IN THE MATTER OF: BEVILL, BRESLER & SCHULMAN ASSET MANAGEMENT CORPORATION, A NEW JERSEY CORPORATION, DEBTOR-IN-POSSESSION,

v.

SPENCER SAVINGS & LOAN ASSOCIATION, APPELLANT IN 88-6020. IN THE MATTER OF: BEVILL, BRESLER & SCHULMAN ASSET MANAGEMENT CORPORATION, A NEW JERSEY CORPORATION, DEBTOR-IN-POSSESSION, V. NIAGARA COUNTY SAVINGS BANK, APPELLANT IN 88-6021. IN THE MATTER OF: BEVILL, BRESLER & SCHULMAN ASSET MANAGEMENT CORPORATION, A NEW JERSEY CORPORATION, DEBTOR-IN-POSSESSION V. CITY OF HARRISBURG, APPELLANT IN 88-6022. IN THE MATTER OF: BEVILL, BRESLER & SCHULMAN ASSET MANAGEMENT CORPORATION, A NEW JERSEY CORPORATION, DEBTOR-IN-POSSESSION, V. CITY OF ALLENTOWN, APPELLANT IN 88-6023

ALDISERT, Circuit Judge.

The ultimate question for decision in these appeals by purchasers of federal government securities repurchase agreements (“repos”), is whether the Chapter 11 bankruptcy trustee of a bankrupt securities dealer may avoid certain pre-petition deliveries of securities to the purchasers.

The trustee contends the deliveries are avoidable as preferential transfers. The purchasers argue that the deliveries are protected by provisions of Chapter 11 designed to exempt participants in repurchase agreements from avoidance actions.

The appeals come to us in the form of two questions certified under 28 U.S.C. § 1292(b) and Rule 5, Fed.R.App.P. The questions require us to interpret provisions of the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub.L. No. 98-353, 98 Stat. 333. We must decide:

Whether section 546(f) of the Bankruptcy Code, 11 U.S.C. § 546(f), bars a Chapter 11 trustee from utilizing sections 547 and 548 to recover securities or their proceeds from a repo participant;

and

Whether section 559 of the Code, 11 U.S. C. § 559, bars a Chapter 11 trustee from claiming the proceeds of a repurchase agreement liquidated by a repo participant.

The district court answered both questions in the negative and found for the trustee. The repo purchasers have appealed. Jurisdiction was proper in the district court based on 28 U.S.C. § 1334(b). Jurisdiction on appeal is proper based on 28 U.S.C. § 1292(b). The appeals were timely filed under Rule 4(a), Fed.R.App.P. We answer these questions in the affirmative and will reverse the order of the district court.

I.

The dispute here arises out of certain transfers of federal government securities from Bevill, Bresler & Schulman Asset Management Corporation (AMC) to appellants, Niagara County Savings Bank, City of Allentown, City of Harrisburg, and Spencer Savings & Loan Association. The transfers were made pursuant to repurchase agreements between the appellants and AMC. A standard repurchase agreement, commonly called a “repo,” consists of a two-part transaction. The first part is the transfer of specified securities by one party, the dealer, to another party, the purchaser, in exchange for cash. The second part consists of a contemporaneous agreement by the dealer to repurchase the securities at the original price, plus an agreed upon additional amount on a specified future date. A “reverse repo” is the identical transaction viewed from the perspective of the dealer who purchases securities with an agreement to resell. See 11 U.S.C. § 101(40)-(41); see also S.Rep. No. 65, 98th Cong., 1st Sess. 44 n. 1 (1983).

AMC is one of several hundred secondary dealers in government securities. Secondary dealers are to be distinguished from primary dealers who purchase securities directly from the Federal Reserve. Savings and loan associations and local governments make up a significant number of customers engaging in repo transactions with secondary dealers. Other customers include money market and mutual funds, pension funds, insurance, financial and other corporations, and foreign investors.

Under the repurchase agreements here, the individual appellants agreed to purchase certain securities from AMC and simultaneously agreed to sell the securities back to AMC on an agreed upon date and for an agreed upon price. The appellants had entered into a type of repurchase agreement with AMC known as a “hold-in-custody” agreement. AMC initially re tained possession of the securities. Appellants did not take physical possession of the securities until several weeks after entering into the agreements. Less than ninety days later, AMC filed a voluntary petition for reorganization under Chapter 11. Appellee, Saul S. Cohen, was appointed trustee for AMC. After the Chapter 11 petition was filed, appellants liquidated the securities.

On April 8, 1985, the Securities and Exchange Commission filed a complaint against AMC and related individuals, alleging securities fraud. The complaint said that the dealer perpetrated a massive fraud upon its customers consisting of the sale of the same securities to multiple customers, and the sale of non-existent securities. According to the trustee, the claims of AMC’s repo customers totaled approximately $207 million, and exceeded by over $140 million the value of the securities in AMC’s possession as of the date the Chapter 11 commenced.

In April 1987, the trustee filed a complaint seeking to avoid the transfers of securities to the appellants, and to receive either a return of the securities, or award of equivalent money damages. The trustee alleged that AMC’s pre-petition deliveries of the securities to each of the appellants were voidable under 11 U.S.C. § 547 (“... the trustee may avoid any transfer of an interest of the debtor in property — (4) made —(A) on or within 90 days before the date of filing of the petition ...”) and 11 U.S.C. § 548 (“The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred in or written one year before the filing of the petition, if the debtor ... received less than a reasonably equivalent value in exchange_”).

Appellants filed a joint motion to dismiss the complaint under Rule 12(b)(6), Fed.R. Civ.P., for failure to state a claim under which relief could be granted. The basis of the motion was that the trustee’s preference actions were barred by 11 U.S.C. §§ 546(f) and 559.

11 U.S.C. § 546(f) provides:

Notwithstanding sections 544, 545, 547, 548(a)(2), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment, as defined in § 741(5) or 761(15) of this title, or settlement payment, as defined in § 741(8) of this title, made by or to a repo participant in connection with a repurchase agreement and that is made before the commencement of the case, except under section 548(a)(1) of this title.

11 U.S.C. § 559 provides in pertinent part:

The exercise of a contractual right of a repo participant to cause the liquidation of a repurchase agreement because of a condition of the kind specified in section 365(e)(1) of this title shall not be stayed, avoided, or otherwise limited by operation of any provision of this title or by order of a court or administrative agency in any proceeding under this title....

The district court denied the repo purchasers’ joint motion to dismiss, holding that section 546(f) of the Code did not insulate the deliveries from avoidance under section 547 or 548 because the deliveries were not “settlement payments” within the meaning of section 741(8). The court also held that because the transfers were preferential, the repo purchasers had no rights under 11 U.S.C. § 559 to liquidate the securities and retain the proceeds. The district court issued an opinion from the bench, entered an order denying the motion to dismiss the complaint, and later certified the questions for an interlocutory appeal. We granted the appellant’s petition to appeal from the interlocutory order of the district court.

It must be emphasized that this court is not reviewing all the proceedings that took place in the district court. We are called upon to decide only the issues presented by the certified questions.

In reaching its holding, the district court assumed that none of the securities in question had been “delivered” to the repo purchasers prior to the physical transfer of possession. The court based this assumption on its earlier conclusion that the securities had not been previously “delivered” within the meaning of the Uniform Com mercial Code (UCC). See In the Matter of Bevill, Bresler & Schulman Asset Management Corp., 67 B.R. 557 (D.N.J. 1986) (“Test Cases”). In the Test Cases, the district court held, inter alia, that re-pos are purchases and sales of securities. Id. at 598. We accept that characterization.

The test cases also determined that a repo purchaser would be considered as “owning” the securities, even though the securities were in the custody of the seller, provided that those securities were “delivered” or “transferred” under the UCC. Id. at 603. If the district court had determined in the test cases that a UCC delivery had taken place and, that ownership of the securities here had passed prior to physical delivery, we would not be involved in the present litigation. For there could have been no preference, because there would have been no “antecedent debt” satisfied by the deliveries. Under such interpretation, the repo purchasers would not be considered creditors of AMC, but owners of the securities.

We will proceed in this case under the assumption that the district court was correct in its analysis of the ownership characteristics of these transactions. We emphasize, however, that this is an assumption we are constrained to make because of the limited nature of the review of certified questions. We specifically do not meet the question whether the district court erred in its determination of what constitutes transfer of ownership under repo market practices. We decide only whether the district court misinterpreted and misapplied sections 546(f) and 559 of the Code.

Appellants argue that the district court decision was a restrictive and erroneous interpretation of “settlement payment” as set forth in section 546(f). Appellants also contend that the district court decision failed to recognize the flexible and varied settlement practices in the government securities market, an understanding which is key to the proper interpretation and application of the statutory sections at issue.

II.

The issues before us are questions of first impression involving statutory interpretation as to which this court has plenary review. Creque v. Luis, 803 F. 2d 92, 93 (3d Cir.1986).

III.

Before proceeding to the controlling statutes, we, as did Congress, deem it advisable to emphasize the important role that repo transactions have in our nation’s economy. In 1983, it was estimated that the aggregate daily volume of repo transactions amounted to several hundred billion dollars. S.Rep. No. 65, 98th Cong., 1st Sess. 45 (1983) (“1983 Senate report”). More recently, it has been reported that the aggregate daily repo volume during the week of November 9, 1988, was approximately $600 billion. Br. for amicus curiae (Public Securities Assoc. (PSA)) at 10 n. 10 (citing Fed.Res.Bull. at A32 (Fed.1989) (Table 1.43)). By contrast, the record volume of stock exchange and over-the-counter trades during the week of October 26, 1987 (when stock trades for the week of October 19, 1987 settled) has been estimated to have been less than $200 billion. Id. (citing Division of Market Regulation, U.S. Securities and Exchange Commission, The October 1987 Market Break at 10-1, appearing in, The Stock Market Crash, October 19, 1987: Reports, Studies and Testimony, Vol.¹, (1980)). Repos involve large amounts of money (agreements are usually for $500,000 or more), are typically of limited duration, often for just one night, and are usually closed by an oral agreement subject to written confirmation. See SEC v. Miller, 495 F.Supp. 465, 469 (S.D.N.Y. 1980).

The repo market is used by the Federal Reserve System to help execute monetary policy, and serves to finance the national debt at the lowest possible cost. Repos are an attractive cash-management investment for businesses, state and local governments, and financial institutions.

The Federal Reserve uses repos and reverse repos to meet temporary needs for reserves by purchasing securities under re verse repos, or to counter temporary excesses of reserves by selling securities under repos. Primary dealers act in effect as first-tier underwriters of new issuances of U.S. Treasury securities. Because primary dealers do not have the funds to purchase new issuances outright, they finance a major portion of their purchases by selling the securities under repos to secondary dealers, such as AMC, who in turn finance their purchases by selling the securities under repos to institutional and other customers. In re Bevill, Bresler & Schulman Asset Management Corp., 67 B.R. 557, 567 (D.N.J.1986). Because the cost of financing United States Treasury securities under re-pos is usually less than the cost of other financing sources (such as bank loans), the repo market reduces the cost of distributing Treasury securities.

The repo market also enhances the liquidity of mortgage-backed securities. Id. at 567-68. “The common element in all these extensive uses of repo agreements is liquidity. Without that characteristic, the repurchase agreement would not serve the function that it now does.” Bankruptcy Law and Repurchase Agreements: Hearings on S. 445 Before the Subcomm. on Monopolies and Commercial Law of the Senate Comm, on the Judiciary, 98th Cong., 1st Sess. 306 (1983) (Statement of Peter Stemlight, Executive Vice President, Federal Reserve Bank of New York).

IV.

It is important to understand how securities are delivered under traditional repo practices. In proposing government securities broker-dealer regulations under the Government Securities Act of 1986,15 U.S. C. § 78o -5, the Treasury Department recognized that typically a repo may be structured in one of three ways. First, the agreement may require that the securities be delivered to the purchaser, or to the purchaser’s designated custodial bank. This is often called a “deliver-out repo.” Second, the agreement may provide for delivery to a third party, usually a custodial bank, holding the securities for the benefit of both parties. This method is often called a “tripartite repo.” A third method of delivery, known as “hold-in-custody (HIC) repo”, is the type of transaction implicated here. In a HIC repo the dealer may retain control of the securities and earmark them on its own books as securities subject to a specific repo transaction. Under the latter arrangement, the dealer usually will instruct its clearing bank to segregate the securities subject to repurchase from the securities in the dealer’s clearing account. However, the clearing bank will not necessarily be advised of the identity of the purchaser of specific repo securities. Under these circumstances, the securities will be subject only to the control of the dealer and its clearing bank. 52 Fed.Reg. 5671 (1987). As indicated in a 1987 Securities and Exchange Commission staff study on the repo market, some broker-dealers find it advantageous to pay a slightly higher repo rate if the buyer does not require that securities be physically delivered, or that ownership be transferred over the wire (book-entry) in the case of certificateless securities. Instead, the selling broker-dealer sends a confirmation to the purchaser naming the certificates that are subject to the repo and indicating how they are segregated for safekeeping. Br. for appellant Niagara County Savings Bank (citing The Use of Repurchase Agreements by Broker-Dealers, SEC Directorate of Economic and Policy Analysis 18 (Dec.1987)).

Furthermore, in a HIC repo, the dealer may commingle the purchaser’s securities with its own securities during the day and use such securities to facilitate deliveries of securities to third parties if necessary. The dealer’s use of securities in this way “appears to be a common practice in the government securities market.” 52 Fed. Reg. 5672 (1987). The Treasury Department has recognized that HIC repos represent “the greatest potential for loss on the part of the investors since the securities purchased remain in the control of the seller.” Id. at 5671.

V.

Although we are the first appellate court to interpret and apply these provisions, we are fortunate that there is substantial legislative history to assist us in ascertaining the intent of Congress. To place the certified questions in proper perspective, it is first necessary to understand the history of the various amendments to the Bankruptcy Reform Act of 1978, Pub.L. No. 95-598.

A.

Although our major concern is with the 1984 amendments to the Bankruptcy Reform Act, we must first consider the 1982 amendments. At the time of their passage, Congress was concerned about the volatile nature of the commodities and securities markets, and decided that certain protections were necessary to prevent "the insolvency of one commodity or security firm from spreading to other firms and possibly threatening the collapse of the affected market.” H.Rep. No. 97-420, 97th Cong., 2d Sess.¹ (1982) (“1982 House report”), U.S.Code Cong. & Admin.News 1982, p. 583. As stated in the House Report on the 1982 amendments:

The Bankruptcy Code now expressly provides certain protections to the commodities market to protect against such a ‘ripple effect.’ One of the market protections presently contained in the Bankruptcy Code, for example, prevents a trustee in bankruptcy from avoiding or setting aside, as a preferential transfer, margin payments made to a commodity broker....

Id.

Congress wanted to go further to protect margin payments and settlement payments made by and to participants in the securities market generally. Accordingly, it added a new subsection to 11 U.S.C. § 546:

11 U.S.C. § 546(e). It will be seen shortly that this section was the model upon which section 546(f) of the 1984 amendments was based.

B.

After the 1982 amendments were in effect, Congress became concerned that the amendments did not “adequately [ ] protect liquidations of repos in the event of the insolvency of a dealer or other participant in the repo market, even though the principal objective of Public Law 97-222 [the 1982 amendments] was to prevent the insolvency of one commodities or securities firm from spreading to other firms and possibly threatening the stability of the affected market.” 1983 Senate report at 47. Congress noted: “The repo market serves a crucial function for both parties to the repo transaction. The country’s major institutional and fiduciary investors make heavy use of repos. For these investors, including such entities as state and local governments, public and private pension funds, money market and other mutual funds, banks, thrift institutions, and large corporations, repos have become a vital tool of cash management.” Id. at 45. Moreover, Congress stated, “The repo is particularly well-suited to the needs of these investors. Receipts of taxes and the proceeds of bond issues in the case of state and local governments, cash flows from corporate operations, and liquidity needs of thrift institutions and money market funds often fail to coincide with the planned expenditures of such funds, thereby creating the need for such entities to invest idle funds for short periods in as risk-free a manner as possible.” Id. Accordingly, Congress came to the decision that:

The effective functioning of the repo market can only be assured if repo investors will be protected against open-ended market loss arising from the insolvency of a dealer or other counter-party in the repo market. The repo market is as complex as it is crucial. It is built upon transactions that are highly interrelated. A collapse of one institution involved in repo transactions could start a chain reaction, putting at risk hundreds of billions of dollars and threatening the solvency of many additional institutions.

Id. at 47.

The uncertainty was highlighted when Lombard-Wall, Inc., filed a Chapter 11 bankruptcy petition in the Southern District of New York in August, 1982. A bench decision in the Lombard-Wall case held that the holder of securities subject to a repurchase agreement was subject to the automatic stay provision of the Code, and that the holder was precluded from closing out its position with the debtor without approval of the court. Lombard-Wall Inc. v. Columbus Bank & Trust Co. (In re Lombard-Wall Inc.), No. 82 B 11556 (Bankr.S.D.N.Y. Sept. 16, 1982). This case made clear the risks to the repo market created by the Code’s automatic stay and avoidance provisions. It also demonstrated that the 1982 amendments were not sufficient in scope to protect the market from major dislocations caused by the bankruptcy of market participants. Under its holding, the repo participant would be subjected “both to the unexpected inability to liquidate securities it holds and to the risk of capital loss should unfavorable interest rate changes occur; these risks impair the qualities that are the essence of the appeal of repo agreements.” Bankruptcy Law and Repurchase Agreements: Hearings on H. 2852 and H. 3418 Before the Subcommittee on Monopolies and Commercial Law of the House Comm. on the Judiciary, 98th Cong., 2d Sess. 72 (1984) (“House hearings”) (letter of Hon. Paul A. Volcker, Chairman, Federal Reserve, to Hon. Peter W. Rodino, Jr., Chairman, House Judiciary Committee).

Congress, the Board of Governors of the Federal Reserve, the Public Securities Association, the Investment Company Institute and others, were concerned that if Lombard-Wall became the law governing repo transactions, the failure of one repo dealer, and the consequent inability of repo participants to promptly liquidate their investments to obtain cash to meet obligations, could have a ripple effect throughout the country’s financial markets, causing an otherwise isolated financial problem to spread to many other entities. Congress recognized:

The bankruptcy of a repo participant could result in possible substantial losses to investors, large and small, and also imposes at least the possibility of liquidity and solvency risks on the entire market, since parties holding repos with the bankrupt might be unable to promptly liquidate their investments, and in turn meet their obligations to third parties.

House hearings at 87.

The certainty and fluidity needed by professionals on both sides of the transactions is of such importance that one debt-or’s filing of a petition should not be permitted to impair the functioning of the market as a result of the Code’s automatic stay, or have the integrity of contract relationships upset by the Code’s avoidance provisions.

Id. at 517.

Congress determined to correct these “uncertainties” by amending the Code to “ensure there is no question that repo participants are afforded the same treatment with respect to the stay and avoidance provisions of the Code in connection with repurchase agreements” as is afforded other market participants under the 1982 amendments. 1988 Senate report at 44-45.

The congressional response was a series of amendments, effective in 1984, now known as the “Repo Amendments”: sections 546(f) and 559 of the Bankruptcy Code, 11 U.S.C. § 101 et seq., together with sections 101(41), 362(b)(7) and 548(d)(2)(C).

C.

In the amendments, Congress provided not only that the repo participant could liquidate its securities, but also that it could keep the proceeds of that liquidation to the extent of its contract price. Congressional understanding of this issue is demonstrated by the following colloquy. Peter W. Rodino, Jr., Chairman of the House Committee on the Judiciary, posed the following question to Paul A. Volcker, Chairman of the Federal Reserve System: A representative of the National Bankruptcy Conference has suggested that ... [the proposed bill which] would authorize the liquidation of a repurchase agreement during the bankruptcy of a counterpart, should be subject to the debtor’s right to use the cash collateral created by the exercise of such a provision under existing section 363 of the Code. Would the Federal Reserve support legislation containing such a provision?

The Federal Reserve responded that it would not support such a provision. Preston Martin, on behalf of the Federal Reserve, responded as follows:

The essence of a repurchase agreement is the liquidity afforded by the ease with which the underlying security can be converted to cash in the marketplace. Permitting liquidation of a security by a repo holder but retaining those funds for the debtor’s use rather than releasing them to the holder eliminates this liquidity. Such a restriction would be contrary to the intent of ensuring a stable and efficient market for repurchase agreements.

House hearings at 102-104.

Similarly, there was testimony from the Public Securities Association (PSA). PSA is a not-for-profit association that represents approximately 300 banks and broker-dealers that underwrite, trade and distribute federal government and agency securities, mortgage-backed and municipal securities. All of the primary dealers in federal government securities, as recognized by the Federal Reserve Bank of New York, are members of PSA. Robert C. Brown, Chairman of the PSA Board, explained that:

The ability of the repo market to serve all of its functions in the money market depends upon a high level of certainty about the ability of the various repo participants to close out repo transactions in the event of insolvency of the other party to the transaction, and to assure that repo transaction payments previously received from that party will not be reclaimed by the trustee under the Bankruptcy Code.

Id. at 83.

VI.

With the legislative history of the 1982 and 1984 amendments as our guide, we now turn to the interpretation of section 546(f) of the 1984 amendments. As stated before, section 546(f) provides:

Notwithstanding §§ 544, 545, 547, 548(a)(2), and 548(b) of this title, the trustee may not avoid a transfer that is a margin payment, as defined in § 741(5) or § 761(15) of this title, or settlement payment, as defined in § 741(8) of this title, made by or to a repo participant in connection with a repurchase agreement and that is made before the commencement of the case, except under § 548(a)(1) of this title,

section 741 provides in pertinent part:

(5) “margin payment” means payment or deposit of cash, a security, or other property, that is commonly known to the securities trade as original margin, initial margin, maintenance margin, or variation margin, or as a mark-to-market payment, or that secures an obligation of a participant in a securities clearing agency; ...

(8) “settlement payment” means a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.

At issue in this case is whether AMC’s pre-petition transfer of the securities to appellants constituted a “settlement payment” as contemplated by Congress.

A.

“Where, as here, the question is one of statutory construction, we begin with the language of the statute. See, e.g., Blum v. Stenson, 465 U.S. 886, 896 [104 S.Ct. 1541, 1547-48, 79 L.Ed.2d 891] (1984); Consumer Product Safety Comm’n v. GTE Sylvania, Inc., 447 U.S. 102, 108 [100 S.Ct. 2051, 2056, 64 L.Ed.2d 766] (1980),” Mansell v. Mansell, — U.S.-, 109 S.Ct. 2023, 104 L.Ed.2d 675 (1989). In interpreting section 546(f), we start first with its critical language: “settlement payment.” “Payment” is defined as “paying or being paid,” Webster’s New World Dictionary of the American Language (Second college ed. 1970). “Pay” means “1. to give (a person) what is due ... 4. to discharge or settle (a debt, obligation, expenses, etc.) by giving something in return.” Id. The district court interpreted “settlement payment” in accordance with a strictly monetary view of “payment,” and construed it to mean those funds paid by or credited to the purchaser at the moment the repo agreement was entered into without respect to any delivery of the securities. The court then looked at definitions of “settlement” applicable to orthodox corporate securities transactions between a stockholder and a customer, and concluded that “settlement payment” is a transaction that is, and indeed must be, consummated within five days of the agreement to purchase. In so doing, the court equated “settlement payment” contained in section 546(f) with “settlement date” as commonly understood in traditional corporate securities stockholder-purchaser transactions. The district court considered as authority for what constitutes a settlement payment for purposes of the Code, a treatise definition of “settlement day” peculiar to routine trades in the securities market, i.e., the day normally five days after a trade is executed. In this case the deliveries took place more than five days after the execution of the agreement.

The district court concluded that the actual deliveries of the securities — at a later date and within the 90 days of the petition filing — did not constitute part of the “settlement” because they occurred after the traditional “settlement day.” Under this view they did not constitute a “settlement payment” and did not bar the trustee from avoiding the transfer. We believe that the district court erred in both its interpretation of the critical phrase and the application of its definition.