STEPHEN V. WILSON, District Judge.
This is an appeal from the Bankruptcy Court's July 24, 2014 Order Establishing Scope of the Automatic Stay in Connection with Alleged Swap Agreement. (8:14-bk-13606-SC Dkt. 74.) This appeal stems from an interest rate swap agreement between appellees Shaukat A. Chohan and Mahmooda K. Chohan ("Debtors") and U.S. Bank, National Association (the "Bank"). At the heart of this appeal are three intertwined questions: (1) what if any interest was assigned to appellant A62 Equities, LLC ("A62"); (2) whether this assignment entitles A62 to avail itself of the swap agreement exemption from the application of the automatic stay, 11 U.S.C. §§ 362(b)(17) & 560; and (3) whether A62 may collect such interest (if any exists) by foreclosing on the subject trust deed. The nebulous nature of the inquiry surrounding these questions is confounded by the seemingly unique facts of this case, as well as the expedited nature of the appealed from decision.
This case involves an alleged post-termination assignment of some interest related to a terminated interest rate swap agreement. A62, the alleged assignee, sought to foreclose on the collateral used to secure the swap agreement after the defaulting party filed for bankruptcy. The parties fail to point to, and the Court has not found, any other case involving this set of facts. As such, this case apparently presents "a proving ground for interpreting, applying and testing the boundaries" of the swap agreement exemption from the automatic stay. In re Lehman Bros. Holdings Inc., 502 B.R. 383, 385 (Bankr. S.D.N.Y.2013). Because this is seemingly the first time that the disputed statutory language is being interpreted and applied in this manner, the Court anticipates that the current ruling may be controversial. Nevertheless, it is unavoidable that a case such as this involving sophisticated commercial transactions and complex underlying financial structures "being analyzed for the first time from a real world bankruptcy perspective" will occasionally "break new ground as to unsettled subject matter." In re Lehman Bros. Holdings Inc., 422 B.R. 407, 422 (Bankr.S.D.N.Y.2010) ("BNY"). For the reasons discussed below, the Court AFFIRMS the Bankruptcy Court's July 24 Order.
On April 11, 2006, Debtors and the Bank entered into an interest rate swap agreement
Under the Swap Agreement, the Debtors agreed to pay to the Bank a fixed interest rate and the Bank agreed to pay to Debtors a floating interest rate. (ER 113-14.) Payments were to be calculated based on a notional amount
The Swap Agreement includes a termination provision allowing for the termination of the swap agreement upon one of several defined "Events of Default." (ER 41-43.) Under Section 6 of the Master Agreement, if an Event of Default occurs, then the non-Defaulting Party may "by not more than 20 days notice to the Defaulting Party specifying the relevant Event of Default, designate a day not earlier than the day such notice is effective as an Early Termination Date in respect of all outstanding Transactions." (ER 41.) Section 6(d) provides that "[a]n amount calculated as being due in respect of any Early Termination Date under Section 6(e) will be payable on the day that notice of the amount payable is effective[.]" ("termination damages"). (ER 42.) Section 6(e) specifies methods for calculating the amount of termination damages to be paid. (ER 42.)
The Agreement further states that "[w]ithout prejudice to Sections 2(a)(iii) and 6(c)(ii), the obligations of the parties under this Agreement will survive the termination of any Transaction." (ER 44.) Section 6(c)(ii) provides that:
Section 7 of the Master Agreement includes an anti-assignment clause. In relevant part, Section 7 provides:
(ER 43.)
On May 26, 2006, roughly five weeks after signing the Swap Agreement, Debtors obtained a loan from the Bank secured by a Trust Deed, Security Agreement, and Assignment of Rents. (ER 31 ¶ 9.) On March 20, 2008, Debtors obtained a second loan from the Bank, also secured by a Trust Deed, Security Agreement, and Assignment of Rents. (ER 31 ¶ 10.)
On June 8, 2012, the Bank sent to Debtors a letter notifying them that an Event of Default had occurred and that the Bank was designating June 12, 2012 as the Early Termination Date. (ER 31 ¶ 12.) On June 12, 2012, the Bank sent to Debtors a letter notifying them of the Early Termination Amount of $527,384.59 payable to the Bank. (ER 63-65.) The Bank did not then exercise any rights to collect under any security agreements; instead it added the Early Termination Amount to the balance of the loan due by Debtors. (ER 31 ¶ 13.)
A62 asserts that on January 25, 2013, the Bank sold to A62 the May 26, 2006 and March 20, 2008 Trust Deeds, Security Agreements, and Assignments of Rents. (ER 31 ¶ 13.) A62 asserts that the Bank also assigned to it the Bank's interest in the Swap Agreement. (Appellee's Rep. Br. 3.) It is undisputed that Debtors did not consent to any such transfers from the Bank to A62. (Id.)
On June 6, 2014, Debtors filed a Chapter 11 petition for bankruptcy.
On July 8, 2014, the Bankruptcy Court held a hearing regarding Debtors' motion. (ER 205.) At the hearing, the Bankruptcy Court accepted the parties' mutual representations that A62 was in fact the Bank's assignee. (ER 163.) The parties did not submit any documentary evidence of the assignment. (Id.) At the hearing, the parties argued over what was assigned to A62 and whether it became a swap agreement participant by virtue of the assignment. (ER 149-82.) The Bankruptcy Court ruled from the bench as follows:
(ER 182-83.) On July 24, 2014, the Bankruptcy Court issued the a short Order stating that the
(ER 145-46.) On July 29, 2014, A62 appealed from the Bankruptcy Court's July 24 Order. (Dkt. 1.)
A bankruptcy court's findings of fact are reviewed for clear error and its conclusions of laws are reviewed de novo. In re Clark, 262 B.R. 508, 514 (9th Cir. BAP 2001). "A lower court's findings are reversible for clear error when the appellate court is left with a definite and firm conviction that a mistake has been committed." Id. at 514 (citing United States v. Maldonado, 215 F.3d 1046, 1050 (9th Cir. 2000), cert. denied, 531 U.S. 1172, 121 S.Ct. 1141, 148 L.Ed.2d 1004 (2001)). Mixed questions of law and fact are generally reviewed de novo. Id. (citing Diamond v. City of Taft, 215 F.3d 1052, 1055 (9th Cir.2000), cert. denied, 531 U.S. 1072, 121 S.Ct. 763, 148 L.Ed.2d 665 (2001)).
Section 362 of the Bankruptcy Code provides that the filing of a bankruptcy petition triggers an automatic stay of, inter alia, actions to enforce a lien against estate property, actions to enforce against the debtor's property a lien to the extent that it secures a claim that arose before the bankruptcy, and actions to obtain possession or to exercise control over the estate's property. 11 U.S.C. § 362(a). Section 362 also stays the "setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor." 11 U.S.C. § 362(a)(7). Courts have stated that the "automatic stay is the single most important protection afforded to debtors by the Bankruptcy Code." Acands, Inc. v. Travelers Cas. & Sur. Co., 435 F.3d 252, 258 (3d Cir.2006) (quoting In re Cavanaugh, 271 B.R. 414, 424 (Bankr.D.Mass. 2001)) (internal quotation marks omitted).
Notwithstanding the importance of the automatic stay, Congress saw fit to exempt certain actions from its grasp. However, Courts must construe these exceptions narrowly. In re Weisberg, 136 F.3d 655, 659 (9th Cir.1998). Section 362(b)(17) provides an exemption for:
11 U.S.C. § 362(b)(17). In relevant part, § 560 provides that:
11 U.S.C. § 560. The Bankruptcy Code defines a "swap participant" as "an entity that, at any time before the filing of the petition, has an outstanding swap agreement with the debtor." 11 U.S.C. § 101(53C). In relevant part, the Bankruptcy Code defines a "swap agreement" as "an interest rate swap, option, future, or forward agreement" or "any security agreement or arrangement ... related to any [interest rate swap] ... including any guarantee or reimbursement obligation by or to a swap participant.... in connection with [an interest rate swap] ..., but not to exceed the damages in connection with any such agreement or transaction[.]" 11 U.S.C. §§ 101(53B)(A)(i), (vi).
The parties to the current appeal focus on whether A62 is a "swap participant" under § 560 and if so, whether A62's foreclosure sale of the subject assets would be the exercise of a contractual right to cause the "liquidation, termination, or acceleration" of a swap agreement. As discussed above, the Bankruptcy Court found that A62 purchased a right to receive payment secured by a trust deed, not an interest in a swap agreement. However, this right to receive payment was derived from the Swap Agreement and was secured by a related security agreement. While the Swap Agreement was terminated before Debtors filed the instant bankruptcy, their obligations related to the Terminated Transactions remained outstanding. Thus, if the Bank hadn't assigned any interest related to the termination damages then Bank would have arguably been a swap participant at the time Debtors filed for bankruptcy. If so, the question becomes whether this status was also conferred upon A62 by virtue of the alleged assignment. This question is complicated by the absence of the relevant assignment documents from the record.
Undeniably, at the time that the Bank and Debtors entered the subject agreement, it was a "swap agreement" within the meaning of the Bankruptcy Code. Under the terms of the Master Agreement and attached documents, the Bank and Debtors agreed to make periodic payments to one another based on the interest that would accrue on a $3,000,000 notional amount, with the Bank paying a floating interest rate and Debtors paying a fixed interest rate. However, when the Bank invoked its right to terminate the agreement early it ended any obligation that either party to the Swap Agreement would have had with respect to future periodic payments to be calculated after the Termination Date. Though the Agreement provides that the Bank's and Debtors' rights and obligations survive termination, these surving rights and obligations only involve past transactions — i.e. those periodic payments which were already calculated, had become due, and were still outstanding as of the time of termination. The Bank calculated the amount of termination damages to be paid and notified the Debtors of such amount. Thus, the parties' only remaining rights and obligations at the time of the Bank's alleged assignment were Bank's right to collect (and Debtors' obligation to pay) the specified termination damages amount. Therefore, at the time of the Bank's alleged assignment, the only right that the Bank could assign was its right to collect termination damages from Debtors (which was secured by the Trust Deeds). Moreover, as the Bankruptcy Court recognized, because it is undisputed that Debtors did not consent to the Bank's alleged assignment to A62, the Agreement prevented the Bank from transferring anything other than "all or any part of its interest in" termination damages owed to it by Debtors. Thus, the Bankruptcy Court correctly found that the Bank assigned to A62 only the right to payment and not an interest in a swap agreement. However, that is not the end of the inquiry.
A62 argues that as the Bank's assignee, it stands in the Bank's shoes; thus if the Bank was a swap participant for purposes of § 560 then so is A62. Under basic principles of contract law, A62 is correct that an assignee stands in the shoes of the assignor. See In re Enron Corp., 379 B.R. 425, 435 (S.D.N.Y.2007). However, this doesn't answer the question of how to characterize the right assigned. In other words, this finding does not address whether, as part of its assignment of the right to payment, then Bank also assigned its right to avail itself of § 560's exemption from the automatic stay (assuming that the Bank had such a right). If the Bank's interest in the termination damages also included the right to collect on the debt by foreclosure sale, irrespective of the automatic
When a statute is plan and unambiguous face, Courts ordinarily do not look to the legislative history. Tennessee Valley Auth. v. Hill, 437 U.S. 153, 185, 98 S.Ct. 2279, 57 L.Ed.2d 117 (1978). Nothing in the language of § 560 or of § 362(b)(17) addresses whether one may become a "swap participant" entitled to invoke the swap agreement exemption by virtue of an assignment. The Oxford English Dictionary defines a "participant" as, inter alia, "[a] person who participates in something; a person who experiences something in common with others; a partaker, a sharer; a participator." Oxford English Dictionary (3d ed. 2005), available at http:// www.oed.com/view/Entry/138242? redirectedFrom=participant#eid. Thus, relying on common vernacular, a "swap participant" might mean either one who participates in a swap agreement by signing it or one who partakes in the agreement by exercising rights conferred thereunder.
Where the language of a statute is unclear, the Court may look to the statute's legislative history for guidance. Heppner v. Alyeska Pipeline Serv. Co., 665 F.2d 868,
Id. at 3. Section 560 was intended "to permit either the non-debtor swap participant or the trustee to terminate a swap agreement, so that a swap agreement may continue after the bankruptcy petition is filed only by mutual consent of both the non-debtor swap participant and the trustee." Id. at 6.
This legislative history "reflects a concern for the stability of the often-volatile swap market. Consequently, Congress emphasized that the Safe Harbor Provisions permit immediate termination of swap transactions in order to minimize the non-bankrupt counterparty's exposure to such unpredictability." In re Lehman Bros. Holdings Inc., 445 B.R. 130, 135 (S.D.N.Y.2011) (Swedbank). The legislative history also indicates that the intent of § 560 was to allow swap participants to terminate swap agreement transactions; it does not extend to the "general commercial obligations of parties to swap agreements."
The foregoing illustrates that Congress passed the swap agreement safe harbor in order to safeguard against two particular kinds of risk — (1) the risk that the non-bankrupt would face from volatility in the swap market if it could not readily terminate the swap agreement, and (2) the risk that the non-bankrupt would be prejudiced by the debtor cherry-picking only the self-serving portions of the agreement and avoiding the rest. Sections 362(b) (17) and 560 serve this purpose by ensuring that the filing of a bankruptcy will not prevent a swap participant from immediately terminating, accelerating, and liquidating a swap agreement. Thus, these sections eliminate the risk that a swap participant will remain locked into an unfavorable swap agreement while interest rates move in the debtor's favor.
However different considerations are raised where the non-defaulting party to a swap agreement exercises its right to terminate and liquidate the agreement, determines the amount of termination damages due, and then assigns its interest in the termination damages to a third party. Once the swap agreement is terminated and the amount of termination damages is calculated, there is no longer a risk of ongoing and mounting harm from interest rate changes. Instead, the primary risk posed by an interest in termination damages is the risk of default — which is then a sum certain. Thus, when an assignee agrees to the post-termination assignment of a non-defaulting party's interest in a specified termination damages sum, the assignee can determine ex ante the magnitude
In essence, allowing an assignee to qualify as a swap participant for purposes of § 560 under the circumstances of this case would serve the purpose of protecting the assignee from the risk of counterparty default rather than from the risk of volatility. Moreover, any risk that the assignor faced from its interest in the swap agreement is terminated upon assignment. Thus, the Congressional intent animating § 560 would not be served by allowing an assignee such as A62, under the circumstances of this case, to qualify as a "swap participant."
Additionally, the Court notes that A62's proposed rule entitling it to invoke § 560 as a "swap participant" by virtue of the Bank's assignment would create a substantial risk of arbitrage. In essence, any entity would be able to accumulate "super-priority" debt by speculatively obtaining assignments of interests in swap agreement termination damages. Cf. Swedbank, 445 B.R. at 137 ("Finally, if we were to accept Swedbank's argument, we would be obliged to conclude that a swap participant is entitled to a super-priority status that extends to all of its commercial transactions with the debtor. Congress neither wrote a statute that created this de facto super-priority status nor did Congress intend to do so"). The facilitation and encouragement of such a market would not serve Congress's interest in protecting the innovate use of swap agreements to hedge against interest rate risk.
Assuming arguendo that the Bank would be able to foreclose on the subject properties notwithstanding the automatic stay if it hadn't assigned its interest, this rule would admittedly treat an assignor and assignee differently. It thus risks creating a somewhat inconsistent regime. Nevertheless, when consistency would be foolish this interest must yield to more pressing concerns. Here, the protections afforded to the bankrupt by the automatic stay are crucial; the swap agreement exemption is a carve-out from this protection. The exemption meant to serve a competing interest which Congress apparently found overriding in this circumstance. As other courts have recognized, exceptions to the automatic stay should be construed narrowly. Thus, in a case such as this, it is more important to ensure that the automatic stay remains strong and the exception thereto remains canalized than to ensure that the law yields perfectly symmetrical results.
For the aforementioned reasons, the Court AFFIRMS the Bankruptcy Court's July 24 Order holding that A62's claims are not excepted from the automatic stay.
