CUSTODIAN OR NOT: SCRIVENER'S ERROR IN A BANKRUPTCY CODE SAFE HARBOR

• Published in: Bankruptcy developments journal Vol. 38; no. 1; pp. 51 - 96
• Main Author: Plank, Thomas E
• Format: Journal Article
• Language: English
• Published: Atlanta Emory University, School of Law 01.01.2022
• Subjects: Agreements; Bankruptcy; Bankruptcy laws; Financial institutions; Loans; Mortgages; Purchasing; Repurchase agreements; Safe harbor; Trust companies; United States > US
• ISSN: 0890-7862

This Article analyzes a drafting error in the United States Bankruptcy Code that remained latent for 36 years until 2020. This drafting error limits a safe harbor that Congress enacted in 1984 and expanded in 2005 to protect an important segment of the securities and mortgage loan markets. When a person becomes a debtor in bankruptcy, the Bankruptcy Code imposes an automatic stay on substantially all actions by creditors and other entities against the debtor or the debtor's bankruptcy estate. It also abrogates contractual provisions, known as ipso facto clauses, that otherwise permit a party to terminate a contract because its counterparty filed a bankruptcy petition. In most cases, these rules produce a net benefit. Congress, however, has determined that, because of the nature and importance in the financial markets of certain qualifiedfinancial contracts, the costs imposed by these rules outweigh their benefits. In particular, Congress enacted specific safe harbor provisions for "securities contracts," which are contracts for the purchase and sale of securities and mortgage loans. These safe harbors permit a financial institution (a) to liquidate, terminate, or accelerate the securities contract immediately if the counterparty became a debtor in bankruptcy and (b) notwithstanding the automatic stay, to exercise immediately its rights under any security agreement or its rights of set off and netting. A financial institution as defined includes not only a banking institution or trust company but also includes a customer of a banking institution or trust company that acts as a custodian for the customer. Congress intended to extend the safe harbor to customers who used a banking institution or trust company as a custodian in the ordinary sense of the word-a person holding securities or mortgage loans for another. Unfortunately, the drafters of the safe harbor were not aware that the Bankruptcy Code had already given the term "custodian" a narrow and misleading definition- a "Humpty-Dumpty definition." As defined, a "custodian" is, in the words of the legislative history, a prepetition liquidator such as an assignee for the benefit of creditors or other receiver or trustee appointed to liquidate the property of a borrower that later becomes a debtor in bankruptcy. The use of this misleading Humpty-Dumpty definition of a prepetition liquidator in the definition of financial institution produces an absurd result. It nullifies the intended extension of the securities contract safe harbor to a customer that uses a banking institution or trust company as a custodian of the securities or mortgage loans. This use of this misleading defined is a true scrivener's error that permits courts to ignore the plain language of the statute. This Article argues that courts should ignore this misleading definition of "custodian" in the definition offinancial institution. Instead, they should give the term "custodian " its commonly understood, ordinary meaning. They can easily add a simple judicial amendment comparable to other Bankruptcy Code definitions that specify the ordinary meaning of a defined term as an exception to an express technical meaning.