In a recent decision, In re National Gas Distributors, LLC ¹, the U.S. Court of Appeals for the Fourth Circuit reversed and remanded a ruling of the U.S. Bankruptcy Court for the Eastern District of North Carolina, which had narrowly defined the term “commodity forward agreement”. The term “commodity forward agreement” is used by the Bankruptcy Code, but the Bankruptcy Code does not actually define the term. Additionally, no prior case has defined the term “commodity forward agreement”.

Background

Prior to filing for bankruptcy, National Gas Distributors, LLC, distributed natural gas to industrial, governmental and other customers. After National Gas filed for bankruptcy, the bankruptcy Trustee commenced adversary proceedings against several of National Gas’ customers. In commencing the adversary proceedings, the Trustee sought to avoid certain natural gas supply contracts entered into between National Gas and these customers during the year prior to filing the bankruptcy petition. In the complaints, the Trustee alleged that the natural gas supply contracts and natural gas transfers were fraudulent conveyances because they were made when the debtor was insolvent and for less than market value.

In defense, the customers argued that the natural gas supply contracts were “swap agreements”. The customers made such an argument, because if the natural gas supply contracts were found by the bankruptcy court to be “swap agreements”, then the customers would have a complete defense to the Trustee’s complaint under sections 546(g), 548(c), and 548(d)(2)(D) of the Bankruptcy Code.

In arguing that the natural gas supply contracts were “swap agreements”, the customers first argued that the contracts were “commodity forward agreements”. The customers also argued that since the natural gas supply contracts were “commodity forward agreements”, under the Bankruptcy Code, the contracts would also be considered “swap agreements”, since the definition of “swap agreements” in the Bankruptcy Code includes “commodity forward agreements”.

However, the bankruptcy court held that the natural gas supply contracts were not “commodity forward agreements”. Although the Bankruptcy Code provides no definition for the term “commodity forward agreement”, and no prior case has provided a definition of the term, the bankruptcy court reviewed legislative history to determine what constituted a “commodity forward agreement”. The bankruptcy court ruled that a “commodity forward agreement” must be traded in a financial market and cannot involve physical delivery of the commodity to an end user. Since the natural gas supply contracts in the case were not traded in financial markets but were simply supply contracts, the bankruptcy court held that the contracts were not “commodity forward agreements” which were exempt from the Trustee’s avoidance power.

Fourth Circuit Decision

In reversing the decision of the bankruptcy court, the Fourth Circuit held that “the bankruptcy court in this case construed ‘commodity forward agreements’ too narrowly – i.e., by requiring that they be traded on an exchange and not involve physical delivery of the commodity.” The Fourth Circuit also precluded the bankruptcy court “from requiring, in defining a ‘commodity forward agreement,’ that the contract be traded in a market or on an exchange or that it not involve physical delivery of the commodity.”

In its decision, however, the Fourth Circuit did not actually define the term “commodity forward agreement”. The Fourth Circuit did provide certain nonexclusive elements that it argues the statutory language appears to require, including:

(1) The subject of a commodity forward agreement must be a commodity.

(2) A forward commodity contract, in being “forward,” must require a payment for the commodity at a price fixed at the time of contracting for delivery more than two days after the date the contract is entered into.

(3) As a forward agreement in relation to a commodity, in addition to the price element, the quantity and time elements must be fixed at the time of contracting.

(4) While the broad class of “swap agreements” includes contracts that are readily assignable and therefore tradable, “swap agreements” also include forward contracts, which are not necessarily assignable.

In making its decision, the Fourth Circuit did not rule that the natural gas supply contracts in the case were in fact “commodity forward agreements”, but instead remanded to the bankruptcy court for further legal and factual development. Accordingly, the full scope of this decision’s authority will not be realized until the bankruptcy court has made its ruling in the remanded proceedings.