The Fourth Circuit Court of Appeals, in In re National Gas Distributors, LLC, recently issued a decision that could serve as a basis for extending "safe harbour" treatment to bilateral supply contracts that have only a limited impact on the public financial markets.

The Bankruptcy Code extends protections to certain types of financial contracts, including "swap agreements", to prevent a systemic market disruption in the event of a bankruptcy of the contract counterparty.

These protections (safe harbours), include preserving a contract party's right to terminate the agreement based on the counterparty's bankruptcy - an exception to the general rule of invalidating clauses in contracts that purport to take effect on a bankruptcy event (so-called "ipso facto clauses"). In addition, sections 546(e), (f) and (g) of the Bankruptcy Code insulate payments made under such contracts from the Bankruptcy Code's general avoidance provisions.

In In re National Gas Distributors, LLC, defendants to avoidance actions brought by the chapter 11 trustee filed motions to dismiss, asserting that the commodities contracts (to supply natural gas) at issue were protected swap agreements. The bankruptcy court denied the motions on the basis that the Bankruptcy Code safe harbours were meant to apply only to those contracts traded in the open market, and that bilateral supply contracts were not contemplated by the drafters of the Bankruptcy Code to receive protection as "swap agreements".

On appeal, the Fourth Circuit Court of Appeals, relying on the plain language of the applicable sections of the Bankruptcy Code, disagreed and held that the analysis of whether a contract is entitled to safe harbour protection should not be based on whether such contract trades in the public market or on an exchange. The Court of Appeals remanded to the bankruptcy court to decide whether the contract at issue qualifies for safe harbour protection without considering that fact.