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IN RE ENRON CORP.

United States District Court, S.D. New York


December 31, 2003.

In re: ENRON CORP., et al., Debtor, AMERICAN HOME ASSURANCE CO. and FEDERAL INSURANCE CO., Plaintiff's-Appellants, against ENRON NATURAL GAS MARKETING CORP. and ENRON CORP., Defendants-Appellees, and J.P. MORGAN CHASE — CO. and AMERICAN PUBLIC ENERGY AGENCY, Defendants

The opinion of the court was delivered by: SHIRA SCHEINDLIN, District Judge

OPINION AND ORDER

American Home Assurance Co. ("American Home") and Federal Insurance Co. ("Federal") (collectively, the "Sureties") appeal from the order of the Bankruptcy Court (Gonzalez, J.) denying summary judgment for the Sureties and dismissing the Complaint.*fn1 At issue is approximately $33.5 million in excess margin collateral monies ("Excess Collateral") to which the Sureties allege they are entitled. The Bankruptcy Court concluded that the Sureties were not entitled to the Excess Collateral under either the terms of their agreement or subrogation principles. The Sureties bring this appeal pursuant to 28 U.S.C. § 158, which grants the district courts jurisdiction to hear appeals from final judgments or orders of bankruptcy judges. For the reasons set forth below, the Bankruptcy Court's order is affirmed.

 I. BACKGROUND

  A. The Agreements

  1. Gas Purchase Agreement

  On April 8, 1999, Enron Natural Gas Marketing Corp. ("ENGMC") entered into a twelve-year Gas Purchase Agreement ("GPA") with American Public Energy Agency ("APEA"), a Nebraska political subdivision.*fn2 Under the agreement, APEA pre-paid the full price for the twelve-year natural gas supply — approximately $287 million.*fn3 This payment was funded through the issuance of public municipal bonds. In the event of ENGMC's default, the GPA provided for two types of damages. First, ENGMC would be obligated to pay an early termination payment ("Termination Payment")*fn4 to compensate APEA for the balance of the natural gas owed to it under the GPA.*fn5 Second, the disadvantaged party would be entitled to the payment of "Market Exposure Damages."*fn6 As discussed in some detail below,*fn7 to secure payment of the Termination Payment, ENGMC was required under the GPA to purchase a surety bond. Moreover, to secure payment of the Market Exposure Damages, ENGMC was required to enter into a Margin Agreement with APEA,

  The GPA contained several provisions relating to the rights of the parties in the event of a default. First, pursuant to article 4.4 of the GPA, the parties preserved "all rights, set-offs, counterclaims and other remedies and defenses consistent with Section 8.3*fn8 . . . arising from or out of [the GPA]; provided, however, that amounts due as the Termination Payment or as Market Exposure Damages shall not be subject to rights of setoff."*fn9 Second, pursuant to article 3.6 of the GPA, the parties agreed that the Termination Payment was to be payable "from the proceeds of the Surety Bond; provided, however, that proceeds of the Surety Bond shall not be applied to the payment of any amounts due as Market Exposure Damages."*fn10 Similarly, "[t]he obligation of [ENGMC] to pay Market Exposure Damages shall be secured by the Margin Agreement. Amounts payable pursuant to the Margin Agreement shall be applied solely to payment of Market Exposure Damages."*fn11 "The Termination Payment shall be payable on the Early Termination Date, and shall be payable solely from the proceeds of the Surety Bond."*fn12

  2. Surety Bond

  ENGMC was required to provide APEA with a "Surety Bond," which is described in the GPA as the bond "posted by [ENGMC] to support performance of its obligations to make Termination Payments under [the GPA]."*fn13

  Accordingly, ENGMC, American Home, and Federal provided APEA with a surety bond dated April 15, 1999.*fn14 The Surety Bond states that payment by each surety constitutes "satisfaction in full of all of its obligations. . . . Such payment shall be the exclusive remedy of [APEA] under this Bond. Upon payment by a Surety, [APEA] shall assign its rights to payment against [ENGMC] under the [GPA] to such Surety."*fn15 As noted earlier, section 3.6 of the GPA specifically states that the Termination Payment shall be payable from the Surety Bond, provided that the proceeds from such bond are not applied to the payment of Market Exposure Damages.*fn16

  On April 5, 1999, in connection with the Surety Bond, ENGMC and Enron Corp. executed indemnity agreements with the Sureties.*fn17 Under these agreements, ENGMC had agreed to indemnify the Sureties for any payments they might make under the Surety Bond.*fn18 While the indemnity agreements provided for ENGMC to post collateral to cover the Surety Bond,*fn19 ENGMC never provided such collateral. Under the indemnity agreements, ENGMC and Enron Corp. had waived "all right to claim any property, including homestead as exempt from levy, execution, sale or other legal process under the law of any state, province or other government as against the right of the surety to proceed against the same for indemnity."*fn20

  3. Margin Agreement

  Pursuant to the GPA, ENGMC and APEA entered into the Margin Agreement on April 8, 1999.*fn21 The Margin Agreement states that "[a]s security for the payment of the Market Exposure Damages due or that may become due from [ENGMC] to [APEA], [ENGMC] hereby grants to [APEA] a security interest in all Margin from time to time delivered to [APEA] pursuant to this Agreement."*fn22 The Margin Agreement provided that if ENGMC failed to pay Market Exposure Damages, APEA or its designee could liquidate any non-cash margin.*fn23 Importantly, the Margin Agreement stated that if, during the pendency of the agreement, the fair market value of the margin exceeded the value of the margin required to be maintained under the agreement, ENGMC could request the return and/or release of the margin upon written request.*fn24

  APEA contemporaneously executed a Swap Agreement; with The Chase Manhattan Bank ("Chase"), assigning to Chase its (APEA's) rights under the Margin Agreement (i.e. APEA's right to recover Market Exposure Damages),*fn25 Damages under the Swap Agreement were triggered by the occurrence of a "Triggering Event," as defined by section 4.2 of the GPA.

  APEA also executed the April 7, 1999 Gas Supply Bond Resolution ("Bond Resolution") authorizing the sale of public bonds.*fn26 Under the Bond Resolution, the Bond Trustee was required to set up a margin account to hold the margin deposited by ENGMC pursuant to the Margin Agreement and a collateral account to hold deposits by Chase to fund APEA's obligation to pay Market Exposure Damages.*fn27 The Bond Resolution specifically provides in a term entitled "Margin Fund — Margin Account," that "[u]pon termination of the Swap Agreement and the payment [to Chase] of all early termination payments due from APEA, all amounts in the Margin Account, including any remaining Margin, shall be transferred to the Gas Supplier [ENGMC]."*fn28

  B. Events Leading to Bankruptcy Proceedings

  In November 2001, Enron's debt rating was downgraded, prompting the Sureties to request that ENGMC and Enron provide collateral to secure the Sureties' right to indemnification.*fn29 No collateral was provided.*fn30 On December 2, 2001, Enron Corp. and ENGMC filed for bankruptcy protection and ENGMC subsequently defaulted on its obligations under the GPA. Shortly thereafter, APEA notified ENGMC that the GPA would terminate on January 16, 2002.*fn31 The Sureties made another unsuccessful request that ENGMC provide collateral.*fn32

  The termination of the GPA precipitated two events. First, Chase declared a default under the SWAP Agreement. At the time, there was approximately $111 million in the margin account to which Chase applied approximately $77.5 million against its Market Exposure Damages.*fn33 The remainder, the so-called "Excess Collateral," totals approximately $33.5 million. Second, on January 16, 2002, the Sureties paid APEA the $251 million Termination Payment pursuant to their obligations under the Surety Bond.*fn34 Consequently, APEA executed a Release and Assignment, assigning to the Sureties "[APEA's] rights to payment against ENGMC under the Surety Bond and the GPA."*fn35.

  C. The Proceedings Below

  On March 15, 2002, the Sureties filed an adversary proceeding seeking a "declaration as to their rights to [the Excess Collateral] and turnover of such funds to the Sureties."*fn36 The Sureties then moved for summary judgment pursuant to Federal Rule of Bankruptcy Procedure 7056,*fn37 and the Bankruptcy Court heard oral argument on the motion on October 17, 2002.*fn38 The Bankruptcy Court denied the motion for summary judgment and granted debtor's request seeking dismissal of the Complaint. Summary judgment was denied on several grounds.

  First, Judge Gonzalez found that "for the Sureties to be entitled to receive the Excess Collateral if they subrogate to ENGMC's rights, the fund in issue had to be amounts payable or `owing' under the contract, or an amount that came into existence as a result of being owing or payable pursuant to the contract."*fn39

  Second, because APEA had no "right to look to the amounts payable from the Margin Agreement to fund the Termination Payment . . . the Sureties cannot acquire a greater right by subrogation to APEA's interest."*fn40 The "plain language of the GPA provides that the Termination Payment was to be paid solely from the proceeds of the Surety Bond, GPA, art. 4.1(b), and proceeds of the Surety Bond were not to be applied to the payment of any amounts due as Market Exposure Damages."*fn41

  Third, the Sureties had no right to recoupment of the Excess Collateral, i.e., the Sureties were not entitled to setoff as to the funds held pursuant to the Margin Agreement. Specifically, while section 553 of the Bankruptcy Code allows setoff of mutual debts that arose prior to the commencement of the case, "APEA expressly waived its right to assert setoff."*fn42

  The Sureties filed a timely Notice of Appeal of the Bankruptcy Court's memorandum decision and order.

 II. DISCUSSION

  A. Standard of Review

  A bankruptcy court's conclusions of law are reviewed de novo and its findings of fact for clear error.*fn43 Because the parties agree that there are no factual issues in dispute,*fn44 de novo review is required.

  B. Issues on Appeal The Sureties argue that the Bankruptcy Court erred in denying the Sureties' motion for summary judgment and dismissing the petition at Enron's request because it "ignored well established principles of law, such as equitable subrogation, when it held that the Sureties were not entitled to the Excess Collateral"*fn45 and Mid not have an equitable lien in and to the Margin, which included the Excess Collateral";*fn46 and "failed to acknowledge that the express terms of the contracts gave APEA (and therefore the Sureties) a right to retain the Excess Collateral and exercise whatever common law remedies were available to it at the time the transaction unwound."*fn47 The Sureties also argue that the Bankruptcy Court erred when it "failed to permit the Sureties . . . to setoff and/or recoup their losses from the Excess Collateral."*fn48 1. Sureties' Subrogation Rights to Excess Collateral

  The Sureties allege that they are entitled to the Excess Collateral because they are subrogated to the rights of both ENGMC and APEA. Accordingly, they claim an equitable lien on any remaining contract funds.*fn49 They further claim that such a lien is superior to ENGMC's rights to the Excess Collateral.

  "The New York courts have long recognized and enforced the doctrine of subrogation."*fn50 "Subrogation" means "[t]he substitution of one person in the place of another [as] to a lawful claim, demand or right, so that he who is substituted succeeds to the rights of the other [as] to the debt or claim, and its rights, remedies, or securities."*fn51 "The right of subrogation . . . is founded upon the facts and circumstances of a particular case and upon principles of natural justice . . ."*fn52 It is a "`creature of equity, and `is enforced solely for the purpose of accomplishing the ends of substantial justice.'"*fn53

  "In the suretyship context, subrogation provides a secondary obligor [surety] who performs the secondary obligation with the obligee's rights with respect to the underlying obligation as though that obligation had not been satisfied."*fn54 Where the principal obligor is bankrupt, the Supreme Court has explained that "if the surety at the time of adjudication was . . . either the outright legal or equitable owner of [the] fund, or had an equitable lien or prior right to it, this property interest . . . never became a part of the bankruptcy estate to be . . . distributed to general creditors of the bankrupt."*fn55 a. Sureties' Right to Subrogation as to APEA

  The Sureties argue that they are entitled to the Excess Collateral through subrogation to the rights of APEA. I have reviewed the decision of the Bankruptcy Court on this issue and adopt it in full. The Bankruptcy Court correctly held that:

If APEA did not have the right to look to the Excess Collateral as a source for the Termination Payment, then the Sureties would not acquire such a right by subrogation.
The plain language of the GPA provides that the Termination Payment was to be paid solely from the proceeds of the Surety Bond, GPA, art. 4.1(b), and proceeds of the Surety Bond were not to be applied to the payment of any amounts due as Market Exposure Damages. GPA, art. 3.6. Further, the GPA provided that obligations to pay Market Exposure Damages were to be secured by the Margin Agreement and amounts payable from the Margin Agreement were to be applied solely to the payment of Market Exposure Damages. GPA, art. 3.6. Thus, these two separate sources were plainly intended to fund the separate payment obligations.
While the Margin Agreement provided APEA with a security interest in the Margin Account, it was only as "security for the payment of the Market Exposure Damages." See Margin Agreement ¶ 7, p. 7. Thus, these unambiguous contract provisions establish the rights of the parties concerning the Termination Payment and Market Exposure Damages. APEA did not have a right to look to the amounts payable from the Margin Agreement to fund the Termination Payment and the Sureties cannot acquire a greater right by subrogation to APEA's interest.
The Sureties argue that the Margin Agreement allowed for the possibility that APEA could acquire some greater interest by exercise of its rights pursuant to section 8 of the Margin Agreement*fn56.
The Sureties, however, are not entitled to setoff with respect to the Margin Account. Section 553 of the Bankruptcy Code permits the setoff of mutual debts that arose before the commencement of the case. In re Bennett Funding Group, Inc., 146 F.3d 136, 138-39 (2d Cir. 1998). The section preserves whatever rights of setoff a party has under applicable non-bankruptcy law. Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 18 (1995). A setoff concerns a defendant reducing a plaintiff's claim against it by its claim against the plaintiff which arises out of a different transaction than the one upon which the plaintiff [bases] its claim. . . .
APEA expressly waived its right to assert setoff in this instance. Pursuant to section 8.3 of the GPA, where express remedies and measures of damages for breach of any provision were provided, the obligor's liability was limited to those remedies and damages. As previously discussed, Art. 3.6 and Art. 4.1(b) of the GPA set forth express remedies and measures of damages concerning the Termination Payment and the Margin Account. The remedies and damages set forth were the sole and exclusive ones available and all other remedies and damages at law or in equity were waived. GPA, art. 8.3. . . . Inasmuch as section 8.3 of the GPA set forth that the availability of specific remedies and measures of damages for breach of a contract provision operated as a waiver of other remedies or damages at law or in equity, the right to seek setoff for payment of the Termination or Market Exposure Damages was `expressly . . . waived' in the GPA. As such, the right to seek setoff concerning the Termination Payment or Market Exposure Damages was excluded from those setoff rights that were reserved and was expressly waived pursuant to the GPA.*fn57
For the foregoing reasons, the Sureties have no right to the Excess Collateral through subrogation to APEA's rights.

  b. Sureties' Right to Subrogation as to ENGMC

  The Sureties argue that their subrogation rights entitle them to "step into the shoes" of ENGMC and exercise all of ENGMC's rights pursuant to all agreements executed in connection with the GPA. Specifically, the Sureties contend that through subrogation, they have a right to the Excess Collateral that is superior to that of ENGMC's general unsecured creditors.*fn58

  This argument lacks merit. First, as the Bankruptcy Court notes, "the Excess Collateral was not owed to ENGMC under the Margin Agreement but, rather, was owned by ENGMC."*fn59 That is, the Excess Collateral was ENGMC's property — ENGMC placed funds into the margin account in excess of its obligations under the Margin Agreement.*fn60 The Excess Collateral is thus not an amount payable or owing to ENGMC pursuant to the Margin Agreement.*fn61 In that respect, it is no different from cash deposited into ENGMC's general bank accounts, to which the Sureties would have no priority relative to ENGMC's general unsecured creditors.*fn62

  Second, even if the Excess Collateral was not "owned" by ENGMC but was "owing" to ENGMC pursuant to the Margin Agreement, the Excess Collateral is not "owing" under the Surety Bond, as it relates to the GPA. As noted by the Second Circuit, "where the duty of the principal [ENGMC] to the creditor [APEA] is fully satisfied, the suret[ies] [American Home and Federal] to the extent that [they have] contributed to this satisfaction[,] [are] subrogated . . . to the interests which the creditor has in security for the principal's performance and in which the creditor has no continuing interest."*fn63 Assuming that the Sureties are entitled to subrogate to the rights of ENGMC,*fn64 the Sureties' rights are limited to those rights arising out of the Surety Bond.*fn65 The Sureties had only one obligation under the GPA — to make the Termination Payment to APEA upon ENGMC's default. Accordingly, if a dispute had arisen between APEA and ENGMC over the magnitude of the Termination Payment, the Sureties would step into the shoes of ENGMC with respect to the disputed payment.*fn66 But, as the Sureties had no obligation to make payments to cover the Market Exposure Damages, they have no rights to step into ENGMC's shoes to recover the Excess Collateral in the margin account. The Sureties point out that the Surety Bond provides that ENGMC and the Sureties "are held and firmly bound unto [APEA] in the maximum penal sum of [$300 Million]."*fn67 This, the Sureties argue, demonstrates that the constellation of agreements relating to the GPA should be viewed as an integrated transaction,*fn68 rather than discrete contracts. Under such an interpretation, the Excess Collateral could be considered amounts payable under the "integrated gas purchase transaction" to ENGMC and, therefore, owed to the Sureties through subrogation. But, under the express terms of the GPA, the Termination Payment was payable "solely from the proceeds of the Surety Bond."*fn69 Accordingly, the parties clearly intended that the proceeds of the Surety Bond would only cover the Termination Payment owed to APEA under the GPA. Thus, the Sureties' argument that "the Excess Collateral and Sureties' payment on the Surety Bond [are] integrally related and inseparable"*fn70 fails, as it is inherently inconsistent with the plain meaning of the GPA. For the reasons set forth above, the Bankruptcy Court properly determined that the Sureties are not entitled to the Excess Collateral through subrogation to the rights of ENGMC. The Bankruptcy Court also properly concluded that the Sureties' claim against ENGMC as to the Excess Collateral is an unsecured creditor's claim.

  2. Sureties' Rights to Setoff and Recoupment

  The Bankruptcy Court's determination that the Sureties have no rights to setoff*fn71 or recoupment*fn72 is also affirmed for the reasons articulated in the Bankruptcy Court's memorandum decision and order.*fn73

 III. CONCLUSION

  For the foregoing reasons, the decision of the Bankruptcy Court denying the Sureties' motion for summary judgment and dismissing the complaint is affirmed in its entirety. The Clerk of the Court is directed to close this case.

  SO ORDERED.


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