John Rapisardi and Joseph Zujkowski
John Rapisardi and Joseph Zujkowski ()

At the end of last year, the U.S. Court of Appeals for the Third Circuit added to several recent decisions addressing whether a creditor was entitled to payment of a “make whole” premium in connection with a Chapter 11 case. See Delaware Trust Co. v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings), 842 F.3d 247 (3d. Cir. 2016)). The Third Circuit’s opinion is the most creditor-friendly decision issued to date on this issue, as the Third Circuit found that the refinancing of certain first and second lien notes after EFIH’s Chapter 11 cases were commenced triggered payment of a “make whole” premium. Notably, the Third Circuit found that the “make whole” premium was payable despite the fact that the indentures governing the notes did not expressly provide for payment of the premium in the event of an EFIH bankruptcy.

Background

In 2010, Energy Futures Intermediate Holding Company and EFIH Finance (collectively, EFIH) issued approximately $4 billion in 10 percent first lien notes due 2020 pursuant to an indenture governed by New York law. Two specific indenture provisions were of significance. First, §3.07, captioned “Optional Redemption,” provided that “[a]t any time prior to December 1, 2015, [EFIH] may redeem all or a part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium.” Id. at 251. The amount of the “Applicable Premium” decreased over time, and was structured to compensate noteholders for interest that would have otherwise been paid through the Notes’ stated maturity date following an early redemption.Id.

Second, §6.02 of the indenture provided that, following an EFIH bankruptcy, “all outstanding Notes” shall automatically “be due and payable immediately without further action or notice.” Id. Unlike many other indentures and credit agreements, the EFIH first lien indenture did not expressly provide that the amount immediately due following automatic acceleration of the Notes included a premium. For example, the indenture governing EFIH’s second lien notes provided that the amount due on acceleration included “all principal of and premium, if any, interest …[,] and any other monetary obligations on the outstanding Notes.” Id.

‘Momentive’

Shortly after EFIH filed for Chapter 11, Judge Robert Drain of the U.S. Bankruptcy Court for the Southern District of New York issued a controversial decision in the Momentive Chapter 11 cases. See In re MPM Silicones, No. 14-22503-RDD, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 (S.D.N.Y. 2015). The decision confirmed a Chapter 11 plan over the objection of two secured creditor groups that argued, among other things, that the plan could not be confirmed without providing for payment of the make-whole premium due under their respective indentures. Like the EFIH indentures, the Momentive indentures required payment of the “Applicable Premium” following an “Optional Redemption” of the notes prior to a specified date. Additionally, like the EFIH second lien indenture, the Momentive indentures provided that the amount due upon automatic acceleration of the notes as a result of a bankruptcy filing included the principal balance of the notes, accrued and unpaid interest, and the applicable “premium, if any.” Id. at *13-14.

In overruling the plan objections, Judge Drain stressed that it is “well settled” under New York law that a lender generally is deemed to forfeit its right to a prepayment premium upon acceleration of a loan, noting that “by accelerating the debt, the lender advances the maturity of the loan and any subsequent payment by definition cannot be a prepayment.” Id. He further clarified that this general rule is inapplicable only where “a clear and unambiguous clause calls for the payment of a prepayment premium or make-whole even in the event of acceleration, or the establishment of a new maturity date.” Id.

Judge Drain ultimately concluded that the phrase “premium, if any,” used in the acceleration section of the indentures was not “a clear and unambiguous” clause entitling noteholders to payment of a premium. In order to satisfy the “clear and unambiguous” standard, Judge Drain stressed that a credit document must contain either (1) “an explicit recognition that the make-whole would be payable notwithstanding the acceleration of the loan” or (2) “a provision that requires the borrower to pay a make-whole whenever debt is repaid prior to its original maturity.” Id. As a result, nearly all new credit agreements and indentures that include a make-whole premium now explicitly provide that the amount due upon acceleration (as a result of a bankruptcy filing or for any other reason) includes the premium that would have been due if the debt was prepaid or redeemed immediately prior to acceleration.

EFIH DIP Financing

In April 2014, EFIH filed for Chapter 11 relief in the U.S. Bankruptcy Court for the District of Delaware. As noted above, the Chapter 11 filing automatically accelerated the debt governed by the first and second lien indentures.

Two months after the Chapter 11 filing, EFIH obtained bankruptcy court approval for debtor-in-possession financing and paid off the first lien notes with proceeds of the DIP facility (EFIH saved approximately $13 million in interest per month as a result of the lower interest rate on the DIP facility). Although the bankruptcy court authorized the repayment of the outstanding principal and interest under first lien notes, it deferred judgment on whether first lien noteholders were entitled to payment of the Applicable Premium (which would have been approximately $431 million) as a result of the post-petition refinancing. EFIH also refinanced a portion of the second lien notes in March 2015 without paying the premium due under the second lien indenture. Energy Future Holdings, 842 F.3d at 251-54.

Lower Court Decisions

Nine months after the first lien notes were refinanced in Chapter 11, the bankruptcy court held that the first lien noteholders were not entitled to payment of the Applicable Premium as a result of the refinancing. Citing Judge Drain’s Momentive opinion, the bankruptcy court stressed that the first lien indenture failed to explicitly provide that the accelerated amount automatically due following a bankruptcy filing included the premium otherwise payable under §3.07 in the event of an early redemption. The bankruptcy court later entered a similar opinion with respect to the refinancing of the second lien notes. Id. Both opinions were affirmed by the district court. Id.

Third Circuit Opinion

At the end of last year, the Third Circuit entered an opinion reversing the decisions of the bankruptcy court and the district court. The opinion relies heavily on a distinction the Third Circuit perceived between how the terms “prepayment” and “redemption” have been interpreted under New York law. The Third Circuit acknowledged that under New York law it is well-settled that debt cannot be “prepaid” after it is accelerated, because the debt’s maturity date becomes the date of acceleration. However, the Third Circuit stressed that New York state and federal courts have interpreted the phrase “redemption” to capture “both pre- and postmaturity repayments of debt.” Id. at 257-61. In light of the fact that the parties to the EFIH indentures elected to condition payment of a premium on an “optional redemption” and not a prepayment, the Third Circuit concluded that acceleration of the notes had “no bearing on whether and when the make-whole is due.”Id.

With §3.07 remaining applicable following EFIH’s Chapter 11 filing, the Third Circuit found that there was an “optional redemption” of the first and second lien notes prior to the calendar dates specified in the indentures. In the Third Circuit’s view, EFIH voluntarily filed Chapter 11 and used proceeds of its DIP facility to repay existing first and second lien notes at the outset of its Chapter 11 cases. It further stressed that as a debtor-in-possession, EFIH had a variety of options with respect to its prepetition secured notes, which included reinstating the notes under a Chapter 11 plan. The Third Circuit also cited EFIH public filings, in which the company had noted that it was under no legal obligation to refinance its secured debt while in Chapter 11, as support for its conclusion that an optional redemption had occurred. Id. at 255-57.

Finally, the Third Circuit found that even if it were to ignore the New York cases suggesting that a different standard should apply where a credit document ties payment of a premium to a redemption as opposed to a prepayment, the language used in the EFIH second lien indentures was sufficiently clear to require payment of the premium under New York law. As noted above, the EFIH second lien indentures, like many indentures and credit agreements, provide that the amount due upon acceleration of the notes includes the outstanding principal amount, accrued and unpaid interest, and the applicable “premium, if any.” While this construction was not specific enough for the bankruptcy court in Momentive, the Third Circuit found that the EFIH second lien indenture (like the indentures at issue in Momentive) made clear that “a premium is in play” following acceleration of notes. In light of the fact that the only relevant premium in the indenture was the premium set forth in the optional redemption section, the Third Circuit found that the reference to a “premium, if any” in the acceleration section was specific enough to satisfy New York law.Id. at 257-58.

Analysis

As a result of the Third Circuit’s EFIH opinion, an assessment of whether a particular creditor group is entitled to payment of a make-whole premium in connection with a Chapter 11 case should begin with a review of the terms used in the key sections of the applicable credit document. Where payment of a premium is tied to a redemption before a specific date, the Third Circuit made clear in EFIH that the redemption provisions of a credit document are not rendered irrelevant following acceleration of the debt. Alternatively, where payment of a make-whole is conditioned on a prepayment, the Third Circuit acknowledged that the credit document must specifically provide for payment of the premium if the debt is accelerated, but took issue with the level specificity required by Judge Drain in Momentive.

The Third Circuit’s opinion also leaves unanswered several interesting issues related to make-whole premiums. For example, while repayment of the EFIH notes through the proceeds of a DIP facility clearly constituted a redemption for the reasons described above, the Third Circuit did not address whether the repayment of debt through cash or new securities under a plan of reorganization would also be considered a redemption. Additionally, while not relevant to the Third Circuit’s opinion, the question of whether a debtor’s solvency is relevant to a particular creditor’s entitlement to payment of a make-whole premium was raised before the bankruptcy court in EFIH (but ultimately resolved by the parties through a stipulation). We will address these issues in a future column.

At the end of last year, the U.S. Court of Appeals for the Third Circuit added to several recent decisions addressing whether a creditor was entitled to payment of a “make whole” premium in connection with a Chapter 11 case. See Delaware Trust Co. v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings ), 842 F.3d 247 (3d. Cir. 2016)). The Third Circuit’s opinion is the most creditor-friendly decision issued to date on this issue, as the Third Circuit found that the refinancing of certain first and second lien notes after EFIH’s Chapter 11 cases were commenced triggered payment of a “make whole” premium. Notably, the Third Circuit found that the “make whole” premium was payable despite the fact that the indentures governing the notes did not expressly provide for payment of the premium in the event of an EFIH bankruptcy.

Background

In 2010, Energy Futures Intermediate Holding Company and EFIH Finance (collectively, EFIH) issued approximately $4 billion in 10 percent first lien notes due 2020 pursuant to an indenture governed by New York law. Two specific indenture provisions were of significance. First, §3.07, captioned “Optional Redemption,” provided that “[a]t any time prior to December 1, 2015, [EFIH] may redeem all or a part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium.” Id. at 251. The amount of the “Applicable Premium” decreased over time, and was structured to compensate noteholders for interest that would have otherwise been paid through the Notes’ stated maturity date following an early redemption.Id.

Second, §6.02 of the indenture provided that, following an EFIH bankruptcy, “all outstanding Notes” shall automatically “be due and payable immediately without further action or notice.” Id. Unlike many other indentures and credit agreements, the EFIH first lien indenture did not expressly provide that the amount immediately due following automatic acceleration of the Notes included a premium. For example, the indenture governing EFIH’s second lien notes provided that the amount due on acceleration included “all principal of and premium, if any, interest …[,] and any other monetary obligations on the outstanding Notes.” Id.

‘Momentive’

Shortly after EFIH filed for Chapter 11, Judge Robert Drain of the U.S. Bankruptcy Court for the Southern District of New York issued a controversial decision in the Momentive Chapter 11 cases. See In re MPM Silicones, No. 14-22503-RDD, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 ( S.D.N.Y. 2015 ) . The decision confirmed a Chapter 11 plan over the objection of two secured creditor groups that argued, among other things, that the plan could not be confirmed without providing for payment of the make-whole premium due under their respective indentures. Like the EFIH indentures, the Momentive indentures required payment of the “Applicable Premium” following an “Optional Redemption” of the notes prior to a specified date. Additionally, like the EFIH second lien indenture, the Momentive indentures provided that the amount due upon automatic acceleration of the notes as a result of a bankruptcy filing included the principal balance of the notes, accrued and unpaid interest, and the applicable “premium, if any.” Id. at *13-14.

In overruling the plan objections, Judge Drain stressed that it is “well settled” under New York law that a lender generally is deemed to forfeit its right to a prepayment premium upon acceleration of a loan, noting that “by accelerating the debt, the lender advances the maturity of the loan and any subsequent payment by definition cannot be a prepayment.” Id. He further clarified that this general rule is inapplicable only where “a clear and unambiguous clause calls for the payment of a prepayment premium or make-whole even in the event of acceleration, or the establishment of a new maturity date.” Id.

Judge Drain ultimately concluded that the phrase “premium, if any,” used in the acceleration section of the indentures was not “a clear and unambiguous” clause entitling noteholders to payment of a premium. In order to satisfy the “clear and unambiguous” standard, Judge Drain stressed that a credit document must contain either (1) “an explicit recognition that the make-whole would be payable notwithstanding the acceleration of the loan” or (2) “a provision that requires the borrower to pay a make-whole whenever debt is repaid prior to its original maturity.” Id. As a result, nearly all new credit agreements and indentures that include a make-whole premium now explicitly provide that the amount due upon acceleration (as a result of a bankruptcy filing or for any other reason) includes the premium that would have been due if the debt was prepaid or redeemed immediately prior to acceleration.

EFIH DIP Financing

In April 2014, EFIH filed for Chapter 11 relief in the U.S. Bankruptcy Court for the District of Delaware. As noted above, the Chapter 11 filing automatically accelerated the debt governed by the first and second lien indentures.

Two months after the Chapter 11 filing, EFIH obtained bankruptcy court approval for debtor-in-possession financing and paid off the first lien notes with proceeds of the DIP facility (EFIH saved approximately $13 million in interest per month as a result of the lower interest rate on the DIP facility). Although the bankruptcy court authorized the repayment of the outstanding principal and interest under first lien notes, it deferred judgment on whether first lien noteholders were entitled to payment of the Applicable Premium (which would have been approximately $431 million) as a result of the post-petition refinancing. EFIH also refinanced a portion of the second lien notes in March 2015 without paying the premium due under the second lien indenture. Energy Future Holdings , 842 F.3d at 251-54.

Lower Court Decisions

Nine months after the first lien notes were refinanced in Chapter 11, the bankruptcy court held that the first lien noteholders were not entitled to payment of the Applicable Premium as a result of the refinancing. Citing Judge Drain’s Momentive opinion, the bankruptcy court stressed that the first lien indenture failed to explicitly provide that the accelerated amount automatically due following a bankruptcy filing included the premium otherwise payable under §3.07 in the event of an early redemption. The bankruptcy court later entered a similar opinion with respect to the refinancing of the second lien notes. Id. Both opinions were affirmed by the district court. Id.

Third Circuit Opinion

At the end of last year, the Third Circuit entered an opinion reversing the decisions of the bankruptcy court and the district court. The opinion relies heavily on a distinction the Third Circuit perceived between how the terms “prepayment” and “redemption” have been interpreted under New York law. The Third Circuit acknowledged that under New York law it is well-settled that debt cannot be “prepaid” after it is accelerated, because the debt’s maturity date becomes the date of acceleration. However, the Third Circuit stressed that New York state and federal courts have interpreted the phrase “redemption” to capture “both pre- and postmaturity repayments of debt.” Id. at 257-61. In light of the fact that the parties to the EFIH indentures elected to condition payment of a premium on an “optional redemption” and not a prepayment, the Third Circuit concluded that acceleration of the notes had “no bearing on whether and when the make-whole is due.”Id.

With §3.07 remaining applicable following EFIH’s Chapter 11 filing, the Third Circuit found that there was an “optional redemption” of the first and second lien notes prior to the calendar dates specified in the indentures. In the Third Circuit’s view, EFIH voluntarily filed Chapter 11 and used proceeds of its DIP facility to repay existing first and second lien notes at the outset of its Chapter 11 cases. It further stressed that as a debtor-in-possession, EFIH had a variety of options with respect to its prepetition secured notes, which included reinstating the notes under a Chapter 11 plan. The Third Circuit also cited EFIH public filings, in which the company had noted that it was under no legal obligation to refinance its secured debt while in Chapter 11, as support for its conclusion that an optional redemption had occurred. Id. at 255-57.

Finally, the Third Circuit found that even if it were to ignore the New York cases suggesting that a different standard should apply where a credit document ties payment of a premium to a redemption as opposed to a prepayment, the language used in the EFIH second lien indentures was sufficiently clear to require payment of the premium under New York law. As noted above, the EFIH second lien indentures, like many indentures and credit agreements, provide that the amount due upon acceleration of the notes includes the outstanding principal amount, accrued and unpaid interest, and the applicable “premium, if any.” While this construction was not specific enough for the bankruptcy court in Momentive, the Third Circuit found that the EFIH second lien indenture (like the indentures at issue in Momentive) made clear that “a premium is in play” following acceleration of notes. In light of the fact that the only relevant premium in the indenture was the premium set forth in the optional redemption section, the Third Circuit found that the reference to a “premium, if any” in the acceleration section was specific enough to satisfy New York law.Id. at 257-58.

Analysis

As a result of the Third Circuit’s EFIH opinion, an assessment of whether a particular creditor group is entitled to payment of a make-whole premium in connection with a Chapter 11 case should begin with a review of the terms used in the key sections of the applicable credit document. Where payment of a premium is tied to a redemption before a specific date, the Third Circuit made clear in EFIH that the redemption provisions of a credit document are not rendered irrelevant following acceleration of the debt. Alternatively, where payment of a make-whole is conditioned on a prepayment, the Third Circuit acknowledged that the credit document must specifically provide for payment of the premium if the debt is accelerated, but took issue with the level specificity required by Judge Drain in Momentive.

The Third Circuit’s opinion also leaves unanswered several interesting issues related to make-whole premiums. For example, while repayment of the EFIH notes through the proceeds of a DIP facility clearly constituted a redemption for the reasons described above, the Third Circuit did not address whether the repayment of debt through cash or new securities under a plan of reorganization would also be considered a redemption. Additionally, while not relevant to the Third Circuit’s opinion, the question of whether a debtor’s solvency is relevant to a particular creditor’s entitlement to payment of a make-whole premium was raised before the bankruptcy court in EFIH (but ultimately resolved by the parties through a stipulation). We will address these issues in a future column.