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Article Excerpt
On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "Reform Act"). Although principally a measure to guard against consumer bankruptcy abuse, the Reform Act clarifies, expands, and adds provisions to title 11 of the United States Code (the "Bankruptcy Code") dealing with financial transactions. Notwithstanding the Reform Act's broader scope, this discussion is limited to those portions of the Reform Act bearing on financial transactions. The amendments discussed below will take effect on Monday, October 17, 2005, and will not apply to cases commenced prior to that date.
I. BACKGROUND
Sections 555, 556, 559, and 560 of the Bankruptcy Code currently provide special protections to transactions involving financial markets. Without these provisions, a non-debtor party to a protected financial contract would be stayed pursuant to section 365(e)(1) of the Bankruptcy Code from taking immediate action to protect itself upon the bankruptcy of its contract counterparty. By enacting these provisions, Congress recognized that financial markets can change significantly in a matter of days and a non-bankrupt party to certain types of complex financial transactions may face heavy losses unless the transactions are promptly and finally closed out and resolved. The Reform Act contains modifications to sections 555, 556, 559, and 560 of the Bankruptcy Code to expand and clarify the protections afforded with regard to "securities contracts," "forward contracts," "repurchase agreements" and "swap agreements" under the Bankruptcy Code and adds new sections 561 and 562 to the Bankruptcy Code to provide protections with regard to master netting agreements and to define the timing of the measure of damages under such agreements, respectively. Set forth below is a summary of the relevant amendments to the Bankruptcy Code pertaining to financial transactions.
II. GLOBAL MODIFICATIONS
A. Financial Participants
One of the most important changes in the Reform Act is that it broadens the class of parties protected by the Bankruptcy Code's financial transactions provisions. Specifically, protected parties now include all "financial participants," which is essentially defined to include most clearing organizations as well as any entity which, on any day during the 15-months immediately preceding the commencement of the case under the Bankruptcy Code has had securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements or master netting agreements involving non-affiliates with a total gross dollar value of not less than $1 billion in notional or actual principal amount outstanding or had gross mark-to-market positions of not less than $100 million (aggregated across counterparties). The complete definition of "financial participant" (as well as other relevant definitions and the revised text of sections 555, 556, 559 and 560) is set forth in the statutory appendix annexed hereto.
B. Termination and Acceleration of Qualifying Financial Contracts
The Reform Act also provides that neither filing for protection under the Securities Investor Protection Act of 1970 nor any court order or decree obtained by the Securities Investor Protection Corporation may act as a stay of any contractual right to "liquidate, terminate, or accelerate a securities contract, commodity contract, forward contract, repurchase agreement, swap agreement, or master netting agreement," to offset or net termination payments or other obligations arising under such agreements, or to foreclose on cash collateral. In contrast, such an application, order or decree may still operate as a stay of any foreclosure or other disposition of securities collateral pledged by a debtor.
The Reform Act clarifies sections 555, 556, 559 and 560 by providing that the liquidation of a qualifying securities contract also encompasses termination and acceleration. In addition, the Reform Act broadens the definition of "contractual right" to include a right set forth in a bylaw of a derivative clearing organization, a multilateral clearing organization, a national securities exchange, a national securities association, a contract market designated under the Commodity Exchange Act, a derivatives transaction execution facility registered under the Commodity Exchange Act or a board of trade or in a resolution of the governing board thereof, and a right (whether or not in writing) arising under common law, merchant law, or by reason of normal business practice.
III. DEFINITIONAL AMENDMENTS TO EXISTING SECTIONS OF THE BANKRUPTCY CODE
The Reform Act also expands the definitions of sections 555 (securities contracts), 556 (commodity or forward contracts), 559 (repurchase agreements) and 560 (swap agreements) of the Bankruptcy Code as follows:
A. Securities Contracts
The Reform Act expands the definition of "securities contract" to include, most significantly, any contact for the purchase, sale or loan of a mortgage loan or interest in a mortgage loan and options on any of the foregoing, including repurchase or reverse repurchase transactions. More specifically, the revised definition of "securities contract" explicitly includes, among other things: (a) a contract for the purchase, sale, or loan of a security, a certificate of deposit, a mortgage loan or any interest in a mortgage loan, a group of index of securities, certificates of deposit or mortgage loans or interests therein or options on any of the foregoing; (b) the guarantee by or to any securities clearing agency of a settlement of cash, securities, certificates of deposit, mortgage loans, or interests therein, group or index of securities, or mortgage loans or interests therein or option of any of the foregoing; (c) any margin loan; and (d) (i) any other agreement or transaction that is similar to an agreement or transaction referred to above, (ii) any combination of agreements or transactions referred to above, (iii) any option to enter into any agreement or transaction referred to above, (iv) a master agreement that provides for an agreement or transaction referred to above, and (v) a security agreement or arrangement, or other credit enhancement related to any agreement or transaction referred to therein but not to exceed the damages in connection with any such agreement or transaction measured in accordance with section 562. However, the definition of "securities contract" explicitly excludes any purchase, sale, or repurchase obligation under a participation in a commercial mortgage loan.
B. Commodity Contract
Under section 761(4) of the Bankruptcy Code prior to enactment of the Reform Act, a "commodity contract" was defined as (a) with respect to a futures commission merchant, a 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, a foreign future (as defined in section 761); (c) with respect to a leverage transaction merchant, a leverage transaction (as defined in section 761); (d) with respect to a clearing organization, a 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...
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