Helping Clients With Their Energy and Environmental Needs


Bankruptcy: NAESB Contracts

By Vorys

Bankruptcy and energy are topics frequently in the news these days, reminding us of the following case:

Earlier this year, the United States Court of Appeals for the Fourth Circuit reversed and remanded for further proceedings a lower court decision holding that certain NAESB natural gas supply contracts entered into by National Gas and a few of its customers were not "swap agreements" protected from avoidance proceedings under the Bankruptcy Code.  See In re National Gas Distributors, LLC (Case No. 07-2105) (a copy can be found here).

The facts were straightforward:  The year before National Gas filed its bankruptcy petition, it sold natural gas to several of its customers under a series of NAESB Base Contracts for Sale and Purchase of Natural Gas and related transaction confirmations.  The Trustee commenced adversary proceedings to avoid these contracts and recover the cash value of the difference between the market prices when the customers took delivery and the prices that they paid.  The Trustee claimed that the contracts and transfers were fraudulent conveyances because they were made for less than market value when the debtor was insolvent.

The customers' defense was that the NAESB contracts were "commodity forward agreements" - a subset of swap agreements - and thus not avoidable under the Bankruptcy Code (presumably relying on Section 10.5 of the NAESB General Terms and Conditions).  The lower court disagreed, finding that the agreements were simply contracts by single-end users to purchase a commodity, physically settled and not traded in financial markets, and therefore not exempt from avoidance.

The Court of Appeals found the lower court's understanding of a "commodity forward agreement" too narrow - i.e., that the Bankruptcy Code does not preclude physical delivery in connection with these types of agreements - and reversed for further proceedings.  Recognizing that there was little guidance for determining whether the NAESB contracts were "commodity forward agreements" or "swap agreements" under the Code, the Court identified certain non-exclusive elements required by the statutory language, including:

  • "First, the subject of a commodity forward agreement must be a commodity.  That is, substantially all of the expected costs of performance must be attributable to the expected costs of the underlying commodity, determined at the time of contracting;"
  • Second, the contract must require payment at a price fixed at the time of contracting for delivery more than two days after the contract was entered into; and,
  • Third, the quantity and time elements must also be fixed at the time of contracting.

We'll let you know what the lower court says.

Tags: Bankruptcy, Energy

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