In its second go-around before the Court of Appeals for the Second Circuit, Chesapeake Energy Corp. was required to pay noteholders a make-whole of $440 million for its 2013 early redemption of senior notes. The notes, with a total value of $1.3 billion, were issued in 2012 at 6.775% and were scheduled to mature in 2019. The supplemental indenture provided Chesapeake with two separate redemption rights. Under 1.7(b), Chesapeake could conduct a Special Early Redemption at a special redemption price of par plus accrued interest. Under 1.7(c), Chesapeake was obligated to pay a customary make-whole if it redeemed at “any time after March 15, 2013, to the Maturity Date.” In either case, the supplemental indenture required Chesapeake to provide 30 to 60 days’ notice to holders before commencing a redemption.

In the face of falling interest rates, Chesapeake announced on February 20, 2013, that it planned to redeem the notes at the special redemption price. Although there were less than 30 days before the March 15 deadline, the company asserted that March 15 was the deadline to give notice to holders of the Special Early Redemption, not the deadline for the redemption itself. On this basis, the company sought a declaratory judgment from the District Court that it was exempt from paying the make-whole.

The District Court ruled in favor of Chesapeake in May 2013, and the company completed the redemption several days later. However, BNY Mellon, the indenture trustee for the notes, succeeded on appeal in 2014 in having the ruling overturned by the Second Circuit. The Second Circuit rejected the company’s interpretation of the indenture, holding that the notes could only be redeemed at par if the redemption itself was completed, upon 30 to 60 days’ notice, no later than March 15, 2013. Thus, Chesapeake’s providing notice on February 20 precluded the redemption from qualifying as a Special Early Redemption. The Second Circuit remanded to the District Court to determine just how much the company owed noteholders.

On remand, Chesapeake asserted that it did not have to pay the make-whole as calculated under the indenture, which used the rate on Treasury notes of a comparable term plus 50 bps as the discount rate for calculating the present value. It argued that an equitable, or “restitutionary,” measure of damages was appropriate, on the grounds that it had attempted a Special Early Redemption in good faith. The noteholders should be economically returned to the position they would have been in had there been no redemption – by giving them the economic equivalent of the interest payments they would have received to maturity – but no better. On this theory, Chesapeake maintained, present value should be determined based on a market discount rate, which would generate a smaller present value. The company relied on cases that awarded restitution to defendants who forfeited money under compulsion of a trial judgment and later prevailed on appeal. By analogy, Chesapeake argued that it conducted the redemption in reliance on the District Court’s initial ruling that it qualified as a Special Early Redemption, which was later reversed on appeal.

The District Court ruled against the company in July 2015, explaining that restitution is commonly utilized in circumstances where no contract defines the litigants’ relationship. The notes, in contrast, were governed by a valid and enforceable indenture, which did not have a carve-out for botched early redemptions, even a failed redemption made in good faith.

In a brief decision, the Second Circuit recently affirmed the District Court’s holding that Chesapeake was obligated to pay the make-whole prescribed by the indenture. The Second Circuit reiterated the lower court’s basic premise that, where a valid and enforceable contract governs the relevant subject matter, the equitable remedy of restitution is generally not appropriate. It also observed that substituting out the prescribed make-whole on equitable grounds would confound investors’ valid expectations. The appellate court’s ruling ends Chesapeake’s attempts to avoid paying the make-whole premium. The result will be costly for Chesapeake – $380 million plus prejudgment interest, for a total of $440 million.

While there is not much that is surprising in the end game of Chesapeake’s failed attempt to evade its contractual obligations under the indenture, the basic lessons remain the same. Indentures will be strictly construed in accordance with their terms. Reliance on a lower court decision will not excuse failure to perform under the terms of the indenture, as ultimately interpreted by an appellate court. And restitutionary damages, formulated to approximate actual damages suffered by noteholders, will not be substituted for the express payment obligations of the issuer under the indenture.