Dashed Expectations: Delaware Court Rules Make-Whole Premium Not Payable Upon Early Repayment of Bond Debt in Bankruptcy
Whether a provision in a bond indenture or loan agreement obligating a borrower to pay a “make-whole” premium is enforceable in bankruptcy has been the subject of heated debate in recent years. A Delaware bankruptcy court recently weighed in on the issue in Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 527 B.R. 178 (Bankr. D. Del. 2015).
Aligning itself with a number of New York bankruptcy courts, the Energy Future court granted partial summary judgment to the debtor-borrower. The court ruled that, although the debtor repaid the bonds prior to maturity, a make-whole premium was not payable under the plain terms of the bond indenture because automatic acceleration of the debt triggered by the debtor’s chapter 11 filing was not a “voluntary” repayment. However, the court reserved judgment on the indenture trustee’s request for relief from the automatic stay to revive the make-whole premium claim by decelerating the bonds, as permitted under the terms of the indenture.
Enforceability of Make-Whole Premiums in Bankruptcy
Restrictions on a borrower’s ability to prepay secured debt are a common feature of bond indentures and credit agreements. Lenders often incorporate “no-call” provisions to prevent borrowers from refinancing or retiring debt prior to maturity. Alternatively, a loan agreement may allow prepayment at the borrower’s option, but only upon payment of a “make-whole” premium. The purpose of such a provision is to compensate the lender for the loss of the remaining stream of interest payments it would otherwise have received had the borrower paid the debt through maturity.
Bankruptcy courts almost uniformly refuse to enforce no-call provisions against debtors, allowing debtors to repay outstanding debt despite such provisions. See, e.g., HSBC Bank USA, N.A. v. Calpine Corp., No. 07 Civ. 3088, 2010 U.S. Dist. LEXIS 96792, at *17 (S.D.N.Y. Sept. 14, 2010); In re Vest Assocs., 217 B.R. 696, 698 (Bankr. S.D.N.Y. 1998); Cont’l Sec. Corp. v. Shenandoah Nursing Home P’ship, 188 B.R. 205, 213 (W.D. Va. 1995). Further, the majority of courts have disallowed a lender’s claim for payment of a make-whole premium when the premium is not explicitly payable in the event of acceleration. Such courts find that acceleration due to the debtor’s bankruptcy filing, and any subsequent repayment of the debt during the bankruptcy case as part of a chapter 11 plan or otherwise, is not voluntary and therefore does not trigger any make-whole premium obligations. See, e.g., Bank of New York Mellon v. GC Merchandise Mart, LLC (In re Denver Merchandise Mart, Inc.), 740 F.3d 1052, 1059 (5th Cir. 2014); U.S. Bank Trust Nat’l Assoc. v. Am. Airlines, Inc. (In re AMR Corp.), 730 F.3d 88, 105 (2d Cir. 2013); In re MPM Silicones, LLC, 2014 BL 250360 (Bankr. S.D.N.Y. Sept. 9, 2014) (memorializing bench ruling of Aug. 26, 2014), aff’d U.S. Bank National Association v. Wilmington Savings Fund Society, FSB (In re MPM Silicones, LLC), 2015 BL 131356 (S.D.N.Y. May 4, 2015); Premier Entm’t Biloxi, LLC v. U.S. Bank Nat’l Ass’n (In re Premier Entm’t Biloxi, LLC), 445 B.R. 582, 627–28 (Bankr. S.D. Miss. 2010); In re Solutia Inc., 379 B.R. 473, 488 (Bankr. S.D.N.Y. 2007); but see In re School Specialty, Inc., No. 13-10125, 2013 Bankr. LEXIS 1897, at *19 (Bankr. D. Del. Apr. 22, 2013) (allowing claim for make-whole premium under New York law where loan agreement specifically provided for make-whole premium in event of “either prepayment or acceleration” and make-whole premium was not plainly disproportionate to lender’s probable loss).
The courts are divided on the alternative argument sometimes made that a lender should be entitled to contract damages (apart from a make-whole premium) for “dashed expectations” when its outstanding debt has been paid prior to its original maturity. See, e.g., Calpine, 2010 U.S. Dist. LEXIS 96792, at *18 (noteholders were not entitled to expectation damages because notes did not provide for payment of premiums upon acceleration and claims for expectation damages violated prohibition against unmatured interest under section 502(b)(2)); Premier Entm’t Biloxi, 445 B.R. at 631 (although lenders were not entitled to secured claim for make-whole damages because indenture required prepayment penalties only if debtor repaid loan prior to maturity, and maturity was automatically accelerated due to bankruptcy filing, lenders were entitled to unsecured claim for dashed expectations).
The bankruptcy court in Energy Future recently added to this growing body of jurisprudence.
Known as TXU Corp. until 2007, when it was acquired in what was then the largest leveraged buyout ever, Texas-based Energy Future Holdings Corp. and its subsidiaries (collectively, “Energy Future”) filed for chapter 11 protection in the District of Delaware on April 29, 2014, to implement a restructuring that would split the company and eliminate more than $26 billion in debt.
Energy Future’s pre-bankruptcy capital structure included $4 billion of first-lien notes divided into two separate tranches bearing different interest rates and maturities. Both issuances of first-lien notes included identical make-whole provisions designed to protect the noteholders from early redemption. In particular, the indenture governing each tranche of notes, in specifying what constitutes an “Optional Redemption,” stated that “at any time prior to December 1, 2015, the Issuer 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.” The “Applicable Premium” was defined as an amount equal to the greater of: (i) 1 percent of the principal amount of the notes; and (ii) the excess, if any, of the present value of the notes’ redemption price and the required interest payments to maturity over the outstanding principal amount of the notes.
The indenture also stated that an “Event of Default” occurs when Energy Future “commences proceedings to be adjudicated bankrupt or insolvent.” If such an Event of Default should occur, the indenture provided that “all outstanding Notes shall be due and payable immediately without further action or notice.” In the event of acceleration, the indenture gave the indenture trustee a qualified right to effectively decelerate the first-lien notes upon the request of the holders of at least a majority in principal amount of the notes.
On the bankruptcy petition date, Energy Future filed a restructuring support and lockup agreement that documented a broad settlement reached among Energy Future and various creditors. This “global settlement” included a settlement between Energy Future and some of the first-lien noteholders that was to be implemented by means of a postpetition tender offer. The tender offer proposed a “roll-up”—an exchange of existing first-lien notes for new notes bearing a lower interest rate to be issued under a $5.4 billion debtor-in-possession financing facility.
In exchange for new notes valued at 105 percent of outstanding principal and 101 percent of accrued interest, participating noteholders would agree to release their make-whole premium claims. Of Energy Future’s two tranches of first-lien debt, 97 percent of one tranche and 34 percent of the other tranche accepted the tender offer. Nonsettling noteholders retained the right to litigate the validity of their make-whole premium claims.
On the basis of these results, the bankruptcy court approved the settlement with accepting first-lien noteholders on June 6, 2014. That order was later upheld on appeal in Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 527 B.R. 157 (D. Del. 2015). Prior to the bankruptcy court’s approval of the settlement, the indenture trustee for the tranche of first-lien notes that had not overwhelmingly accepted the tender offer filed an adversary proceeding seeking, among other things, a determination that the nonsettling noteholders were entitled to a secured claim for a make-whole premium in the amount of approximately $660 million.
The bankruptcy court later bifurcated the adversary proceeding into two phases. In the first phase, it considered: (i) whether Energy Future was liable for the make-whole premium or other damages for breach of the no-call provision in the note indenture; and (ii) whether Energy Future intentionally defaulted on the notes in order to avoid paying the make-whole premium or other damages. The court assumed for purposes of this phase of the litigation that Energy Future was solvent and able to pay all creditor claims in full. The indenture trustee and Energy Future cross-moved for summary judgment on these issues.
The Bankruptcy Court’s Ruling
The court granted Energy Future’s motion for summary judgment in part and denied the trustee’s motion in its entirety.
Initially, the court ruled that the plain language of the indenture governing the first-lien notes did not require payment of a make-whole premium following acceleration due to a default caused by the commencement of a “proceeding to be adjudicated bankrupt or insolvent.” The court explained that the indenture provision, specifying the consequences of an event of default triggered by a bankruptcy filing, did not include any reference to “anything that would support the Trustee’s position that the Applicable Premium is owed upon a bankruptcy event of default and acceleration.” The court agreed with the approach applied in Calpine, Premier Entm’t, MPM Silicones, and Solutia, ruling that “the acceleration provision in the Indenture does not include clear and unambiguous language that a make-whole premium (here, the ‘Applicable Premium’) is due upon the repayment of the Notes following a bankruptcy acceleration.”
In so ruling, the court focused on the distinction between “redemption” and “acceleration.” Under the indenture, “Optional Redemption . . . is an act separate and apart from automatic acceleration.” The court agreed with Energy Future that the make-whole premium was due only upon an Optional Redemption and that repayment following acceleration did not constitute an Optional Redemption. It found that the Optional Redemption provision contemplated a voluntary action by Energy Future, noting that, under New York law (which governed the indenture), “a borrower’s repayment after acceleration is not considered voluntary.”
The court rejected the indenture trustee’s contention that Energy Future should be liable for the make-whole premium because its bankruptcy filing was an intentional default specifically designed to skirt such liability. According to the court, the indenture did not provide that the make-whole premium would be owed if Energy Future intentionally defaulted. Moreover, the court explained, although Energy Future had made no secret of its plans to use the default caused by the bankruptcy filing to refinance the first-lien notes without having to pay the Applicable Premium, “that is not enough to counter the overwhelming evidence that [Energy Future] filed for bankruptcy because [it] was facing a severe liquidity crisis.”
However, the court agreed with the indenture trustee that it has a qualified right under the indenture to rescind the automatic acceleration which took place upon Energy Future’s bankruptcy filing. If the rescission were to be effective retroactively (i.e., prior to the June 2014 repayment date), the court explained, Energy Future’s repayment of the first-lien notes would in fact constitute an Optional Redemption, and the make-whole premium would be payable. Although the trustee could not rescind the acceleration without violating the automatic stay, the court ruled that there was a material issue of fact as to whether “cause” existed to lift the stay. It accordingly denied Energy Future’s motion for summary judgment on this issue, stating that a trial must be held to consider the indenture trustee’s ability to decelerate the first-lien notes retroactively.
Five weeks after the bankruptcy court handed down its ruling in Energy Future, the U.S. District Court for the Southern District of New York affirmed the bankruptcy court’s rulings in MPM Silicones regarding make-whole premiums, subordination provisions in an intercreditor agreement, and the appropriate rate of interest to be paid to secured creditors under a cram-down chapter 11 plan. See U.S. Bank National Association v. Wilmington Savings Fund Society, FSB (In re MPM Silicones, LLC), 2015 BL 131356 (S.D.N.Y. May 4, 2015). In affirming the bankruptcy court’s order denying the payment of a make-whole premium to senior noteholders, the district court wrote that “[n]either the 2012 Indentures nor the Senior Lien Notes themselves clearly and unambiguously provide that the Senior Lien Noteholders are entitled to a make-whole payment in the event of an acceleration of debt caused by the voluntary commencement of a bankruptcy case.”
Viewed as a whole, the rulings in Energy Future, Calpine, Premier Entm’t, MPM Silicones, and Solutia send a clear message: In Delaware and New York, a bond indenture or other governing instrument must expressly and unequivocally provide that repayment is not permitted prior to the maturity date and that a make-whole premium is payable upon an automatic acceleration of the notes caused by a bankruptcy default. If such express and unequivocal provisions were included in the Energy Future bond indentures, the nonsettling first-lien noteholders would not have been forced to rely on the uncertain prospect that the court might grant relief from the stay to permit deceleration of the notes. It remains to be seen whether this alternative strategy to collect the make-whole premium will succeed.