In Re Co Petro Marketing Group, Inc., Debtor. Co Petro Marketing Group, Inc., and Irving Sulmeyer, as Trustee of Co Petro Marketing Group, Inc. v. Commodity Futures Trading Commission

Citations: 680 F.2d 566; 7 Collier Bankr. Cas. 2d 128; 1982 U.S. App. LEXIS 17946; 9 Bankr. Ct. Dec. (CRR) 466Docket: 81-5393

Court: Court of Appeals for the Ninth Circuit; June 28, 1982; Federal Appellate Court

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Irving Sulmeyer, as trustee for Co Petro Marketing Group, Inc., appeals a Bankruptcy Appellate Panel decision that reversed a bankruptcy court ruling and directed the dismissal of Co Petro’s Chapter 11 reorganization petition. The appeal addresses key issues under the Bankruptcy Code, including the definition of a commodity broker and the standing of the Commodity Futures Trading Commission (CFTC) to intervene and appeal in Chapter 11 cases. The court partially reversed the panel's decision, reinstating Co Petro's Chapter 11 petition. 

Co Petro filed for reorganization on May 19, 1980, while under a permanent injunction prohibiting it from engaging in commodity futures contracts for petroleum products, following violations of the Commodity Exchange Act. Co Petro's business model involved selling contracts for future delivery of petroleum products, where customers paid deposits with the option to resell the contracts based on market prices. The CFTC argued these transactions constituted illegal commodity futures contract sales, leading to the earlier injunction and related court orders. The court affirmed the injunction and ancillary relief granted to the CFTC, including the appointment of a receiver and the disgorgement of profits.

Co Petro filed for Chapter 11 reorganization after a district court decision, but the Commodity Futures Trading Commission (CFTC) sought to dismiss the petition, which the bankruptcy court denied. The bankruptcy court determined Co Petro was not a commodity broker under the Bankruptcy Code, allowing it to continue under Chapter 11. However, the Bankruptcy Appellate Panel reversed this decision, ruling that Co Petro was indeed a commodity broker and thus barred from reorganizing under Chapter 11, which was a mistake for the bankruptcy court to deny the CFTC's request to intervene and seek dismissal.

Co Petro's creditors include customers from its illegal commodities activities and general unsecured creditors from its legitimate businesses. Under 11 U.S.C. § 109(d), commodity brokers cannot reorganize under Chapter 11; instead, their assets must be liquidated under subchapter IV of Chapter 7, where customer claims are prioritized. The Bankruptcy Appellate Panel's interpretation of Co Petro as a commodity broker was contested. The definition of a commodity broker per the Bankruptcy Code requires it to first qualify as a futures commission merchant under the Commodity Exchange Act, which necessitates dealing in orders for commodities for future delivery according to contract market rules.

Co Petro satisfies the first condition by engaging in futures contracts but fails the second since the commodities were not traded under a designated contract market. The Commodity Exchange Act outlines a process for designating contract markets, which must meet strict requirements to ensure market integrity, and futures contracts for a commodity can only be traded through a member of such a contract market.

The bankruptcy court determined that Co Petro was neither a futures commission merchant nor a commodity broker, as it sold futures contracts for commodities that were not traded on a designated contract market. The Bankruptcy Appellate Panel disagreed, asserting that the phrase "on or subject to the rules of a contract market" serves as a legal requirement for trading commodity futures contracts. The Panel emphasized that statutes should not be interpreted to render any part meaningless, and if Congress intended a broader definition for futures commission merchants, it would have omitted the limiting phrase. The interpretation aims to reveal Congress's intent, which should be adhered to unless clear legislative intent suggests otherwise.

The Commodity Futures Trading Commission (CFTC) argued that the purpose of the Commodity Exchange Act and the relevant bankruptcy provisions is to protect commodity customers, and that classifying Co Petro as not a commodity broker undermines that intent. However, the Panel maintained that defining a futures commission merchant strictly to those dealing in futures contracts on a recognized market does not jeopardize investor protection, citing other provisions in the Commodity Exchange Act that prohibit Co Petro's conduct. The CFTC successfully obtained an injunction against Co Petro without alleging a violation of the registration requirements for futures commission merchants.

The ruling does not significantly hinder the CFTC's ability to enforce laws against unlawful futures trading, nor does it contradict the objectives of the Bankruptcy Code. The Senate Report accompanying the Bankruptcy Reform Act of 1978 highlighted customer protection as a priority, consistent with the goals of the Commodity Exchange Act, emphasizing the importance of maintaining customer confidence in the commodity markets.

Customer protection is a primary goal of the special liquidation procedures under subchapter IV, which Congress designed to preserve the unique broker-customer relationship. The House Committee on the Judiciary characterized this relationship as a 'deposit relationship,' where customers transact through brokers without considering the brokers' creditworthiness. Customers generally expect that their investment risks are tied solely to the commodity market, not the financial health of the broker, hence the legislation protects customers' margin deposits and securities from being classified as the broker's bankruptcy assets.

In contrast, Co Petro's customers did not enjoy this deposit relationship; they relied directly on Co Petro's creditworthiness, taking on the risk that Co Petro might fail to fulfill its contractual obligations due to insufficient resources. Unlike standard commodity transactions, where brokers execute orders, Co Petro created the market itself, meaning its solvency was crucial to the contracts it executed. Co Petro's customers were engaged in a speculative endeavor, driven by a shared expectation of rising petroleum prices.

The scheme employed by Co Petro violated the Commodity Exchange Act, raising the question of whether its customers' claims should have priority over other creditors. However, an analysis of the Bankruptcy Code indicates no basis for preferential treatment for Co Petro's customers, as the legislative intent was to maintain the traditional depositary relationship between brokers and customers.

The legislation governing the commodity broker liquidation subchapter aims to protect commodity market stability, particularly during a broker's insolvency, which is more challenging in commodities than in other markets due to the limited duration of contracts and daily settlement of gains and losses. Delays or abrupt actions by the trustee could lead to market disruptions and significant losses. In the case of Co Petro, the commodity market has been enjoined, and the trustee is prohibited from executing its contracts; thus, concerns regarding market stability typical in other bankruptcies do not apply. The court held that Co Petro does not qualify as a commodity broker under the Bankruptcy Code, reversing the Bankruptcy Appellate Panel's decision and directing reinstatement of Co Petro's Chapter 11 petition.

The Commodity Futures Trading Commission (CFTC) was found to have standing to intervene in the case to move for dismissal of Co Petro's Chapter 11 petition, as it is considered a party in interest under 11 U.S.C. 1109(b). This authority is supported by precedent from SEC v. United States Realty, which established that regulatory bodies have the right to intervene to protect their interests in bankruptcy proceedings. The CFTC's interest aligns with that of the SEC in ensuring that only eligible parties proceed under Chapter 11. 

The trustee's argument that the CFTC could not appeal to the Bankruptcy Appellate Panel, based on an analogy to the SEC's appeal rights under 11 U.S.C. 1109(a), was rejected by the court. The court did not agree that the restrictions on the SEC's appeal rights should apply to the CFTC in this case.

To intervene in the proceeding, the Commodity Futures Trading Commission (CFTC) needed to establish itself as a party in interest, as outlined in United States Realty and 1109(b). Unlike the SEC, which can participate freely under 1109(a), the CFTC had to demonstrate its status. Having successfully done so, the CFTC is entitled to the right of appeal typical for parties in interest. The statutory limitation of 1109(a) on SEC appeals does not apply to the CFTC, either explicitly or implicitly, supporting the Bankruptcy Appellate Panel's conclusion that the CFTC's appeal was valid. 

The decision of the Bankruptcy Appellate Panel is partially affirmed, partially reversed, and remanded for further action consistent with this ruling. Judge Russell E. Smith concurs in the result. 

Further findings indicate that Co Petro is not classified as a futures commission merchant, negating the need to assess the statutory definition of a customer. No claims were made regarding Co Petro selling futures contracts on a contractual market. Definitions from the Commodity Exchange Act and the Bankruptcy Code regarding 'board of trade,' 'member of a contract market,' and 'contract market' are provided, establishing that Co Petro violated the Commodity Exchange Act by trading futures contracts outside the required framework. The court clarified that Co Petro's actions fell within statutory prohibitions, and noted that this situation does not permit a violator to evade liability due to their illegal business status.

The Commission asserts that the district court's disgorgement order in the previous injunctive proceeding aimed to protect Co Petro's commodity customers. Allowing Co Petro to reorganize under chapter 11 would undermine this protection, as general creditors would access the disgorged funds. The rationale for disgorgement is to prevent a violator from keeping profits from wrongdoing, as established in relevant case law. Consequently, creditor preferences do not affect the disgorgement order, which is a separate issue under the Bankruptcy Code.

Challenges exist in applying the commodity broker liquidation provisions to Co Petro, particularly regarding the requirement to respond to margin calls and manage open contracts, which may conflict with an injunction against illegal trading. This indicates that the current statutory framework is unsuitable for a market disrupted by unlawful operations. The provisions for commodity broker liquidations were largely shaped by testimony from Commodity Futures Trading Commission Chairman William Bagley during the 1978 Bankruptcy reform discussions, with no indication of his concerns regarding the specific customer types or unlawful markets involved in the case.

The Bankruptcy Court recognized the Commission as a party in interest but initially denied its intervention due to a lack of a formal motion. The Bankruptcy Appellate Panel reversed this decision, and Co Petro did not contest this ruling. The determination confirms the Commission's status as a party in interest for intervening to dismiss an improperly filed chapter 11 petition. However, no judgment is made on the Commission’s claim regarding the SEC’s right to appeal as a party in interest under 1109(b).