merchant to
cause the liquidation of a commodity
contract, as defined in section 761, or
forward contract because of a condition
of the kind specified in section 365(e)(1)
of this title, and the right to a variation or
maintenance margin payment received
from a trustee with respect to open
commodity contracts or forward
contracts, shall not be stayed, avoided,
or otherwise limited by operation of any
provision of this title or by the order of a
court in any proceeding under this title.
As used in this section, the term
"contractual right" includes a right set
forth in a rule or bylaw of a clearing
organization or contract market or in a
resolution of the governing board thereof
and a right, whether or not evidenced in
writing, arising under common law,
under law merchant or by reason of
normal business practice.
The Bankruptcy Court=s Choice of
Solution.
The bankruptcy court, in the end, recognized the
need for protection of ENA=s cash and additional
protection for the rights of the ENA creditors. The
court entered an order (1) temporarily preventing
the Debtors from utilizing the cash of ENA, and
(2) directing the appointment of an examiner, 11
U.S.C. Sec. 1104(c), with expanded powers.
Those expanded powers include the authority and
responsibility to sit on the Cash Committee, to sit
on the Risk Assessment Committee, and to conduct
an investigation into certain matters relevant to the
issues surrounding the use of ENA cash. Harrison
J. Goldin was appointed examiner with certain
expanded powers as delineated in the court=s
order. It remains to be seen whether and to what
extent this remedy will suffice to protect the
interests of ENA.
IV. ISSUES UNIQUE TO THE WORLD'S
LARGEST
ENERGY
TRADING
COMPANY:
HEDGES, COLLARS,
SWAPS,
AND
FINANCIAL
CONTRACTS.2
Accordingly, there are terms that must be defined
as a precursor to understanding the applicability of
the statute to a given set of facts.
2The
author gratefully acknowledges the
assistance of Sarah McLean and Todd Leitstein,
both associates at Thompson & Knight, LLP, in
the writing of this section of the paper.
N-16
"commodity" it had to be listed in the statute.5 But
those cases were decided prior to the CEA's
amendment in 1974.6 Thus, commodity is now any
of the listed items, as well as, "all other goods and
articles . . . and all services, rights, and interests in
which contracts for future delivery are presently or
in the future dealt in."
"Commodity," under Section 761(8) of the Code,
has the same meaning that is has under the
Commodities Exchange Act.
2.
Enumerated
Commodities
Commodity Exchange Act
of
the
Section 1a (3) of the Commodity Exchange Act
(CEAct) defines the term "commodity" as follows:
Pursuant to 11 U.S.C. Sec. 761(4), "commodity
contract" means:
The term "commodity" means wheat, cotton,
rice, corn, oats, barley, rye, flaxseed, grain
sorghums, mill feeds, butter, eggs, Solanum
tuberosum (Irish potatoes), wool, wool tops, fats
and oils (including lard, tallow, cottonseed oil,
peanut oil, soybean oil, and all other fats and oils),
cottonseed meal, cottonseed, peanuts, soybeans,
soybean meal, livestock, livestock products, and
frozen concentrated orange juice, and all other
goods and articles, except onions as provided in
Public Law 85-839 (7 U.S.C. 13-1),and all
services, rights, and interests in which contracts for
future delivery are presently or in the future dealt
in.
(A) With respect to a futures commission
merchant, contract for the purchase or sale of a
commodity for future delivery on, or subject to the
rules of, a contract market or board of trade;
(B) with respect to a foreign futures
commission merchant, foreign future;
(C) with respect to a leverage transaction
merchant, leverage transaction;
(D) with respect to a clearing organization,
contract for the purchase or sale of a commodity
for future delivery on, or subject to the rules of, a
contract market or board of trade that is cleared by
such clearing organization, or commodity option
traded on, or subject to the rules of, a contract
market or board of trade that is cleared by such
clearing organization;
The agricultural commodities shown in
bold above are commonly referred to as the
enumerated commodities of the Commodity
Exchange Act. These enumerated commodities
were added to the CEAct at different times so that
futures trading in those commodities would fall
under the jurisdiction of the CFTC's predecessor B
the Commodity Exchange Authority, an agency of
the U.S. Department of Agriculture. In 1974 when
the CFTC was created, the CEAct was amended so
that CFTC jurisdiction was broadened to cover
futures and option trading based on any underlying
commodity, not just the specific agricultural
commodities enumerated in the law.3
(E) with respect to a commodity options
dealer, commodity option."
A "commodity broker" is a "futures commission
merchant, foreign futures commission merchant,
clearing organization, leverage transaction
merchant, or commodity options dealer . . . with
respect to which there is a customer."4
5See,
Early cases tended to interpret "commodity"
narrowly and held that for something to be a
3http://www.cftc.gov/dea/analysis/deaenumera
t.htm
(visited
12/01/2001)(emphasis
omitted)(emphasis added).
411
e.g., Goodman v. H. Hentz. & Co., 265
F.Supp. 440, 442-43 (N.D. Ill 1967)(copper is not
a "commodity"); Weinfeld v. Paine, Webber,
Jackson and Curtis, 191 F.Supp. 750 (D. Mass.
1961)(same).
6See
e.g., Bartley v. P.G. Commodities Assoc.,
Inc., Fed. Sec. L. Rep. (CCH) P95, 394
(recognizing expansion of 1974 definition).
U.S.C. ' 101 (6).
N-17
As broadly defined by the statute, 11 U.S.C.
Section 101 (25), a "forward contract" is a contract
(other than a commodity contract) for the
purchase, sale, or transfer of a commodity . . . 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, including, but not limited to, a
repurchase transaction, reverse repurchase
transaction, consignment, lease, swap, hedge
transaction, deposit, loan, option, allocated
transaction, unallocated transaction, or any
combination thereof or option thereon;7
Subject to certain contractual, custom, or other
recognized authorization, the plain language of
Section 556 provides that the Bankruptcy Code
does not prohibit or stay the following with respect
to the protected parties: the ability to liquidate and
the ability to maintain or vary margin or settlement
payments. These rights are exempted from the
automatic stay and avoidance.
The right to liquidate the contract is often found in
the contract itself, but under the Section's plain
meaning the authorization to liquidate may be
extra-contractual. It can come from a trade custom,
resolution, or even the common law. The ability to
liquidate affords the non-defaulting party the
ability to simultaneously terminate the contract and
fix its damages.
Although subject to interpretation and current
debate,8 "forward contract merchant" "means a
person whose business consists in whole or in part
of entering into forward contracts as or with
merchants in a commodity . . . 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."
Section 556 protects both commodities brokers and
forward contract merchants. It offers protection to
virtually "any person that is in need of protection
with respect to a forward contract in a business
setting. . . ."9 To be sure, the class of "protected
parties" is much greater than the class of
unprotected parties B forward contract participants
who are not merchants and who have not
contracted with merchants.10
Under Section 101 (38), "'margin payment' means,
for purposes of the forward contract provisions
[Title 11], payment or deposit of cash, a security or
other property, that is commonly known in the
forward contract trade as original margin, initial
margin, maintenance margin, or variation margin,
including mark-to-market payments, or variation
payments. And, under (51A), "'settlement payment'
means, for purposes of the forward contract
provisions of [Title 11], a preliminary settlement
payment, a partial settlement payment, an interim
settlement payment, a settlement payment on
account, a final settlement payment, a net
settlement payment, or any other similar payment
commonly used in the forward contract trade.
When a margin or settlement payment is received
in connection with a forward contract, the payment
is taken free of the stay and not subject to a
preference action.
2.
C.
B.
Interpretation
1.
Who is Protected?
The protections afforded by section 556
apply to more than liquidation.
7Emphasis
Case Law
To date, only one case appears to have specifically
addressed Section 556, In re R. M. Cordova
International, Inc.11 In Cordova, the trustee
claimed that contracts to buy a certain commodity,
coconut oil, were executory. The trustee sought to
assume the favorable contracts and reject the
unfavorable ones. Some of the counter parties
objected contending that the contracts were already
closed or washed out. Focusing on Section 556, the
Court held that both parties to the contracts were
added.
8See
e.g., Williams v. Morgan Stanley Capital
Group, Inc. (In re Olympic Natural Gas
Company), 258 B.R. 161 (Bankr. S.D. Tex. 2001),
aff'd, S.D. Tex., 2001, appealing pending, Fifth
Circuit Court of Appeals.
Collier on Bankruptcy '556.03[2] (15th
ed. 2001).
95
10Id.
1177
N-18
B.R. 441 (Bankr. D.N.J. 1987).
forward merchants and ultimately that the contracts
were not executory.12
12Id.
at 449.
N-19
The court recognized that Section 556 is an
exception to the usual prohibition against ipso
facto clauses. But more importantly the court
recognized the underlying policy supporting
Section 556 and others like it: "According to
Professor Collier, Section 556 is one of several
provisions in the Code which minimizes the
likelihood that the insolvency of one commodity
broker or forward contract merchant may lead to
that of another."13 Collier was not the only
authority the Cordova court looked to. Feldman &
Somner are cited for the proposition that Section
556 assures that the protected parties will be able
to "close out an insolvent customer's commodity or
forward contract."14 Even the legislative history
was "clear, the right to liquidate a commodity is
'the right to close out an open position.'"
***
(6) under subsection (a) of this section, of
the setoff by a commodity broker, forward
contract merchant, stockbroker, financial
institutions, or securities clearing agency of
any mutual debt and claim under or in
connection with commodity contracts, as
defined in section 761 of this title, forward
contracts, or securities contracts, as defined in
section 741 of this title, that constitutes the
setoff of a claim against the debtor for a
margin payment, as defined in section 101,
741, or 761 of this title, or settlement
payment, as defined in section 101 or 741 of
this title, arising out of commodity contracts,
forward contracts, or securities contracts
against cash, securities, or other property held
by or due from such commodity broker,
forward contract merchant, stockbroker,
financial institutions, or securities clearing
agency to margin, guarantee, secure, or settle
commodity contracts, forward contracts, or
securities contracts.
The court rejected the trustee's contention that any
commodities contract remained in force at the time
of the filing, all had been breached or closed out.
Accordingly, none were assumable or rejectable.
But the policy announced by the court under
Section 556 would presumably have prevented the
trustee's exercise of any attempt to assume or reject
nonetheless.
2.
D.
Similar Provisions / Other Protections
As alluded to in the Cordova decision, the
bankruptcy code contains a number of similar
provision which all combine to protect commodity
brokers and forward contract merchants. Some of
these provisions are:
1.
Section 546 (e) prohibits any preference
action by the trustee related to a margin
payment or settlement payments.
' 546. Limitations on avoiding powers.
***
(e) Notwithstanding sections 544, 545, 547,
548(a)(2) or 548(b) of this title, the trustee
may not avoid a transfer that is a margin
payment, as defined in section 101, 741, or
761 of this title, or settlement payment, as
defined in section 101 or 741 of this title,
made by or to a commodity broker, forward
contract merchant, stockbroker, financial
institution, or securities clearing agency, that
is made before the commencement of the
case, except under section 548(a)(1) of this
title.
Section 362 (b) (6) provides an exemption
from the automatic stay for setoffs of
margin payments or settlement payments.
' 362. Automatic Stay.
***
(b) The filing of a petition under section
301, 302, or 303 of this title, or of an
application under section 5(a)(3) of the
Securities Investor Protection Act of 1970,
does not operate as a stay -
3.
13Id.
at 448 (citing 4 Collier on Bankruptcy
'556.01 (15th ed. 1987)).
Section 560 allows a swap agreement
participant to terminate, net out, or setoff
the contract without lifting the stay or fear
of an avoidance.
' 560. Contractual right to terminate a
swap agreement.
14Id.
N-20
The exercise of any contractual right of any
swap participant to cause the termination of a swap
agreement because of a condition of the kind
specified in section 365(e)(1) of this title or to
offset or net out any termination values or payment
amounts arising under or in connection with any
swap agreement shall not be stayed, avoided, or
otherwise limited by operation of any provision of
this title or by order of a court or administrative
agency in any proceeding under this title. As used
in this section, the term "contractual right" includes
a right, whether or not evidenced in writing, arising
under common law, under law merchant, or by
reason of normal business practice.
E.
damages (which are usually prohibited by the
agreements) but the calculation of the
counterparty's claim against ENA (or vice versa)
would be difficult to calculate.
F.
Whether there is one contract or multiple
contracts?
Because different Swaps are based on different
price strips, one "deal" may be "in the money" for
the swap participant and another one "out of the
money." The right of the swap counterparty to
terminate a specific contract and attempt to not
terminate (continue to enforce) another is thus a
possible issue. Therefore, it is worth considering
whether there is "one contract" or "multiple
contracts."
Analysis of the rights of a forward
contract merchant under contract and
bankruptcy law.
Part of the answer to this question may turn on
whether the counterparty has a master ISDA
contract or any other master Swap agreement with
Enron. In many other instances, with other clients,
we have found Master Swap Agreements or similar
arrangements. The absence of a master ISDA
agreement or other Master Swap Agreement
between Enron and a swap counterparty would be
somewhat unusual. The existence of such a master
agreement is commonly one of the factors that
drive courts to conclude that multiple contracts
should be considered as one.
Typical physical and financial contracts between
Enron North America and producers fall within the
statutory definition of "swap agreements" found in
the Bankruptcy Code at Sec. 101(53B). A
counterparty to such an agreement has the
contractual right to terminate the Swaps because of
the bankruptcy of ENA. The right of any swap
participant to terminate a swap agreement based on
the bankruptcy of a counterparty is not "stayed,
avoided, or otherwise limited" by the Bankruptcy
Code. This is expressly provided in Sec. 560 of the
Bankruptcy Code.
Absent a Master Swap Agreement, there seems to
be a substantial question whether there one
contract or multiple contracts. In the case of no
Master Agreement, each contract would typically
refer to the right of a party to terminate it; each
would have its own set of remedies and methods
for exercising them. Each contract would
specifically address the right to "net" and "offset,"
which would make it appear that the parties
contemplated the existence of other contracts. We
are assuming there is no master agreement. While
it would be useful to read the General Terms and
Conditions (see the discussions under Limitations
and Caveats below), we think the better side of the
argument is that, in this case, there would be
multiple contracts and not one. This is not entirely
clear, however.
Thus, we conclude that in a typical transaction, the
counterparty has the right to terminate the Swaps
under the express language of the Agreements and
the Bankruptcy of ENA does not change that
outcome. In any event, pursuant to the Uniform
Commercial Code and the Law Merchant, the
rights of swap participants would be governed by
the "course of conduct" between the parties who
are engaged in the trade.
If the swap counterparty terminates based on the
contract, it may be contractually obligated to give
advance notice. We find no provision in the
Bankruptcy Code or the contract that gives the
counterparty an alternative. Failure to do so will
make it difficult for the counterparty to calculate its
damages because of ENA's entitlement to
"damages for the improperly shortened notice.
There would be no consequential or punitive
It is difficult to make a specific recommendation
but we suggest, based upon prior experience, that a
swap counterparty should be guided by the
following principles: The contracts are "executory
G. What "should" the swap counterparty do?
contracts" under the Bankruptcy Code and are
governed by Sec. 365. During the chapter 11,
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ENA15 has the right to assume or reject executory
contracts, if it is in the best interest of ENA to do
so, using its business judgment. If it assumes an
executory contract, it must "cure" any defaults,
including financial obligations. If it rejects an
executory contract, the amount ENA owes the
counterparty becomes a prepetition unsecured
claim. ENA does not have to make a decision
whether to assume or reject until either (a) a plan is
confirmed, or (b) the judge forces ENA to do so.
The swap counterparty has the right to ask the
court to set a date by which ENA must assume or
reject. The court can set any date it deems
appropriate, based on the facts and the interests of
the parties.
Bankruptcy law does not interfere with this right.
Thus, under the foregoing principles, both sides
have the right to terminate the contracts at any
time. If a contract is terminated, it is "marked to
market" (another way of saying that the nondefaulting party has a claim based on the cost of
"cover"). Thus, depending on the date of
termination, the swap counterparty would owe to
ENA, or be owed from ENA, depending on the
commodity price strip that date. On any given day,
based on the commodity strip for the applicable
remaining months, a given contract is "in the
money" (i.e., positive for the swap counterparty) or
"out of the money" (i.e., negative for the swap
counterparty). If ENA is "in the money" and ENA
terminates, the swap counterparty has to pay ENA
(though it would entitled to exercise any rights of
setoff).
There is clearly a period of time between the date
of filing bankruptcy and the date on which ENA
will assume or reject an executory contract This
period is known by bankruptcy practitioners as the
"Twilight Zone" because neither party knows
whether the contract will be assumed or rejected.
During the Twilight Zone, it is just "there." There
is Supreme Court authority that specifically states
that a debtor can take the benefit of an executory
contract during the Twilight Zone without bearing
the burdens. This is extremely unfair and most
bankruptcy judges are loathe to enforce this.
Indeed, most bankruptcy practitioners recognize
that for a debtor to take the benefit of a contract
during bankruptcy, it must perform its side of the
deal. Nonetheless, there is Supreme Court
authority to the contrary.16
Consider an example. If the swap counterparty
were to terminate Contract A and mark it to
market, ENA might owe the counterparty $1 mm.
(Here, the counterparty is "in the money"). If the
counterparty did not terminate for another week,
the market could move in the counterparty's favor
or against the counterparty. If it moved one way,
Enron might owe the counterparty $1.5 mm. If it
moved another way, ENA might owe the
counterparty $500,000. In either case, as of the
date of termination, ENA will owe the
counterparty a prepetition claim that can be netted
and setoff against other amounts that the
counterparty may owe to ENA on other contracts.
The swap counterparty has the right to terminate
under the express terms of the contracts.
In an opposite example, if the counterparty were to
terminate Contract B, and market it to market, the
counterparty might owe ENA $1 mm. (Here, the
counterparty is "out of the money"). If the
counterparty did not terminate for another week,
the market could move in the counterparty's favor
and the counterparty might owe ENA $500,000. If
it moved in another direction, the counterparty
might owe ENA $1.5 mm. In either case, as of the
date of termination, counterparty will owe ENA
actual dollars that it will have to pay, subject only
to setoff and netting against other claims.
15For
the sake of convenience, we have
assumed that the chapter 11 counterparty is Enron
North America ("ENA").
16NLRB
v. Bildisco & Bildisco, 465 U.S. 513
(1984), where the Supreme Court held that after a
debtor commences a chapter 11 proceeding, but
before executory contracts are assumed or rejected
such contracts remain in existence, enforceable by
the debtor but not against the debtor. Id. at 532.
See also United States v. Dewey Freight System,
31 F.3d 620, 624 (8th Cir. 1994); In re Providence
Television Limited Partnership, 113 B.R. 446, 451
(Bankr. N.D. Ill. 1990) (brokerage agreement);
Wilson v. TXO Production Corp. (In re Wilson),
69 B.R. 960, 965 (Bankr. N.D. Tex. 1987) (joint
operating agreement).
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Each of these examples is subject to ENA's right to
terminate as well. On any given day, as the
counterparty attempts to ride the market to a more
favorable position, ENA is riding the market also
and could terminate based on its perception of
whether it is more favorable for ENA or not. There
are, of course, numerous other permutations. These
examples are merely intended to show that both the
counterparty and ENA are riding the market on
each contract, but the counterparty is playing with
real dollars whereas ENA is playing with
bankruptcy dollars. The foregoing is a careful
analysis of the counterparty's options based on a
combination of contract, bankruptcy, and market
factors. Clearly, the best conclusion for a swap
counterparty should be a careful consideration of
all factors, including the futures market.
H. Conclusion
Section 556 and others were enacted to stop the
tide of ruin that can surround a bankrupt. The
reason commodities contracts and swap
agreements were chosen for exemption can be
explained by the sheer size of the fallout if forward
contracts could be held in abeyance until plan
confirmation. In the absence of Section 556 and
similar provisions, the concentric fall of entire
markets might be unavoidable and inevitable. But
these sections represent Congress' attempt to
constrain the effect of one customer's insolvency.
Before assuming that any of these sections applies
it will be necessary to determine if the client is a
protected party, and then whether there is a basis
either in law or contract for proceeding with the
setoff, termination, net out, or liquidation. If the
both conditions are met than the action can be
taken without lifting the stay and will be free from
avoidance by the trustee.
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