Enron: a Report from the Front

ENRON: A REPORT FROM THE FRONT

David M. Bennett

Thompson & Knight LLP

1700 Pacific Street, Suite 3300

Dallas, Texas 75201

Fax: 214-969-1751

Telephone: 214-969-1700

Independent Petroleum Association of America (IPAA)

Law Committee Meeting

March 21, 2002

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555555 008268 DALLAS 1412676.1

TABLE OF CONTENTS

I. INTRODUCTION. N-1

II. THE VENUE FIGHT - WHY THE ENRON CASE IS NOT IN HOUSTON. N-1

A. An inability to file an involuntary. N-1

B. An inability to obtain an expedited hearing on the motion to transfer. N-1

C. The legal standard applicable to venue issues. N-2

D. The Venue Facts in the Enron Case. N-3

E. Applying the Venue Facts to the Enron Case. N-3

F. The bank debt and bondholder debt, and the Debtors' choice of forum. N-5

G. The court's 30 days of involvement with the case at the time of the hearing. N-5

III. THE CASH MANAGEMENT SYSTEM FIGHT B WHY AND HOW ENRON

NORTH AMERICA'S CASH IS FUNDING THE ENRON BANKRUPTCY CASE. N-5

A. The problem: Enron North America's cash is being used to fund Enron's

chapter 11 proceeding. N-6

1. Facts Adduced at the Cash Management Hearing. N-7

2. The ENA Creditors Argument in Favor of a Firewall Around ENA Cash N-9

a. Whether the Postpetition Sweep of ENA Cash Violates the Code N-9

b. Debtors' actions are prohibited by Section 345(b). N-9

c. The Debtors' loans are outside the ordinary course of its business. N-9

d. The Court's Cash Management Order did not authorize the loans at issue here. N-10

e. The Cash Committee is insufficient to protect ENA. N-11

f. The Debtors' current cash management system is riddled with conflicts

of interest. N-11

g. Debtors Use Of ENA's Assets To Fund The Operations Of Other

Enron Entities B Debtors And Nondebtors B Without Adequate

Protection Should Not Be Permitted. N-12

B. The continuing problem. N-13

C. The attempted solutions. N-14

1. The preferred solution: A "firewall" around Enron North America's cash. N-14

2. A separate Enron North America Creditors Committee. N-15

3. A trustee for Enron North America. N-16

D. The Bankruptcy Court=s Choice of Solution. N-16

IV. ISSUES UNIQUE TO THE WORLD'S LARGEST ENERGY TRADING COMPANY:

HEDGES, COLLARS, SWAPS, AND FINANCIAL CONTRACTS. N-17

A. Termination of Commodity and Forward Contracts Under 11 U.S.C. ' 556 N-17

1. Definitions N-17

2. Enumerated Commodities of the Commodity Exchange Act N-17

B. Interpretation N-18

1. Who is Protected? N-18

2. The protections afforded by section 556 apply to more than liquidation. N-19

C. Case Law N-19

D. Similar Provisions / Other Protections N-20

1. Section 362 (b) (6) provides an exemption from the automatic stay for

setoffs of margin payments or settlement payments. N-20

2. Section 546 (e) prohibits any preference action by the trustee related to

a margin payment or settlement payments. N-20

3. Section 560 allows a swap agreement participant to terminate, net out,

or setoff the contract without lifting the stay or fear of an avoidance. N-20

E. Analysis of the rights of a forward contract merchant under contract and

bankruptcy law. N-20

F. Whether there is one contract or multiple contracts? N-21

G. What "should" the swap counterparty do? N-21

H. Conclusion N-22

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ENRON: A REPORT FROM THE FRONT[1]

I. INTRODUCTION.

The fall of Enron Corporation and its resulting chapter 11 proceeding has affected thousands, if not millions, of Americans. Corporate finance may take decades to recover and, in some ways, may never be the same again. For the insolvency specialist, the Enron case presents special issues for consideration, some unique to Enron and some merely unusual for the size of the case. As chapter 11 cases go, Enron is still in its infancy. The end is not only not in sight, it is not even clear that the beginning has gotten a good start. Nonetheless, it is never too early to take stock of what has happened, what lessons have been learned, and what the future may hold in store. In this paper, we will address some, though certainly not all, of the issues that Enron has brought to the forefront of bankruptcy practice.

II. THE VENUE FIGHT - WHY THE ENRON CASE IS NOT IN HOUSTON.

The first and most obvious Enron issue, and the one directly affecting the Houston bankruptcy bar, is the question of venue. Why, with its many demonstrable ties to the Houston community, is the Enron case pending in the Southern District of New York instead of the Southern District of Texas? There is no easy answer to this question and, from the author's perspective, the answer is (at least in part) "not for lack of trying." Much of what follows is taken from the briefing and the argument of the motion to transfer the case from New York to Houston.

A. An inability to file an involuntary.

A substantial part of the reason the Enron case was the inability of certain parties to locate three unsecured creditors of Enron Corp. who were willing to file an involuntary in the weeks leading up to December 2, 2001. Enron Corp., an Oregon corporation, could not justify venue in Delaware or New York. If an involuntary had been filed against Enron Corp. in the Southern District of Texas, it is arguable that the consolidated Enron case could not have been transferred to the Southern District of New York. In the weeks preceding December 2, 2001, at least two creditors of Enron Corp. were willing to file an involuntary but the parties could not find a third. Thus, the absence of a third petitioning creditor as to Enron Corp. was a substantial part of the reason why venue is not in Houston.

B. An inability to obtain an expedited hearing on the motion to transfer.

In the week following the filing on Sunday, December 2, 2001, a substantial number of creditors filed motions to transfer the Enron cases to the Southern District of Texas. Twenty-one debtors whose principal offices and assets are located in Houston, Texas, justified filing their cases in the Southern District of New York on the sole fact that the principal office of one of its minor alleged affiliates B Enron Metal and Commodity Corp. B is located in that district. Debtor Enron Metal and Commodity Corp., ("EMCC") a Delaware corporation, is entirely owned by Enron Trade Holdings, a Delaware Corporation, which is an indirect subsidiary of Enron Corp. Only by stretching the relationship between EMCC and the other debtors nine degrees (of intermediate subsidiaries) were the Debtors able to make any possible connection between the two and justify an "affiliates" filing.

A thoughtful review of the "weight" of venue facts demonstrated that the great weight of the case ought to have compelled transfer to the Southern District of Texas. Among those relationships were the following ties to Houston: (a) a majority of the Debtors' headquarters, (b) the documents and records critical to these cases, (c) the Debtors' auditors and financial advisors, (d) the majority of witnesses, including all senior management, (e) the majority of the Debtors' assets, including the trading floor, (f) the majority of creditors, including a majority of laid off employees, and (g) the majority of the Debtors' remaining employees.

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On December 5, 2001, Thompson & Knight L.L.P., on behalf of a number of movants, filed a Motion to Change Venue to the Southern District of Texas (the "Motion") on the grounds that the doctrine of forum non conveniens and the interest of justice supported such transfer of the Debtors' cases to Houston, Texas. Simultaneously with filing the Motion, the movants filed a motion for expedited consideration of the Motion. The next day, December 6, 2001, the court set the Motion for hearing on January 7, 2002. The same day, December 6, 2001, the clerk of the court called local counsel and asked that the motion for expedited hearing be withdrawn. As the court requested, the local counsel for movants sent a letter to the court withdrawing the motion for expedited consideration. Thereafter, the parties undertook discovery, principally through creating a stipulation dealing with venue facts. The Motion was heard January 7, 2002.

The Debtors are all corporations organized and existing under the laws of either the States of Oregon, Texas or Delaware. None of the Debtors are incorporated in New York. With the exception of Debtor Enron Metal and Commodity Corp., the Debtors' principal place of business for a substantial number of years has been and continues to be in the Southern District of Texas. Only Debtor Enron Metals & Commodity Corp. has an office located in New York. Debtor Metals and Commodity Corp., however, is completely owned by Enron Trade Holdings Inc., a Delaware corporation. It is the location of the offices of Debtor Enron Metals & Commodity Corp. that forms the sole legal basis for the Debtors' choice of forum.

Debtor Enron Corp. is in the business of providing products and services related to natural gas, electricity and communications to wholesale and retail customers. Debtor Enron Corp.'s operations are largely conducted through its subsidiaries and affiliates, the other debtors in the bankruptcy. Together, the Debtors are principally engaged in: (1) the transportation of natural gas through pipelines to markets throughout the United States; (2) the generation, transmission and distribution of electricity to markets in the northwestern United States; (3) the marketing of natural gas, electricity and other commodities and related risk management and finance services; (4) the delivery and management of energy commodities and capabilities to end-use retail customers in the industrial and commercial business sectors; and (5) the development and delivery of bandwidth communication applications.

The Debtors' prepetition relationship to the Southern District of New York was limited to the office of Enron Metals & Commodity Corp. and borrowing from New York financial institutions (and presumably their brief relationship with New York bankruptcy counsel).

The Debtors principal assets are by far located in the Southern District of Texas. In each of the Debtors' voluntary petitions is a disclosure of the location of its assets. Attached to each Debtors' voluntary petition is an Attachment A To Voluntary Petition (the "Attachments"). The Attachments indicate the value of all the Debtors' assets. The Debtors' petitions and Attachments reflect that of the Debtors' $45 billion in assets, only $265 million (about 0.5%) are located in the Southern District of New York. Debtor Enron Metal & Commodity Corp. is the sole debtor with disclosed assets located in New York.

A majority of the Debtors' creditors are located in Texas. The Debtors have prepared a Consolidated List of Creditors, listing all known creditors of the Debtors. Of the creditors listed, 816 are located in Texas, compared to 96 in New York. Additionally, the Debtors' largest unsecured creditor and largest trade creditor are located in the Southern District of Texas.

C. The legal standard applicable to venue issues.

Transfer of the Debtors' cases to the Southern District of Texas is supported by law and equity. Although a debtor may initially pick its forum, a transfer motion under section 1412 of Title 28 of the United States Code requires the balancing of several factors. In re Ocean Properties of Delaware, Inc., 95 B.R. 304, 305 (Bankr. D. Del. 1988). See also In re Ernst Home Center, Inc., Case No. 96-1088 (PJW), transcript at 2, Walsh, J. (Bankr. D. Del. Aug. 28, 1996).

Pursuant to the venue statute, 28 U.S.C. ' 1412, the moving party has the burden of demonstrating that the transfer of venue is supported by a preponderance of the evidence. Gulf States Exploration Co. v. Manville Forest Products Corp. (In re Manville Forest Products Corp.), 896 F.2d 1384, 1390 (2nd Cir. 1990). "Adjudications of motions for transfer are within the discretionary authority of the courts, according to 'an individualized, case by case consideration of convenience and fairness.'" Id. at 1981 (quoting Stewart Org. Inc. v. Ricoh Corp., 487 U.S. 22 (1988)).

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In deciding whether to transfer venue, courts will typically consider the factors in the Commonwealth Oil Refining Case: Commonwealth of Puerto Rico v. Commonwealth Oil Refining Co. (In re Commonwealth Oil Refining Co.), 596 F.2d 1239 (5th ir. 1979), cert. denied, 444 U.S. 1045 (1980):

(a) the proximity of creditors of every kind to the court;

(b) the proximity of the debtor to the court;

(c) the proximity of the witnesses necessary to the administration of the case;

(d) the location of the assets;

(e) the economic administration of the estate; and

(f) the necessity of ancillary administration if liquidation should result.

In re FRG, 107 B.R. at 471 (citing Commonwealth Oil, 596 F.2d at 1247). See also Ocean Properties, 95 B.R. at 304; In re Pope Vineyards, 90 B.R. 252, 255 (Bankr. S.D. Tex. 1988); Ernst Home Center, transcript at 2-3.

Of considerable importance is whether the transfer will promote the interest of justice. "The standards for determining the 'interest of justice' [or] 'convenience for the parties overlap.'" In re FRG, Inc., 107 B.R. 461, 471 (Bankr. S.D.N.Y. 1989). While the two components are separate under the disjunctive term of the statute, "as a practical matter, in most cases . . . if the convenience of the parties and witnesses will be served by transfer, it usually follows that justice will also be served by transfer." In Pinehaven Associates, 132 B.R. 982, 990 (Bankr. E.D.N.Y. 1991).

D. The Venue Facts in the Enron Case.

According to the papers filed by Debtors with their petitions, a large portion of the Debtors' assets are located in the Southern District of Houston. Disclosures attached to the Debtors' petitions reflect that of the Debtors' $45 billion in assets, only $265,622,903 (less than 1%) are located in New York. In fact, the Debtors' petitions reflect that with the exception of those assets held by Enron Metal & Commodity Corp., virtually all of the Debtors' assets are located in Texas. The Debtors' assets include a significant amount of Texas real estate, including a large amount of commercial real estate located in downtown Houston. Morever, one of the Debtors' most prized assets is a 40-story high rise currently being constructed in Houston. To date, the Debtors have paid over $180 million towards construction of this building, with another $40 million expected to be expended to complete the project. When completed in January 2002, the building is expected to be the Debtors' world headquarters. This Houston asset is of such importance that at its first day hearings, the Debtors immediately sought permission to continue paying their contractors.

Most of the witnesses that may be necessary to the administration of the estate are located in Texas. Almost all of the Debtors' employees, including its managers and advisors, and a large number of its creditors are located in Texas. In the event appraisal testimony or other testimony is required with respect to the valuation of the Debtors' assets, these witnesses will most likely come from Texas. At present, there are no known witnesses from New York who might potentially be involved in this case. Nearly all of the potential witnesses that may be in this case will come from the Southern District of Texas, not from New York.