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Make-Whole Mayhem
Make-whole premiums are essentially prepayment penalties imposed on borrowers when loans are paid off in advance of their maturity dates. These premiums are increasingly common yield-protection tools meant to compensate lenders for interest they would otherwise receive for the remainder of the term but for the unexpected early repayment. Make-whole premiums remove the borrowers' incentives to refinance whenever interest rates drop, and provide stability and predictability to the world of secured lending.
Recently, tempted by attractive interest rates, certain borrowers have sought to use the bankruptcy process to shield themselves from their obligations to pay make-whole premiums contemplated by their indenture documents. Although certain courts have allowed crafty borrowers to shed unwanted make-whole obligations through the bankruptcy process, other courts, including the U.S. Court of Appeals for the Third Circuit, refuse to sanction such manipulation.
In a recent decision in the tumultuous bankruptcy proceedings of Energy Future Holdings Corp., et al. (hereinafter EFIH), the Third Circuit appears to have restored the vitality of so-called make-whole premiums. Delaware Trust Company v. Energy Future Intermediate Holding Company, et al. (In re Energy Future Holdings Corp.), Case No. 16-1351 (3rd Cir., Nov. 17, 2016). Reversing the decisions of the district and bankruptcy courts in Delaware, the Third Circuit held that certain noteholders were entitled to receive roughly $670 million in make-whole premiums pursuant to their respective indentures where the debt was “automatically accelerated” upon the issuer's bankruptcy filing. In so finding, the Third Circuit expressly rejected the reasoning and holdings expressed in recent decisions of the lower courts in the U.S. Court of Appeals for the Second Circuit, In re MPM Silicones, LLC, et al., No. 14-22503-RDD, 2014 WL 4436335, at *13-14 (Bankr. S.D.N.Y. Sept. 9, 2014) (hereinafter Momentive), perhaps generating a circuit split that will require resolution in the near future.
EFIH Notes
In 2010, Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (collectively, EFIH) borrowed approximately $4 billion at a 10% interest rate by issuing Notes due in 2020 (the First Lien Notes). The Indenture governing the loan (the First Lien Indenture) provided, in Section 3.07, for payment of an additional make-whole premium — called the “Applicable Premium” — if the notes were redeemed prior to Dec.1, 2015. Additionally, the First Lien Indenture contained, in Section 6.02, an acceleration provision that would make “all outstanding Notes … due and payable immediately” in the event EFIH was to file a bankruptcy petition.
Subsequently, in 2011 and 2012, EFIH borrowed additional funds by issuing two sets of second-priority Notes (the Second Lien Notes, together with the First Lien Notes, the Notes). The Indenture for the Second Lien Notes (the Second Lien Indenture, together with the First Lien Indenture, the Indentures) similarly provided, in Section 3.07, for payment of the “Applicable Premium” and contained a slightly broader acceleration provision, in Section 6.02, that would make “all principal of and premium, if any, interest … [,] and any other monetary obligations on the outstanding Notes … due and payable immediately[.]“.
EFIH Refinancing
In late 2013, market interest rates had declined such that EFIH was in a position to save nearly $13 million in interest payments per month if it could avoid the costly make-whole premiums due upon early repayment. Accordingly, on Nov. 1, 2013, EFIH filed an 8-K form with the Securities and Exchange Commission (SEC) where it revealed its plan to “file for bankruptcy and refinance the Notes without paying any make-whole amount.” Then, on April 29, 2014, EFIH and certain affiliates filed Chapter 11 bankruptcy petitions in the Bankruptcy Court for the District of Delaware, and immediately sought to refinance the Notes without paying the make-whole premiums. In response, the trustees for the holders of the Notes (the Noteholders) commenced two roughly identical adversary proceedings seeking declarations that the refinancing would trigger the make-whole premiums in their respective Indentures.
The Lower Courts Shed EFIH's Obligations To Pay 'Make-Whole' Premiums
Initially, it appeared that EFIH's strategy had worked: First, the United States Bankruptcy Court for the District of Delaware (the Bankruptcy Court) found that no make-whole premium was due on the First Lien Notes because the First Lien Indenture lacked “clear and unambiguous language that a make-whole premium … [would be] due upon the repayment of the Notes following a bankruptcy acceleration.” Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 527 B.R. 178, 193-194 (Bankr. D. Del. 2015).
The Bankruptcy Court similarly found no make-whole premium due on the Second Lien Notes because, even with the expanded acceleration clause, the Second Lien Indenture remained “insufficient and lacking in explicitness regarding whether a make-whole premium [would be] due upon an event of default.” Computershare Trust Co. N.A. v. Energy Future Intermediate Holding Co., LLC (Energy Future Holdings Corp.), 539 B.R. 723, 733 (Bankr. D. Del. 2015).
When the United States District Court for the District of Delaware (the District Court) affirmed these decisions, Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 2016 U.S. Dist. LEXIS 18201 (D. Del., Feb. 16, 2016); Computershare Trust Co., N.A. v. Energy Future Intermediate Holding Co., LLC (In re Energy Future Holdings Corp.), 2016 U.S. Dist. LEXIS 48671, *8-9, 2016 WL 1451045 (D. Del. Apr. 11, 2016), the Noteholders appealed to the Third Circuit.
Third Circuit Reverses And Reinstates EFIH's 'Make-Whole' Obligations
The Third Circuit reversed and found the make-whole premiums were in fact due. Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 2016 U.S. App. LEXIS 20601, *15-18, 842 F.3d 247 (3d Cir. Del. 2016).
First, the Third Circuit performed a critical, textual review of the Indenture to determine whether the refinancing constituted an “optional redemption” so to trigger EFIH's obligation to pay the make-whole premiums. In short, the Third Circuit concluded that: 1) the refinancing was a “redemption” (which, under New York law, includes both pre- and post-maturity repayments of debt) as opposed to a “prepayment” (which does not); and 2) the redemption was “optional” given that EFIH voluntarily filed for Chapter 11 bankruptcy protection. In deciding that the redemption was optional, the court emphasized that this scheme to shed the make-whole premium obligations was premeditated and deliberate, as evidenced by the companies' prior SEC filings.
Next, the Third Circuit considered and rejected EFIH's claim that the acceleration and make-whole provisions of the Indentures were in conflict. Rather than “different pathways” that the court must choose between, the Third Circuit saw these provisions as harmoniously working together to “form the map to guide the parties through a post-acceleration redemption.” In so finding, the Third Circuit relied on a New York Court of Appeals decision in NML Capital, which explained that “[w]hile it is understood that acceleration advances the maturity date of the debt,” there is no “rule of New York law declaring that other terms of the contract not necessarily impacted by acceleration … automatically cease to be enforceable after acceleration.” NML Capital v. Republic of Argentina, 952 N.E.2d 482, 492 (N.Y. 2011). The Third Circuit declared any perceived conflict to be “illusory” and applied them both to conclude that the make-whole premiums were in fact due.
Following the Third Circuit's ruling, EFIH quickly reached a settlement with its senior lenders, providing for modest discounts on the make-whole premiums due. The settlement, detailed in an 8-K filed with the SEC by EFIH, provides for a 95% to 97% recovery on first-lien claims totaling $574 million (plus certain interest, fees and expenses) and for a 87.5% to 92% recovery on second-lien claims totaling $244.6 million (plus certain interest, fees and expenses).
The Court's Apparent Distaste for Manipulation
It seems the Third Circuit was especially troubled by EFH's blatant (and premeditated) attempt to use bankruptcy as a tool to avoid the make-whole premiums. As discussed herein, this intent was no secret — EFIH stated in pre-bankruptcy SEC filings that it would pursue bankruptcy in part to shed these obligations.
These considerations were apparent in the Momentive decisions as well, although in Momentive, they cut in the opposite direction. In finding that the make-whole premiums were not due, the United States Bankruptcy Court for the Southern District of New York (the NY Bankruptcy Court) noted that “it is clear that the debtors' bankruptcy is not simply a tactical device to deprive the [lien holders] of a make-whole claim.” In re MPM Silicones, LLC, 2014 Bankr. LEXIS 3926, *37, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014). Although not relying exclusively on this basis, it appears that the NY Bankruptcy Court was sympathetic to fact that the debtor was not simply using the bankruptcy system for the primary purpose of shedding its make-whole obligations.
Similar to Momentive, the EFIH case is a large Chapter 11 case filed due to a multitude of reasons, not just to avoid the make-whole premium. It is somewhat unsettling that the Third Circuit's decision focused on the fact that EFIH “voluntarily” filed for bankruptcy and chose to take advantage of certain potential rights it has under applicable provisions of its indentures and the Bankruptcy Code. As with all contract interpretation, the task of deciphering ambiguous indenture documents should be guided by the parties' original intent. Importantly, the relevant intent is not whatever ultimately motivated the debtor to enter bankruptcy (which in EFIH's case was multiple reasons), but what the parties understood their respective rights and obligations to be at the time they executed the indenture. Short of the “bad-faith filing” of bankruptcy petitions, see, e.g., NMSBPCSLDHB, L.P. v. Integrated Telecom Express, Inc. (In re Integrated Telecom Express, Inc.), 384 F.3d 108, 128 (3d Cir. Del. 2004) (dismissing for bad faith where Chapter 11 petition filed despite debtor not in financial distress), courts should not let their judgment of the parties' subsequent motivations dictate their findings of those parties' original intent.
Conclusion
The major takeaway for practitioners from this saga is the significance of the specific language in the governing indenture. Although the courts' default leanings on make-whole premiums appear in flux, clear language one way or the other in the indenture documents will win the day. To avoid uncertainty (and costly litigation), indentures should be crafted (or revised) to preempt this issue. Under either the holding in Momentive or EFH, clear language stating that make-whole premiums will (or will not) become due upon a bankruptcy-induced acceleration and redemption will be given effect.
*****
Jeffrey R. Gleit is a partner in Sullivan & Worcester's Bankruptcy & Restructuring Group. His practice consists of representing debtors, creditors, creditor groups and investors in restructuring distressed companies in a variety of industries. Nathaniel R.B. Koslof is an associate in the firm's Boston office in the Litigation Department. The authors can be reached at [email protected] and [email protected], respectively.
Make-whole premiums are essentially prepayment penalties imposed on borrowers when loans are paid off in advance of their maturity dates. These premiums are increasingly common yield-protection tools meant to compensate lenders for interest they would otherwise receive for the remainder of the term but for the unexpected early repayment. Make-whole premiums remove the borrowers' incentives to refinance whenever interest rates drop, and provide stability and predictability to the world of secured lending.
Recently, tempted by attractive interest rates, certain borrowers have sought to use the bankruptcy process to shield themselves from their obligations to pay make-whole premiums contemplated by their indenture documents. Although certain courts have allowed crafty borrowers to shed unwanted make-whole obligations through the bankruptcy process, other courts, including the U.S. Court of Appeals for the Third Circuit, refuse to sanction such manipulation.
In a recent decision in the tumultuous bankruptcy proceedings of
EFIH Notes
In 2010, Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (collectively, EFIH) borrowed approximately $4 billion at a 10% interest rate by issuing Notes due in 2020 (the First Lien Notes). The Indenture governing the loan (the First Lien Indenture) provided, in Section 3.07, for payment of an additional make-whole premium — called the “Applicable Premium” — if the notes were redeemed prior to Dec.1, 2015. Additionally, the First Lien Indenture contained, in Section 6.02, an acceleration provision that would make “all outstanding Notes … due and payable immediately” in the event EFIH was to file a bankruptcy petition.
Subsequently, in 2011 and 2012, EFIH borrowed additional funds by issuing two sets of second-priority Notes (the Second Lien Notes, together with the First Lien Notes, the Notes). The Indenture for the Second Lien Notes (the Second Lien Indenture, together with the First Lien Indenture, the Indentures) similarly provided, in Section 3.07, for payment of the “Applicable Premium” and contained a slightly broader acceleration provision, in Section 6.02, that would make “all principal of and premium, if any, interest … [,] and any other monetary obligations on the outstanding Notes … due and payable immediately[.]“.
EFIH Refinancing
In late 2013, market interest rates had declined such that EFIH was in a position to save nearly $13 million in interest payments per month if it could avoid the costly make-whole premiums due upon early repayment. Accordingly, on Nov. 1, 2013, EFIH filed an 8-K form with the Securities and Exchange Commission (SEC) where it revealed its plan to “file for bankruptcy and refinance the Notes without paying any make-whole amount.” Then, on April 29, 2014, EFIH and certain affiliates filed Chapter 11 bankruptcy petitions in the Bankruptcy Court for the District of Delaware, and immediately sought to refinance the Notes without paying the make-whole premiums. In response, the trustees for the holders of the Notes (the Noteholders) commenced two roughly identical adversary proceedings seeking declarations that the refinancing would trigger the make-whole premiums in their respective Indentures.
The Lower Courts Shed EFIH's Obligations To Pay 'Make-Whole' Premiums
Initially, it appeared that EFIH's strategy had worked: First, the United States Bankruptcy Court for the District of Delaware (the Bankruptcy Court) found that no make-whole premium was due on the First Lien Notes because the First Lien Indenture lacked “clear and unambiguous language that a make-whole premium … [would be] due upon the repayment of the Notes following a bankruptcy acceleration.” Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC ( In re
The Bankruptcy Court similarly found no make-whole premium due on the Second Lien Notes because, even with the expanded acceleration clause, the Second Lien Indenture remained “insufficient and lacking in explicitness regarding whether a make-whole premium [would be] due upon an event of default.”
When the United States District Court for the District of Delaware (the District Court) affirmed these decisions, Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re
Third Circuit Reverses And Reinstates EFIH's 'Make-Whole' Obligations
The Third Circuit reversed and found the make-whole premiums were in fact due. Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re
First, the Third Circuit performed a critical, textual review of the Indenture to determine whether the refinancing constituted an “optional redemption” so to trigger EFIH's obligation to pay the make-whole premiums. In short, the Third Circuit concluded that: 1) the refinancing was a “redemption” (which, under
Next, the Third Circuit considered and rejected EFIH's claim that the acceleration and make-whole provisions of the Indentures were in conflict. Rather than “different pathways” that the court must choose between, the Third Circuit saw these provisions as harmoniously working together to “form the map to guide the parties through a post-acceleration redemption.” In so finding, the Third Circuit relied on a
Following the Third Circuit's ruling, EFIH quickly reached a settlement with its senior lenders, providing for modest discounts on the make-whole premiums due. The settlement, detailed in an 8-K filed with the SEC by EFIH, provides for a 95% to 97% recovery on first-lien claims totaling $574 million (plus certain interest, fees and expenses) and for a 87.5% to 92% recovery on second-lien claims totaling $244.6 million (plus certain interest, fees and expenses).
The Court's Apparent Distaste for Manipulation
It seems the Third Circuit was especially troubled by EFH's blatant (and premeditated) attempt to use bankruptcy as a tool to avoid the make-whole premiums. As discussed herein, this intent was no secret — EFIH stated in pre-bankruptcy SEC filings that it would pursue bankruptcy in part to shed these obligations.
These considerations were apparent in the Momentive decisions as well, although in Momentive, they cut in the opposite direction. In finding that the make-whole premiums were not due, the United States Bankruptcy Court for the Southern District of
Similar to Momentive, the EFIH case is a large Chapter 11 case filed due to a multitude of reasons, not just to avoid the make-whole premium. It is somewhat unsettling that the Third Circuit's decision focused on the fact that EFIH “voluntarily” filed for bankruptcy and chose to take advantage of certain potential rights it has under applicable provisions of its indentures and the Bankruptcy Code. As with all contract interpretation, the task of deciphering ambiguous indenture documents should be guided by the parties' original intent. Importantly, the relevant intent is not whatever ultimately motivated the debtor to enter bankruptcy (which in EFIH's case was multiple reasons), but what the parties understood their respective rights and obligations to be at the time they executed the indenture. Short of the “bad-faith filing” of bankruptcy petitions, see, e.g., NMSBPCSLDHB, L.P. v. Integrated Telecom
Conclusion
The major takeaway for practitioners from this saga is the significance of the specific language in the governing indenture. Although the courts' default leanings on make-whole premiums appear in flux, clear language one way or the other in the indenture documents will win the day. To avoid uncertainty (and costly litigation), indentures should be crafted (or revised) to preempt this issue. Under either the holding in Momentive or EFH, clear language stating that make-whole premiums will (or will not) become due upon a bankruptcy-induced acceleration and redemption will be given effect.
*****
Jeffrey R. Gleit is a partner in
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