Quick Bankruptcy Guide: Safe Harbor Provisions

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Earlier this year, the Supreme Court supported the tightening of restrictions regarding the safe harbor provision. What does this mean? Who does it affect? Also, why does this matter? Let’s look into this a little deeper to help shed some light on this financial option and how it relates to businesses dealing with bankruptcy and the financial cost for potential debtors if this financial arrangement option is simply disregarded.  

What are Safe Harbor Provisions?

In the context of bankruptcy, safe harbor is a protection concerning conduct that is usually unacceptable, but made acceptable under ambiguous circumstances. Congress has described the provisions as an effort to “minimize the displacement caused in the commodities and securities markets” when the involved industries are affected by a bankruptcy. In other words, although the Bankruptcy Code usually protects a debtor with an “automatic stay”, safe harbor is a derivative instrument that can be put in place to protect against the damage that an insolvency can inflict out onto the economy as a whole. This means that asset values will remain protected even if counterparties go bankrupt.

This type of financial tool has proven to be useful for those in industries that depend on certain commodities that fluctuate often. It has even been included in business strategies for years. With this in place, the non-debtor party is allowed to forego the automatic stay that is a major perk for debtors. This has helped them to maintain stability despite their dependence on unstable resources like fuel, oil, corn, and other things. The safe harbor provision has proven to be particularly useful for those in the energy industries.

Recent Change By The Supreme Court

The latest holding by the Supreme Court has taken this a bit further. In the past, safe harbor could have protected the unscrupulous use of financial institutions, such as when they were only used as a conduit for a transaction that the 546(e) of the Bankruptcy Code didn’t typically protect. The parties that enacted this often turned to “conduit defenses” to legally guard themselves, but it was often a method to escape certain types of transfers that are enacted by an entity (often a financial institution) for a debtor’s, creditor’s, or purchaser’s own benefit. If a comprehensive transfer by a company needed protection, this used to prevent it from coming under the gun because the transfers went through a “financial institution” of some kind. Now, this claim will be much more difficult to uphold.

Who Is Affected By The Safe Harbor Provisions?

This is a matter that typically involves Chapter 11 bankruptcy cases. Businesses that are struggling to stay afloat have turned to these protections to claw their way out of a difficult financial situation, and in many cases, it has been a great help. However, enacting this option is not so easy to do, and only certain non-debtors qualify. In addition, the contracts involved in this situation are required to meet one of the definitions of a “derivative” and meet two preconditions:

  1. The contracts must meet the Bankruptcy Code’s
  • “commodity contract”,
  • “forward contract”,
  • “securities contract”,
  • “swap agreement”,
  • “purchase agreement”,
  • OR “master netting agreement.”
  1. The company must qualify to be a
  • “commodity broker”,
  • “forward contract merchant”,
  • “swap participant”,
  • “financial participant”,
  • “repo participant”,
  • OR “master netting agreement participant.”

With that said, it is important to understand that the common meanings for these terms don’t necessarily apply in this case. For this reason, a company in this position is highly recommended to seek the help of a qualified business bankruptcy lawyer to help with navigation through this rather complex financial situation. The last thing a struggling company wants to do is face strong penalization due to poor understanding of the legal parameters of a financial option that ended up hurting them when it could have helped them. The backlash could even require the company to pay punitive damages.

Additional requirements:

  • Even the entity that the transfer is made for must qualify
  • This particular transaction must have been part of a master agreement that qualifies as a Derivative.

Read more: https://www.hklaw.com/publications/derivatives-and-bankruptcy-safe-harbors-02-18-2009/

Why Is It Important to Understand Safe Harbor Provisions?

If careful attention is not given towards the potential of the provisions, a contract can become less iron-clad, and it’s possible that a company could lose its contracts altogether. A company needs to know if it is going to play the role of debtor or counterparty in a bankruptcy proceeding because each path has different things to consider. A company might need to know if it is “in-the-money” or “out-of-the-money”, or it may need to consider a viable termination process. All of these considerations carry great risk with the safe harbor provisions, but they can be dealt with if there is a solid understanding of where the company stands in this situation and knows what steps they could take to rectify the situation.

Seek Legal Support For Guidance

We have barely touched the tip of the iceberg when it comes to the important safe harbor provisions. You took the time to build your company, and now you must take the time and effort you need to protect it. You may find that you have more financial options than you thought.  Talk to a bankruptcy lawyer in your area to get the most up-to-date and thorough support. It is likely that their help could end up saving you time and money in the long run. By hiring a dedicated attorney to be in your corner, you will have already strengthened your odds for financial success.