Do the current bankruptcy laws offer excessive protection to derivatives? Many experts say yes. Under current bankruptcy laws these investment vehicles are exempt from the automatic stay that goes into effect when a bankruptcy case is filed. Contracts that a debtor has entered into regarding derivatives are not legally allowed to be terminated by the bankruptcy court. Many financial experts complain that the protections that derivatives enjoy under current bankruptcy laws is actually a disputed subsidy and is not in the best interest of consumers or investors.
Under the current bankruptcy codes both derivatives and almost all securities contracts are immune to the bankruptcy laws that are use in other areas. Some argue the point that any transactions which could affect brokers and securities dealers are not expected to follow the bankruptcy laws put in place for all other contracts.
In some cases courts have ruled in very unexpected ways concerning which securities contracts and derivatives are covered and which are exempt from the current bankruptcy codes. In the case Lightfoot v. MXEnergy Electric Inc. the United States Court of Appeals for the Fifth Circuit ruled that an agreement to provide electricity to the plaintiff was a forward contract, even though this is a completely new interpretation of what a forward contract consists of.
Based on the ruling by this court any commodity contract which does not include an immediate performance by one party would be termed a forward contract under the current bankruptcy code. In this case the court actually acknowledged that this ruling was risky but determined that Congress set the rules and the court had no choice but to comply with these rules when deciding the case.
Most investment experts doubt that Congress intended for the ruling that the Fifth Circuit Court of Appeals handed down. Unless the bankruptcy code is revised to address this problem and to update the bankruptcy code to provide uniform protection the issue will just continue to get bigger. Even Bernie Madoff clients who should have known that the returns received resulted from fraud were widely granted exemptions under the bankruptcy code due to the fact that Bernie Madoff was a registered stockbroker. This is proof that the link between Wall street and the members of Congress is very close, and needs to be addressed.