The Restructuring Report

By Steven R. Kinsella

In a normal chapter 11 bankruptcy case, the automatic stay and the provisions of 11 U.S.C. § 365 provide a trustee or debtor in possession with substantial tools and power concerning executory contracts and unexpired leases. A trustee or debtor in possession may override certain rights of the counterparties to those agreements, such as invalidating ipso facto clauses that purport to give the counterparty the right to terminate the contract upon the filing of a bankruptcy case. However, when the debtor deals in forward contracts, the balance of power shifts due to 11 U.S.C. § 556.

A forward contract is a contract for the future purchase or sale of commodities that are traded in the forward contract market with a maturity date of more than two days after the date the contract is entered into. Forward contracts are common in the agriculture and energy industries (i.e., an agreement in which the parties agree to purchase and sell grain at some future time under agreed-upon conditions). Section 556 of the Bankruptcy Code permits counterparties to terminate, liquidate or accelerate forward contracts without limitation under the Bankruptcy Code.

Thus, if the debtor is a party to such forward contracts, the debtor faces two immediate dilemmas upon filing for chapter 11 protection:

(1) How to ensure existing counterparties do not immediately terminate agreements and continue to do business with the debtor.
(2) How to convince parties to enter into new, post-petition contracts with the debtor.

To preserve these future contracts after filing for bankruptcy protection, debtors have turned to first day motions. In re Mirant Corp. is considered the first attempt to neutralize the effects of section 556. In re Mirant Corp., No. 03-46590 (Bankr. N.D. Tex.). In Mirant, the debtor filed a first day motion seeking approval of a program to enter into separate “Assurance Agreements” with current counterparties to future contracts. These “Assurance Agreements” provided that the counterparties would not terminate the future contracts in exchange for certain protections, such as super priority liens for post-petition market movement. These same protections were made available to counterparties to any new future contracts.

The debtor in In re Calpine Corp. expanded on this approach by attempting to employ the same type of program but also providing for the immediate assumption of a large number of prepetition future contracts. In re Calpine Corp., No. 05-60200-cgm (Bankr. S.D.N.Y.). The immediate assumption of the contracts drew an objection from the Official Committee of Unsecured Creditors and the objection was eventually resolved by the establishment of a protocol, filed under seal, to determine which contracts should be assumed prior to the final hearing.

Other courts have approved similar programs. These different programs demonstrate that it is possible to minimize the effect of section 556. However, they require planning and immediate implementation to ensure that important futures contracts are not terminated immediately after filing.