Enforceability of Make-Whole Provisions in Bankruptcy: Maximizing - - PowerPoint PPT Presentation

Enforceability of Make-Whole Provisions in Bankruptcy: Maximizing Lender and Noteholder Rights to Prepayment Premiums

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TUESDAY, SEPTEMBER 23, 2014

Presenting a live 90-minute webinar with interactive Q&A Cindy Chen Delano, Vice President, Associate General Counsel, AIG Investments, New York Melinda Franek, Vice President and Senior Counsel, CNH Partners, Greenwich, Conn.

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Disclosures

The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of AQR Capital Management, CNH Partners, AIG Investments, or their respective affiliates and employees.

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General Considerations

Premise of Make-Whole / Yield-Maintenance Provisions

• Make-whole (MW) provisions are also referred to as “prepayment penalties,” “prepayment

premiums,” prepayment fees,” or “optional redemption” clauses.

• Lender Protection: Rather than prohibiting repayment, MW provisions are designed to

merely discourage borrowers from repaying debt as soon as credit markets move in their favor.

• Historically, more prevalent in bond markets and on other long term debt where investors

seek long term deployment of capital at fixed rates. Now, becoming more common in loan market.

• Examples:

– Fixed Percentage: expressed as a certain dollar amount or, more typically, a percentage of the principal amount to be repaid. – Net Present Value: formula-based MW premium that measures the difference between the lender’s expected return and a hypothetical, alternative investment stream (formula could include a minimum rate of return to ensure MW premium is not zero or a negative value).

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Other Protections Designed to Protect Lender Against Early Repayment

• “Hard” call – a specific date after which the company can call the bonds.
• “Soft” call – does not prevent the bonds from being called but pays the

investor a premium to the face value.

• Change of control or fundamental change premiums.
• OID (original interest discount): difference between the face amount of

the debt issued and the money received by the debt issuer. – This amount amortizes over the term of the debt and thus resembles interest accrual. – Often treated as interest in bankruptcy. Not a make-whole per se, but raises related issues.

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Considerations for Drafting

• Time period within which MW premium to apply?
• Amount: what is the amount and how is it calculated?
• Triggers for MW payment, e.g., does a repayment or refinancing in

bankruptcy qualify as a voluntary prepayment or redemption under the terms of the debt documents?

• Market convention plays a role.

– Currently, not seeing any push from the buy-side for explicit language in normal-way HY deals. – Occasionally we see tailored language in distressed situations where the buy-side has engaged counsel (separate from underwriter) and there is actual negotiation about the terms of the indenture.

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Bankruptcy Considerations for Make- Whole Premiums

Bankruptcy Considerations for Make-Wholes

Acceleration Analysis

• In bankruptcy, debt is automatically accelerated to the date the

company filed for bankruptcy. In addition, contracts typically provide for automatic acceleration of debt following a bankruptcy filing.

• If the debt is accelerated, is there still a valid claim for payment of a MW

premium under the agreement (which protected a lender’s expectation

• f future income streams)?

– Example: “Acceleration. If an Event of Default . . . occurs and is continuing, the Trustee by notice to the Company . . . may . . . declare the principal of, premium, if any, and accrued and unpaid interest, if any, on all the Securities be due and

• payable. Upon such a declaration, such principal, premium and accrued and unpaid

interest shall . . . be immediately due and payable”

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• Interest Analysis: Is the MW premium merely a proxy for a claim for unmatured

interest?

• RULE: A claim for “unmatured interest” is disallowed under the Bankruptcy Code. See

11 U.S.C. § 502(b)(2).

• “Unmatured interest” is defined as interest that has not yet accrued as of

the date a debtor filed for bankruptcy.

• Notwithstanding the general rule disallowing claims for unmatured interest, a claim for a

MW premium may still be enforced depending on whether the creditor is “over- secured,” “under-secured,” or “unsecured.”

• A lender is “over-secured” if the debt owed to such lender is less than the value of the

collateral securing that debt. Likewise, a lender is under-secured if the debt owed to such lender exceeds the value of the collateral securing that date. A lender is unsecured if the debt owed to such lender is not secured by any collateral.

• In the case of an over-secured lender,
• 1. the claim is not considered interest, but a reasonable fee or charge on the underlying principal;
• r
• 2. the borrower is solvent.

Bankruptcy Considerations for Make-Wholes

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Leading Cases: Southern District of New York

In re Calpine Corp. (Calpine I)

365 B.R. 392 (Bankr. SDNY 2007)

• Debtors were current on payments pre- and post-petition.
• Indenture provided that bankruptcy (BK) filing was event of default

(EoD) resulting in acceleration; therefore, debt had accelerated and matured by virtue of the Debtors’ filing.

• Secured claim unavailable due to lack of explicit language providing for

MW damages.

• However, court allowed unsecured claim for breach of

contract/expectation damages.

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In re Solutia Inc.

379 B.R. 473 (Bankr. SDNY 2007)

• Filing of BK was EoD resulting in automatic acceleration.
• Cash collateral order provided for interest payments to noteholders.
• Noteholders sent notice of rescission of acceleration and waiver of default, but

indenture only allowed deceleration after “notice of acceleration” as opposed to automatic acceleration. In addition, the notice was void because it violated the automatic stay (noteholders did not move to lift stay).

• Court rejected bondholders’ general unsecured claims for damages resulting

from, among other things, the triggering of a MW provision contained in the indentures for certain secured notes.

• The indentures provided for automatic acceleration, the bondholders had

explicitly opted to give up their future income in return for an immediate right to collect.

• Bondholders failed to include any additional language requiring the payment of

such prepayment premiums in the event of automatic acceleration.

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In re Calpine Corp. (Calpine II)

2010 U.S. Dist. LEXIS 96792 (SDNY 2010)

• No-call provisions became unenforceable once the Debtor filed for BK

(i.e., under the BK code, you cannot prevent a Debtor from reorganizing and paying its creditors).

• Accordingly, there can be no “damages” that result from an

unenforceable provision. In addition, payment did not result before maturity because accelerated debts are mature.

• No explicit provision in indenture providing for MW after acceleration.
• BK Court improperly awarded the noteholders unsecured damages in

lieu of the stream of payments they expected to receive over the life of the loans.

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In re Chemtura Corp.

439 B.R. 561 (Bankr. SDNY 2010)

• Indentures did not contain MW provision that provided for prepayment

premium on BK filing and automatic acceleration of debt.

• One indenture contained different definitions for “Maturity” and “Maturity

Date” – MW payable if payment before “Maturity Date.”

• Court persuaded by argument that BK automatic acceleration only

accelerated “Maturity.”

• The Chemtura court believed that the Calpine II analysis was flawed.
• Expressed concern about whether full MW would be penalty (but did not

have to reach this issue).

• MW settlement amount was within the range of reasonableness under

B.R. 9019.

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In re AMR Corp.

2013 Bankr. LEXIS 239 (Bankr. SDNY 2013)

• In 2009 and 2011, AMR negotiated 3 financing transactions, each of which was secured

by designated aircraft.

• After filing for chapter 11, AMR sought authority to incur $1.5B of new financing to be

used, in part, to refinance the prepetition notes.

• The indenture trustee argued that the payoff fell under the voluntary repayment section of

the indentures, which required a MW premium to be paid.

• AMR asserted that the notes automatically accelerated as a result of the BK filing and in

that situation the indentures explicitly provided that no MW was due.

• The court agreed with the debtors -- several provisions in the indentures were critical to

the court’s decision. The first provided that in the event of a bankruptcy acceleration: “the unpaid principal amount of the [notes] then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder (but for the avoidance of doubt, without Make-Whole Amount), shall immediately and without further act become due and payable[.]”

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In re AMR Corp.

2013 Bankr. LEXIS 239 (Bankr. SDNY 2013)

• Faced with the unfavorable language, the indenture trustee argued that

it could waive the bankruptcy default and decelerate the notes, thereby putting AMR in the position it would have been had it sought to refinance the notes before filing for bankruptcy.

• In addition, the indenture trustee argued that AMR’s §1110 election

effectively decelerated the debt. The court disagreed because: (i) 1110 does not require the debtor to cure a bankruptcy default and (ii) the statute was intended to be narrowly construed.

• As to the indenture trustee’s request for relief from the stay, the court

found it troubling that the noteholders only moved to lift the stay to serve a notice of rescission and deceleration after the issue was raised in oral arguments (late in the case).

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Leading Cases: Delaware

In re Trico Marine Services

450 B.R. 474 (Bankr. Del. 2011)

• Debtors made all payments when due.
• Obligations under indenture were unsecured, but were guaranteed by

the Maritime Administration (MARAD). The MARAD guarantee was secured by a first-priority lien on two supply vessels.

• Indenture also contained a MW provision.
• MW provision is akin to liquidated damages; court rejects argument that

MW is unmatured interest.

• However, claim to MW was at best an unsecured claim notwithstanding

the fact that MARAD required notes to be paid in full on sale of vessels in order to prevent noteholders from calling on the guarantee.

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In Re School Specialty, Inc.

(Bankr. Del. 2013)

• $70 million secured term loan agreement (May 2012) with Bayside

Finance.

• Prepetition the debtors entered into forbearance agreement with

Bayside and acknowledged breach of a covenant in the term loan, triggering the obligation for the premium.

• Interim DIP order stipulated to the $23.7 million prepayment penalty;

UCC moved to disallow the fee.

• Even though premium represented approximately 35% of the entire

principal amount outstanding, the court concluded it was not “plainly disproportionate” to Bayside’s probable loss.

• Drafting was clear on the issues of how much, when and whether the

make-whole payment would become due and payable upon acceleration.

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Leading Cases: Other Jurisdictions

In re Premier Entertainment Biloxi

445 B.R. 582 (Bankr. SD Miss. 2010)

• Notes accelerated automatically on filing of BK, moving the maturity

date from 2/1/12 to the petition date.

• Noteholders could rescind acceleration and waive any EoD.
• A separate provision provided for prepayment premium if Debtor willfully

caused notes to accelerate with intent of avoiding no-call provision.

• No specific language providing for premium after acceleration; however,

in solvent debtor cases damages for breach of no-call provision are allowable.

• Distinguished Solutia, noting that indenture provided that all remedies

were cumulative to the extent permitted by law.

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In re South Side House

2012 BL 26024 (E.D.N.Y. Jan. 30, 2012)

• In 2007, the debtor executed a note, mortgage and assignment of

leases and rents.

• The note was subject to a prepayment premium in the event the debtor

paid off the balance before the termination of the loan. In addition, if the debtor attempted to satisfy the debt prior to a foreclosure sale, such tender would constitute an evasion of the prepayment penalty.

• In November 2008, the debtor defaulted on the loan. The lender

accelerated and commenced foreclosure proceedings but the debtor filed for bankruptcy protection several months later, staying the foreclosure action.

• The bankruptcy court disallowed the prepayment penalty, reasoning that

the debtor never attempted to tender payment in satisfaction of the debt.

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In re GMX Resources

(Bankr. W .D. Okl. 2013)

• The lenders' anticipated losses were difficult to estimate at the time the

debt documents were drafted; calculating the rate by referencing U.S. Treasury bonds was not disproportionate to the anticipated losses.

• The MW premium was in the nature of liquidated damages and not

unmatured interest subject to disallowance under section 502(b)(2) of the Bankruptcy Code.

• The court did take testimony on whether the calculation of the MW

premium followed industry practice but ultimately concluded that the $66 million MW was part of the 1L claim.

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In re LaGuardia Assoc.

2012 BL 320564 (Bankr. E.D. Pa. Dec. 5, 2012)

• Debtor and UCC objected to the portion of a first mortgage holder's proof of claim which

represented a prepayment fee.

• The lender argued that the fee was triggered after the debtor defaulted on its payment
• bligations and the lender accelerated the maturity date of the loan.
• The note provided for a yield maintenance charge in connection with a prepayment following

lender’s exercise of remedies, but the lender conceded that event had not occurred.

• On an EoD, the lender was entitled to accelerate the maturity date of the note and declare any
• r all of the “Obligations” to be immediately due and payable.

– The note further provided that “[u]pon any such acceleration, payment of such accelerated amount shall constitute a prepayment of the principal balance of the Note and any applicable prepayment fee provided for in the Note shall then be immediately due and payable.”

• The lender argued that upon acceleration the prepayment fee became part of the "Obligations"

that become immediately due and payable; however, the court concluded that “[s]uch a reading completely nullifies the second sentence, rendering it wholly superfluous. In other words there is no need to declare "immediately due and payable" in the second sentence what has already become "immediately due and payable" pursuant to the first sentence.”

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Lessons from Precedent Cases

• The express language of the debt instrument is the single most

important factor in the analysis.

• Other questions/considerations:

– Unmatured interest subject to disallowance under §502(b)(2) of the Bankruptcy Code? – Solvent debtor? – Does premium amount to an impermissible penalty? – Voluntary “redemption” rather than payment following acceleration? – Timely enforcement of rights (AMR). – Results driven analysis.

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Pending/Recent Matters

Momentive Performance Materials

(Bankr. SDNY 2014)

• 1L and 1.5L notes asserted right to MW premium on repayment in

connection with plan of reorganization.

• Additional arguments included breach of the no-call provision and/or

the “perfect tender” rule.

• The indentures lacked language that would otherwise clearly and

specifically provide for the payment of the MW, notwithstanding automatic acceleration of the debt.

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Momentive Performance Materials

(Bankr. SDNY 2014)

• In its ruling, the court expressed frustration that the holders did not accept the

settlement offer embedded in the plan (par plus accrued in cash in exchange for waiving right to MW premium).

• The court concluded that lenders forfeit their right to an early payment penalty if

the debt documents provide for automatic acceleration on event of default (i.e., bankruptcy). – However, this leaves lenders in the untenable position of either forfeiting yield protection versus running afoul of the automatic stay.

• In addition, the noteholders’ motion to lift the stay to decelerate the debt was

denied on the basis that it would significantly affect other creditors and the debtors’ collective estate, enhancing the noteholders’ claims by hundreds of millions of dollars (but consider absolute priority rule?)

• Finally, the court determined that damages for breach of the perfect tender rule

would be barred by section 502(b)(2)’s prohibition against claims for unmatured interest.

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EFIH (TXU) (Bankr. Del. 2014)

• Court has ordered bifurcation of MW litigation.
• First phase to cover MW claims and any other potential redemption

claims such as breach of the no-call provisions or damages arising under the perfect tender rule.

• First phase will also cover whether debtors intentionally defaulted (to

the extent its relevant to the MW litigation).

• For phase 1, the court will assume the debtors are solvent and able to

pay allowed claims in full.

• If the notes are entitled to a redemption claim, phase 2 will cover the

amount of the claim and whether insolvency (if asserted by debtors) provides a basis for disallowing or limiting the redemption claim.

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EFIH (TXU) (Bankr. Del. 2014)

• Optional Redemption: 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 as of, and accrued and unpaid interest to, the date of redemption . . .

• Acceleration: In the case of an Event of Default under clause (6) or (7)
• f Section 6.01(a) hereof, all outstanding Notes shall be due and

payable immediately without further action or notice.

• Did EFIH’s refinancing actions during the bankruptcy case give rise to a

MW payment?

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Analysis Framework

State/Contract Law: Does the agreement allow for payment

• f the MW premium?

Acceleration Analysis Prepayment Analysis

Federal Bankruptcy Law: What is the nature of the MW premium?

Proxy for a Claim for Unmatured Interest?

Liquidated Damages

No Yes

Is the creditor secured or unsecured?

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Thanks

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Cindy Chen Delano AIG Investments Vice President, Associate General Counsel cindy.delano@aig.com Melinda Franek Vice President and Senior Counsel CNH Partners MFranek@cnhpartners.com