Fourth Circuit Restores Bankruptcy Safe Harbor Protections for Natural Gas Supply Contracts That Are "Commodity Forward Agreements"

In reversing and remanding a bankruptcy court ruling that raised concerns among participants in the natural gas markets, the Fourth Circuit Court of Appeals in Hutson v. E.I. du Pont de Nemours & Co. (In re National Gas Distributors, LLC) held that natural gas supply contracts with end users are not precluded as a matter of law from constituting “swap agreements” under the Bankruptcy Code. A factual inquiry will be required to determine whether these natural gas supply contracts can be characterized as “swap agreements” and therefore entitled to the safe harbor protections from the automatic stay and avoidance powers of a bankruptcy trustee for preferences and fraudulent conveyances.

One way for a natural gas supply contract to constitute a “swap agreement” is for it to be found to be a “commodity forward agreement,” which the Fourth Circuit states should include the following nonexclusive elements: (1) substantially all of the expected cost of performance must be attributable to an underlying commodity determined at the time of contracting; (2) payment must be for a commodity that is delivered more than two days after the date of the contract, at a price that is fixed at the time of contracting; (3) quantity and time of delivery must be fixed at the time of contracting; and (4) the agreement itself need not be assignable or tradable. Certain of these elements, such as the requirement that price, quantity, and time of delivery be “fixed” at the time of contracting, are not present in the Bankruptcy Code and may pose challenges in determining whether a given natural gas supply contract is in fact a “commodity forward agreement.”


In 2006, Richard M. Hutson, II, trustee for National Gas Distributors, LLC (the “Trustee”), brought claims under sections 548(a) and 550(a) of the Bankruptcy Code against E.I. du Pont de Nemours and Company, the Smithfield Packing Company, and Stadler’s Country Hams (collectively, the “Customers”), along with more than 20 other customers of National Gas Distributors, LLC (“National Gas”), a distributor of natural gas to predominately industrial customers. The Trustee’s lawsuits sought to avoid payments made under certain natural gas supply contracts and recover “the cash value of the difference between the market prices when the customers took delivery and the prices they paid under the contracts, which the Trustee alleged [to be] over $4 million.” The natural gas supply contracts at issue were entered into by National Gas within 12 months of the date its bankruptcy petition was filed. These contracts employed the “Base Contract for Sale and Purchase of Natural Gas,” published by the North American Energy Standards Board, Inc., copyright 2002 (“NAESB Contracts”), and email confirmations between the parties that established (or “fixed”) the prices for future natural gas deliveries by National Gas to its Customers’ designated facilities. Under the NAESB Contracts, National Gas was obligated to sell natural gas to the Customers at these fixed prices, notwithstanding fluctuations in market prices, or pay the Customers the difference between the applicable market price and the contract price. This contractual requirement resulted in National Gas making sales to the Customers that were below the prevailing market price.

Under section 548(a), bankruptcy trustees may seek to avoid transfers of property that are made within two years of the filing of a bankruptcy petition when such transfers are “fraudulent,” as defined in the Bankruptcy Code. Consequently, the Trustee claimed that the sales by National Gas below the prevailing market price were constructively fraudulent conveyances because National Gas was insolvent at the time of such sales. Alternatively, the Trustee claimed that National Gas’s management engaged in actual fraudulent conveyances by intentionally using the NAESB Contracts to “hinder, delay or defraud” National Gas’s creditors. In light of these alleged fraudulent transfers by National Gas, the Trustee argued that the NAESB Contracts should be avoided pursuant to section 548(a).

However, section 546(g) of the Bankruptcy Code provides a “safe harbor” from constructive fraud claims under section 548(a)(1)(B) for payments made to swap participants under “swap agreements.” Further, sections 548(a)(1)(A) and 548(d)(2)(D) of the Bankruptcy Code provide a defense from both actual and constructive fraud claims to the extent the transferee provided value in good faith. Accordingly, the Customers filed motions to dismiss the Trustee’s actions or, in the alternative, for summary judgment, arguing that the transfers of natural gas were made “in good faith” and “for value” and that “ ‘each Transfer was made by or to a swap participant under or in connection with a swap agreement’ and was thus not avoidable [by Trustee] under 11 U.S.C. §§ 546(g) and 548(d)(2)(D).”

The bankruptcy court denied the Customers’ motions, finding that the NAESB Contracts were “simply agreement[s] by a single end-user to purchase a commodity” and not “swap agreements” as defined in 11 U.S.C. section 101(53B) of the Bankruptcy Code. The bankruptcy court reasoned that since the NAESB Contracts were physically settled and not traded in any organized financial markets, these NAESB Contracts were not the type of agreements that Congress intended to exempt from the avoidance provisions of the Bankruptcy Code. Following additional motions by the Customers requesting a modification of the bankruptcy court’s order with respect to conclusions it made regarding the NAESB Contracts that the Customers argued were factual in nature, the bankruptcy court ruled that “as a matter of law,” the NAESB Contracts were not “swap agreements.”

The Bankruptcy Code’s “Countervailing Policy of Protecting Financial Markets”

Although one of the Bankruptcy Code’s primary policies is to provide for the equitable distribution of a debtor’s assets among its creditors, Congress recognized the potentially devastating consequences that could occur if the insolvency of one firm were allowed to spread to other market participants, thereby threatening the stability of entire markets. Beginning in 1982, Congress engaged in formulating a series of changes to the Bankruptcy Code to create certain “safe harbors” to protect rights of termination and setoff under “securities contracts,” “commodities contracts,” and “forward contracts.” The “safe harbor protections” provided to these types of contracts include exemption from several avoidance provisions in the Bankruptcy Code—notably, an exemption from a bankruptcy trustee’s ability to avoid contract payments that are “fraudulent conveyances.”

These amendments to the Bankruptcy Code were augmented and refined in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) and in the Financial Netting Improvements Act of 2006, in which, among other things, the safe harbor protections were expanded to permit cross-product netting among protected transactions (i.e., swap agreements, forward contracts, commodity contracts, repurchase agreements, and securities contracts). The definitions relating to swap and other protected transactions were also broadened to provide “sufficient flexibility to avoid the need to amend the definition as the nature and uses of swap transactions matured.”

As part of these amendments, the term “commodity forward agreement” was added to the definition of “swap agreement” under the Bankruptcy Code. However, Congress did not define the term “commodity forward agreement” in the Bankruptcy Code, and no court has yet sought to provide a definition. The Fourth Circuit acknowledged the bankruptcy court’s “staunch effort” to analyze section 101(53B), which resulted in the bankruptcy court’s conclusion that “a ‘commodity forward agreement’ has to be traded in a financial market and cannot involve the physical delivery of the commodity to an end user,” but ultimately the Fourth Circuit disagreed with the bankruptcy court’s conclusion.

“Commodity Forward Agreements” Need Not Be Traded in Financial Markets

In its opinion, the Fourth Circuit decided to look to the definition of “forward contract” under the Bankruptcy Code to determine whether a “commodity forward agreement” must necessarily be traded in a financial market or on an exchange because the broad term “forward agreement” must include the more narrow “forward contracts.” The Fourth Circuit reasoned that there is statutory authority supporting the proposition that “forward contracts” need not be traded in a market or on an exchange by virtue of the exclusion of “commodity contracts”—which are contracts “on, or subject to the rules of, a contract market or board of trade”—from the definition of “forward contracts.” The Fourth Circuit also noted that no court has required “forward contracts” to be traded in a market or on an exchange, but that some courts have held that “forward contracts” may in fact be directly negotiated by the parties and nonassignable. Consequently, the Fourth Circuit rejected the bankruptcy court’s assumption that “all of the agreements in §101(53B)(A)(i) [which include “commodity forward agreements”] must be ‘found in the financial markets.’ ”

“Commodity Forward Agreements” May Involve the Physical Delivery of Natural Gas

The Fourth Circuit found the bankruptcy court’s assumption that the NAESB Contracts were “simple supply contracts” because they involved the physical delivery of natural gas to be an oversimplification of the NAESB Contracts’ intended purpose. Notwithstanding the fact that the NAESB Contracts involved the physical delivery of natural gas, the Fourth Circuit concluded that the bankruptcy court overlooked the fact that the NAESB Contracts contained financial hedging elements by which “the customers hedged their risk of future fluctuations in the price of natural gas”:

The [NAESB Contracts] obliged the customers to buy, and National Gas to sell, gas on a future date at a price fixed at the time of contracting, regardless of fluctuations in the market price. And if either party did not perform, that party was required to pay the difference between the contract price and the market price.

Thus, the Court reasoned that these “simple supply contracts” could influence and create risk for broader markets and their participants. The Fourth Circuit acknowledged that this was precisely the type of systemic risk that Congress intended to address with the amendments to the Bankruptcy Code set forth in the BAPCPA.

Moreover, the Fourth Circuit stated that there was nothing in the Bankruptcy Code that prohibited the physical delivery of a commodity. To the contrary, many courts have held that “forward contracts” may be settled by physical delivery of the underlying commodity, and therefore, “commodity forward agreements” may also be physically settled. Further, the Fourth Circuit observed that the Bankruptcy Code’s inclusion of “spot” commodity transactions in the definition of “swap agreements” was also contrary to the bankruptcy court’s conclusion because “spot agreements” are agreements in which the subject commodity is “available for immediate delivery after sale.” Therefore, the Fourth Circuit held that Congress did not intend to prohibit the physical delivery of natural gas pursuant to a “commodity forward agreement.”

Elements of “Commodity Forward Agreements”

The Fourth Circuit declined the opportunity to fashion a definition for “commodity forward agreements.” However, the court did set forth several “nonexclusive elements” as guidance for what it believes the statutory language requires for a “commodity forward agreement”:

1. “The subject to a ‘commodity forward agreement’ must be a commodity.” That is, “substantially all of the expected costs of performance must be attributable to the expected cost of the underlying commodity, determined at the time of contracting.”

2. A “commodity forward agreement” must “require a payment for the commodity at a price fixed at the time of contracting for delivery [that is] more than two days after the date the contract is entered into.”

3. In addition to price, “the quantity and time elements must [also] be fixed at the time of contracting.”

4. “Commodity forward agreements” do not necessarily need to be assignable and, therefore, tradable.

Challenges in Interpretation

In describing these contours of a “commodity forward agreement,” the Fourth Circuit sought to “point to certain non-exclusive elements that the statutory language appears to require.” Certain of these elements, such as the requirement that price, quantity, and time of delivery be “fixed” at the time of contracting, are not present in the Bankruptcy Code. The definition of “forward contract” under the Bankruptcy Code does not include any reference to price or quantity, and the only reference to delivery is the requirement for a “maturity date more than two days after the date the contract is entered into” without any further specifics on timing. Although the Fourth Circuit reasoned that “[b]ecause the term ‘agreement’ is broader than the term ‘contract,’ … a forward contract must also be a forward agreement (although it does not follow that every forward agreement is a forward contract),” there is no defined term for “commodity forward agreement” and therefore no statutory guidance on the requirement that price, quantity, and time of delivery be “fixed” at the time of contracting. This lack of guidance may pose challenges in interpretation. Various agreements that are used for hedging purposes in the natural gas markets have price, quantity, and delivery provisions that, while variable in cost, amount, and timing, are expressly determined at the time of contracting by reference to specified extrinsic factors. Consequently, there may be uncertainty in applying these particular elements of a “commodity forward agreement” to these types of agreements.


Nat’l Gas Distributors has been very closely followed by participants in the U.S. natural gas industry—both by energy-industry participants and by their creditors. The dispute drew amicus briefs from the International Swaps and Derivatives Association, Inc. (a global financial trade association that seeks to identify and reduce risk in the derivatives and risk management industry), BP Energy Co. (one of the largest marketers of natural gas in the United States), and First Citizens Bank & Trust Co. Although the Fourth Circuit’s decision seems to be consistent with Congress’s stated desire to mitigate systemic market risk that may arise in connection with a given market participant’s bankruptcy, the “nonexclusive guidance” provided by the Fourth Circuit may offer challenges in interpretation and application of this precedent to future contractual situations.


Hutson v. E.I. du Pont de Nemours & Co. (In re National Gas Distributors, LLC), 556 F.3d 247 (4th Cir. 2009).