If repayment of debt is accelerated as a result of bankruptcy, are debtholders eligible to receive a make-whole premium? The answer from an increasing number of courts is, without specific language in the indenture, no. Indentures usually include specific language to protect investors by declaring that upon certain designated “bankruptcy events,” all outstanding securities issued under that indenture become immediately due and payable (without further action from the holders of the securities). This automatic acceleration remedy is usually reserved solely for an event of default as a result of a bankruptcy.
The make-whole premium is an additional amount on top of the principal amount of the debt that becomes due on the date of redemption. These make-whole premiums are included to prevent companies from redeeming debt early to the detriment of debtholders. Unlike an acceleration upon a bankruptcy event, optional redemption provisions are not automatic and become effective upon a decision by the issuer to redeem the debt early.
In a number of recent, high profile bankruptcy cases in New York and Delaware, trustees have argued, on behalf of debtholders, that acceleration as a result of an event of default arising out of a bankruptcy event should also be treated as an optional redemption. Their position is that the debtholders should be owed the applicable make-whole premium.1
In MPM Silicones, LLC, the Southern District of New York held against the noteholders, holding that the right to a make-whole premium upon bankruptcy must be clearly stated in the relevant indenture, as it is in most optional redemption provisions. Without language specifically stating that a make-whole premium would be due and owing following a bankruptcy default and acceleration, it would not be due in such case.
This precedent was recently followed in Delaware. As with MPM Silicones, LLC, upon the April 2014 bankruptcy filing of Energy Future Holdings Corp. (“EFH”), payments of certain first lien notes issued by Energy Future Intermediate Holding Company LLC (“EFIH”) were automatically accelerated. EFIH sought permission for debtor-in-possession financing to repay the principal and accrued interest under the notes as required under the indenture. The indenture trustee, acting on behalf of the noteholders, objected, arguing that the acceleration and repayment as a result of a voluntary bankruptcy constituted an “optional redemption,” which would require EFIH to pay the applicable make-whole premium. In June 2014, Judge Sontchi of the U.S. Bankruptcy Court for the District of Delaware granted EFIH permission to make the payments as required under the acceleration provision, but preserved the trustee’s right to seek the make-whole premium.
In a subsequent proceeding before Judge Sontchi, the trustee argued the noteholders were entitled to the make-whole amount using two different arguments. First, the trustee argued that EFH and EFIH made a voluntary decision to seek bankruptcy protection, in part, as an effort to avoid being required to pay any make-whole premium in connection with an optional redemption. As a result, the trustee argued, the decision to make the bankruptcy filing and thus cause an automatic acceleration should be construed by the court as an optional redemption.
The trustee also argued that although the event of default as a result of a bankruptcy led to an automatic acceleration, the indenture gave the noteholders the right to waive any default and therefore negate the acceleration. Under the indenture, “[t]he Holders of at least a majority in aggregate principal amount of the Notes by written notice to the trustee may on behalf of all the Holders waive any existing Default… and rescind any acceleration with respect to the Notes and its consequences (so long as such rescission would not conflict with any judgment of a court of competent jurisdiction).”2
The resulting “deceleration” would therefore require the respective debtors to pay the make-whole premium upon the optional redemption, which they would need to effect to redeem the outstanding notes prior to maturity.
The court agreed with the holding under New York law that “an indenture must contain express language requiring payment of a prepayment premium upon acceleration; otherwise, it is not owed.”3 The court also noted that the parties could have bargained for such a provision, and that if such language had been included in the indenture, under New York case law, such provisions have been upheld.4 In addressing the trustee’s first claim, the bankruptcy court disagreed, holding that while seeking to avoid the make-whole premium may have been part of the reason for the company’s decision to seek voluntary bankruptcy protection, EFH and EFIH had an unsupportable capital structure and the resulting liquidity crisis was a larger factor in the ultimate decision to file for voluntary bankruptcy protection. As a result, the court held that the bankruptcy was not designed to evade paying the make-whole premium. Furthermore, unlike some other indentures, there was nothing in the indenture that addressed a “voluntary default” as the trustee alleged the bankruptcy filing to be. Therefore, regardless of EFH and EFIH’s reasons for making the bankruptcy filing, it would likely not have affected the court’s decision. In addition, the indenture had distinct clauses for those cases in which there would be an automatic acceleration versus those situations which were deemed to be an optional redemption. The judge held that an optional redemption is “an act separate and apart from automatic acceleration”5 and that the nature of EFIH’s obligations under each provision was different. The optional redemption was a voluntary act while an acceleration was not.
As a result, the court held the trustee could not impose the duties associated with one on to the other.
In addressing the second claim that the trustee had the option to waive the default and thus rescind the acceleration the court was more sympathetic. As described above, the indenture stated that the right to waive a default could not conflict with a judicial decision. In addition to reviewing the provision granting the trustee this right, the court also held that the automatic stay is an operation of law and not a judicial order or decision.6 By this logic, if the rescission were made effective as of the date of the bankruptcy, any attempts by EFIH to repay the notes would be an optional redemption, subject to the make-whole premium. Despite the favorable holding, the court, however, concluded that any effort to rescind the acceleration would be a violation of the automatic stay imposed by the bankruptcy filing and therefore, a separate proceeding was necessary to determine whether there was “cause” to lift the stay to retroactively decelerate the notes.
The bankruptcy court presided over a three-day trial on the issue of “cause,” which ended on April 22, 2015. In May 2015, the parties filed their post-trial briefs defending their respective positions. On July 8, 2015, Judge Sontchi ruled that cause does not exist to lift the automatic stay to allow the trustee to waive the default and decelerate the notes. The trustee filed its notice of appeal on July 17, 2015.
What is clear is that if investors wish to receive a make-whole premium upon a bankruptcy event of the issuer, definitive language should be included in the relevant indenture document. It remains to be seen whether, given this series of decisions, any issuers will modify their existing disclosure to specifically disclaim any responsibility to pay a make-whole premium upon a bankruptcy event.