Article

Note: ConocoPhillips Co. (Customer) was a customer of MF Global, Inc. (Broker), a commodities broker that became insolvent. Customer was one of only nine of Broker's customers that Broker allowed to post standby LCs in lieu of other collateral to support commodities transactions. Throughout their relationship, Customer obtained six LCs for Broker, all of which had expired before being drawn on. All the standbys required a default on the part of Customer before they could be drawn on, and both parties agree that Customer had never defaulted in its business dealings. When James Giddens (Trustee) was appointed to manage Broker's liquidation, he counted the full value of the six LCs as Customer's property in responding to Customer's claims for cash deposited with Broker. Trustee determined that the value of these LCs offset the cash.

Customer filed an objection to Trustee's calculation of Customer's claim in Broker's bankruptcy proceeding. Trustee moved for an order from the Bankruptcy Court confirming Trustee's calculation. Customer then moved for mandatory withdrawal of its objection from consideration by the Bankruptcy Court pursuant to 28 USC §157(d) on the basis that ruling on Trustee's motion would involve consideration of federal laws other than the Bankruptcy Code. The United States District Court for the Southern District of New York, Forrest, J., granted Customer's motion to withdraw consideration of Trustee's motion from the Bankruptcy Court

The Judge noted that three issues required substantial and material consideration of federal nonbankruptcy law. First, there was a question of whether LCs should be considered at face value when calculating customer property during a bankruptcy proceeding. The District Court ruled that this issue involved federal non-bankruptcy law because analysis of the issue involves the differing treatment of LCs in and out of liquidation. Understanding these differing treatments involves interpretation of the Commodities Futures Trading Commission's (CFTC) Regulation 190.08(a)(1)(i)(E) (the Regulation), which is a federal non-bankruptcy law.

Second, there was a question of whether Trustee's use of the Regulation generated proceeds from the undrawn LCs. If so, then the Regulation may have regulated LCs by controlling their treatment. The Commodity Exchange Act prohibits the CFTC from regulating bank products so any interpretation of Trustee's use of the Regulation would necessarily involve federal non-bankruptcy law.

Third, there was a question of whether the Regulation preempted state banking and contract laws. Any attempts by Trustee to draw on the LCs during liquidation will necessarily invoke state action for fraud because the LCs have expired and there was never any default allowing Broker to draw on the LCs. Trustee argued that the Regulation allows for such draw down during liquidation but admits state law is unclear on the issue. Therefore, even were the Regulation to be accepted as controlling, the bankruptcy court would still have to examine federal preemption laws which are non-bankruptcy.

Since Trustee's motion involved three issues requiring substantial and material consideration of federal non-bankruptcy law, the Judge concluded that the bankruptcy court was obliged to withdraw consideration of Trustee's motion.

[JEB/ael]

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