Derivatives in Bankruptcy

The Bankruptcy Code provides for special and favored treatment to securities, forward and commodities contracts, swaps, and repurchase agreements. This special treatment includes the ability of the non-debtor counter-party to exercise rights free of the automatic stay, the enforceability of ipso facto clauses and protection from avoidance actions, including fraudulent transfers and preferences, except for actual fraud. In light of the explosive growth in the volume of the various derivative contracts, it is imperative for bankruptcy lawyers, whether they represent the debtor or its creditors, as well as for financial engineers, who develop cutting edge financial instruments, to be fully familiar with the benefits that the Bankruptcy Code provides as well as with the pitfalls associated with the application and interpretation of the relevant Code provisions. This is even more so in light of the significant expansion of the protections enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which will become effective for bankruptcy cases filed on or after April 17, 2005. This article analyzes the building blocks required for each derivative contract to qualify for the special treatment provided for in the Bankruptcy Code, and presents a comprehensive analysis as to the various issues that arise as to their interpretation and application.