In February 2016, Energy Future Holdings Corp. (“EF”), which obtained confirmation of a chapter 11 plan on December 3, 2015, prevailed at the district court level in related appeals brought by first- and second-lien noteholders of bankruptcy court orders disallowing the noteholders’ claims for make-whole premiums allegedly due under their note indentures. The forum in this hotly contested and long-running dispute has now moved to the Third Circuit Court of Appeals.

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 have received if the borrower had paid off the debt at maturity.

Bankruptcy courts almost uniformly refuse to enforce no-call provisions against debtors, permitting debtors to repay outstanding debt despite such provisions. Seee.g., HSBC Bank USA, N.A. v. Calpine Corp., 2010 BL 380458 (S.D.N.Y. Sept. 14, 2010); Cont’l Sec. Corp. v. Shenandoah Nursing Home P’ship, 188 B.R. 205 (W.D. Va. 1995); In re Vest Assocs., 217 B.R. 696 (Bankr. S.D.N.Y. 1998). 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 (5th Cir. 2014); U.S. Bank Trust Nat’l Assoc. v. Am. Airlines, Inc. (In re AMR Corp.), 730 F.3d 88 (2d Cir. 2013); In re MPM Silicones, LLC, 2014 BL 250360 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’dU.S. Bank National Association v. Wilmington Savings Fund Society, FSB (In re MPM Silicones, LLC), 531 B.R. 321 (S.D.N.Y. 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 (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., 2013 BL 107127 (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 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. Compare Calpine, 2010 BL 380458, at *6–7 (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)) with 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).

Energy Future

The Delaware bankruptcy court presiding over the chapter 11 cases of EF and its affiliates weighed in on this issue in a pair of rulings in 2015—Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 527 B.R. 178 (Bankr. D. Del. 2015), andComputershare Tr. Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 539 B.R. 723 (Bankr. D. Del. 2015), motion for direct certification of appeal to Third Circuit denied, No. 1:14-ap-50405 (Bankr. D. Del. Nov. 30, 2015).

Aligning itself with a number of Southern District of New York bankruptcy courts, the court granted partial summary judgment to the debtor-borrower in both cases, which involved claims for make-whole premiums asserted by first- and second-lien noteholders. The court ruled that, although the debtor repaid the bonds prior to maturity, make-whole premiums were not payable under the plain terms of the bond indentures because automatic acceleration of the debt triggered by the debtor’s chapter 11 filing was not a “voluntary” repayment.

In the Del. Trust Co. case cited above, 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 first-lien notes, as permitted under the terms of the indenture. The bankruptcy court subsequently denied that request in Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 533 B.R. 106 (Bankr. D. Del. 2015). The court concluded that stay relief was unwarranted because the debtor’s estate and its stakeholders would be greatly prejudiced by lifting the stay, and the harm to the first-lien noteholders did not substantially outweigh the harm to the debtor’s estate. It also held that the noteholders were not entitled to expectation damages due to their inability to rescind the acceleration notice. The indenture trustee appealed the bankruptcy court’s rulings disallowing the make-whole premium claim and denying relief from the automatic stay.

The District Court’s Rulings

Judge Richard Andrews of the U.S. District Court for the District of Delaware upheld both rulings. On February 9, 2016, he ruled from the bench that the first-lien noteholders were not entitled to a make-whole premium for substantially the same reasons articulated by the bankruptcy court.

In a separate decision issued on February 16, Judge Andrews affirmed the bankruptcy court’s ruling denying relief from the automatic stay and disallowing any claim for damages arising from the inability to rescind acceleration of the first-lien notes. See Del. Tr. Co. v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings Corp.), 2016 BL 42871 (D. Del. Feb. 16, 2016).

On appeal to the district court, the indenture trustee argued that the bankruptcy court had erred in ruling that, although the first-lien noteholders had the right under the indenture to rescind acceleration and be paid the make-whole premium, that right was stayed by the automatic stay and, as a result, the noteholders’ claim for the make-whole premium, or for damages due to frustration of the right to rescind, must be disallowed.

Judge Andrews, however, did not fault the bankruptcy court for barring the indenture trustee from pursuing the contractual right to rescind. According to the judge, the indenture trustee’s arguments “appear to be little more than an effort to evade clear precedent that a bankruptcy stay prevents specific enforcement of such contractual rights” (citing AMR Corp., 730 F.3d at 102; In re Chemtura Corp., 439 B.R. 561, 604 (Bankr. S.D.N.Y. 2010)).

Addressing the damages claim, the court ruled that the bankruptcy court correctly concluded that the first-lien indenture does not expressly provide for damages for breach of the right to rescission, “thereby disallowing a secured claim for damages” under section 506(b) of the Bankruptcy Code. Judge Andrews explained that, although some courts have permitted parties to pursue unsecured claims for breach of no-call provisions in bond indentures, he was more persuaded by contrary rulings (citing MPM Siliconesand Calpine).

In light of Judge Andrews’ rulings with respect to the first-lien notes and in anticipation of similar decisions in a related appeal filed on behalf of EF’s second-lien noteholders, the indenture trustee for the second-lien noteholders waived oral argument in the related appeal and requested that it be decided solely on the basis of the pleadings. 

Judge Andrews’ rulings in the Del. Trust case were appealed to the Third Circuit on February 17, 2016.