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In re Qimonda Richmond: Payment on Letter of Credit is Not Protected by Section 546(e) Safe Harbor
Practical Law Legal Update 0-519-4286 (Approx. 5 pages)
In re Qimonda Richmond: Payment on Letter of Credit is Not Protected by Section 546(e) Safe Harbor
by PLC Finance and Practical Law Bankruptcy & Restructuring
| Published on 16 May 2012 • USA (National/Federal) |
The US Bankruptcy Court for the District of Delaware issued a ruling denying a motion to dismiss in the adversary case of EPLG I, LLC v. Citibank, National Association (In re Qimonda Richmond, LLC). The Court's ruling in Qimonda illustrates the potential pitfalls of structuring a transaction unnecessarily involving a letter of credit.
On March 26, 2012, the US Bankruptcy Court for the District of Delaware issued a ruling denying a motion to dismiss in the adversary case of EPLG I, LLC v. Citibank, National Association (In re Qimonda Richmond, LLC). The Court found that the debtors' payments made to satisfy their obligations under a letter of credit and the bank's later debit of the debtors' account did not qualify as "settlement payments" under section 546(e) of the Bankruptcy Code. Settlement payments are shielded from a trustee's avoidance powers under the safe harbor provisions of section 546(e).
Background
In January 2000, a predecessor of Qimonda Richmond (Debtors) raised $33,688,000 in an industrial revenue bond offering. To collateralize the debtors' obligation to pay the bondholders, Citibank issued a letter of credit for $34,103,332 in favor of the indenture trustee. Under the letter of credit, Citibank assumed an obligation to pay the indenture trustee after a valid draw notice. In exchange, the Debtors:
- Agreed to reimburse Citibank if the letter of credit was drawn.
- Gave Citibank liens on their assets to secure the reimbursement obligation.
- In 2008, granted Citibank a security interest in additional collateral, equipment and funds in the Debtors' cash collateral account held at Citibank.
The letter of credit initially expired on January 27, 2001, but automatically renewed in one-year increments unless Citibank notified the indenture trustee of its intent not to renew. In that case, the indenture trustee was entitled to draw on the letter of credit.
In October 2008, Citibank notified the Debtors and the indenture trustee that it would allow the letter of credit to expire on January 27, 2009. As of November 23, 2008, the balance in the Debtors' Citibank account was zero. In December 2008, the Debtors directed the indenture trustee to redeem the bonds. To cover their obligations, the Debtors deposited $47,937,873 into the Citibank account. On January 2, 2009, Citibank debited the Debtors' account for $33,715,873 and paid that amount to the indenture trustee, who retired the bonds. Citibank then released its liens against the Debtors' property.
On February 20, 2009, the Debtors filed for Chapter 11 bankruptcy. On February 11, 2011, the bankruptcy trustee filed an adversary complaint against Citibank seeking to avoid as fraudulent and preferential transfers:
- The Debtors' December 2008 deposit of funds into their Citibank account.
- Citibank's January 2009 debit of the Debtors' funds as reimbursement for the payment it had made under the letter of credit to the indenture trustee to retire the bonds.
Citibank filed a motion to dismiss and that motion was decided on by the Court.
Key Litigated Issues
The primary issue before the Court was whether the Debtors' deposit of funds into their Citibank account and Citibank's later debit of the Debtors' account fell within the safe harbor provisions of section 546(e) of the Bankruptcy Code.
Citibank argued that both the deposit and debit fell within section 546(e) as a settlement payment made "in connection with a securities contract" and were therefore shielded from the trustee's avoidance actions. It argued that:
- The US District Court for the Third Circuit has broadly defined a settlement payment to include any transfer of cash or securities made to complete a transfer payment. Citibank contended that the series of events in this case fell within the Third Circuit's definition.
- A letter of credit is a securities contract within section 741(7)(A) of the Bankruptcy Code because it is a credit enhancement related to a securities contract (the bonds and their indenture).
The bankruptcy trustee argued that the deposit and debit were not "settlement payments" protected by the 546(e) safe harbor because:
- A letter of credit is specifically exempted from the definition of security under section 101(49)(B)(i) of the Bankruptcy Code.
- The collateralization of a letter of credit is not commonly considered a settlement payment by the public securities markets.
- Even if a series of transactions ultimately does include a purchase or sale of a security, this does not automatically make each link in the chain of events a settlement payment. The Court must analyze each discrete transaction separately to determine whether each meets the settlement payment definition.
- While a letter of credit is a credit enhancement to a bond, bonds are not securities contracts within the definition of section 741(7)(A) of the Bankruptcy Code.
Outcome
The Court agreed with the bankruptcy trustee that Citibank had failed to establish that the deposit and debit were settlement payments protected by section 546(e). The Court came to this conclusion because:
- It decided that the Debtors' payments to Citibank were made to fulfill an obligation independent from any securities transaction.
- Citibank failed to prove that payment on a letter of credit is considered a settlement payment in the securities industry or is a commonly used payment structure in a securities transaction.
- It was not persuaded that bonds and their indentures constitute securities contracts under the Bankruptcy Code.
Practical Implications
The Court's ruling in Qimonda underlines the potential pitfalls of structuring a transaction unnecessarily involving a letter of credit. Citibank would most likely have been protected from the trustee's avoidance actions had it instructed the Debtors to pay off their bonds directly instead of by funding their Citibank account.
In addition, the Qimonda opinion illustrates that, while the Third Circuit's definition of section 546(e)'s safe harbor provision is broad, it is not without limits.
For more information on the section 546(e) safe harbor, see Practice Note, Fraudulent Conveyances in Bankruptcy: Overview: Settlement Payment Defense.