On May 7, 2014, the US Bankruptcy Court for the Northern District of Illinois (Court), in Secure Leverage Group, Inc. v. Bodenstein (In re Peregrine Financial Group, Inc.), held that retail spot and forward foreign currency and metals transactions do not fall within the definition of "commodity contract" under section 761(4) of the Bankruptcy Code (No. 12 B 27488, (Bankr. N.D.Ill. May 7, 2014)). As a result, plaintiffs were not entitled to partake in distributions of customer funds from Peregrine's bankruptcy estate. The ruling also has implications for the scope of the Bankruptcy Code's safe harbors for commodities contracts.

Peregrine Financial Group, Inc. was a registered futures commission merchant (FCM) and foreign exchange (forex) dealer member of the National Futures Association (NFA). Plaintiffs were customers of Peregrine who opened accounts with it to trade retail foreign currency (retail forex) and over-the-counter spot metals (OTC metals) contracts. Each plaintiff executed a standard Peregrine customer agreement covering various types of trading activities. Peregrine maintained an online trading system that allowed customers to place trade orders electronically. In July 2012, upon disclosure of theft of customer funds, Peregrine filed for bankruptcy under Chapter 7 of the Bankruptcy Code.

In September 2012, the bankruptcy trustee filed a motion with the bankruptcy court seeking authority to make interim distributions of "customer property" to certain customers of Peregrine under section 766(h) of the Bankruptcy Code. Customer property is defined under section 761(10)(A)(i) of the Bankruptcy Code to include "property received, acquired or held to margin, guarantee, secure, purchase, or sell a commodity contract." The trustee excluded from the interim distribution Peregrine's retail forex and OTC metals customers. Plaintiffs objected, arguing that their OTC forex and metals contracts were commodities contracts, and therefore margin collateral that they had posted in connection with these transactions constituted customer funds, entitling them to participate in the customer funds distribution. The Court overruled the objections and granted the trustee's motion. Plaintiffs then filed an adversary proceeding in Peregrine's bankruptcy case against the trustee seeking to be included in the customer funds distribution.

Plaintiffs argued that retail forex and metals transactions fall within the definition of "commodity contracts" under section 761(4) of the Bankruptcy Code because:

The trustee filed for summary judgment on the issue, maintaining that plaintiffs' transactions did not fall within the Bankruptcy Code's definition of "commodity contract." The Court cited In re Zelener (see 373 F.3d 861 (7th Cir. 2004)), in which the US Court of Appeals for the Seventh Circuit held that retail forex transactions are not futures and set out a distinction between a futures contract and a forward or spot contract.

The Court upheld the trustee's claim that retail forex transactions are not futures, nor are they "similar to" futures. Further, plaintiffs admitted that their OTC metals transactions are spot contracts, not futures. Finding no genuine issue of material fact, the Court granted summary judgment to the trustee.

Plaintiffs argued that their retail forex transactions were "similar to" futures using a common-denominator analysis. The common factor found in all of the transactions listed in section 761(4) of the Bankruptcy Code is that they are all regulated in some way by the CFTC. Since retail forex is regulated by the CFTC, plaintiffs argued that retail forex should be covered by the Similarity Clause of Code section 761(4)(F)(i). However, the Court found no statutory language, legislative history or any other support for this common-denominator approach, which would result in an extremely broad interpretation of the Code's "commodity contract" definition. The Court noted that if Congress had intended for the Similarity Clause to include all transactions regulated by the CFTC, it would not have carefully crafted the specific definition in section 761(4), which includes certain transactions and by implication excludes others.

The Court found that plaintiffs' retail forex transactions were similar to the transactions in the Zelener case, supporting the trustee's argument that retail forex transactions are spot transactions and not futures. Plaintiffs claimed that Zelener was overturned and did not apply, but the Court found that Zelener is still the controlling case regarding the distinction between futures contracts and spot and forward contracts - specifically, the conclusion that retail forex transactions are not futures.

FCM customers who are dealing in retail forex (and OTC spot metals) transactions should keep in mind that margin they post in connection with these transactions is not considered to be customer property under section 766(h) of the Bankruptcy Code (11 U.S.C. § 766(h)), which provides guidance to bankruptcy trustees regarding distributions of customer property.

Further, because the definition of "commodity contract" under section 761(4) of the Bankruptcy Code is picked up under other important sections of the Bankruptcy Code, the ruling clarifies that OTC spot or forward foreign exchange purchases and OTC spot or forward metals purchases are not protected by the safe harbors for commodity contracts found in the following sections of the Bankruptcy Code:

For details, see Guide to Bankruptcy Code Safe Harbors for Financial Contracts: Checklist.