Earlier this month, Judge Sontchi dismissed an intercreditor adversary complaint filed in 2014 by the Energy Future Holdings (“EFH”) first-lien trustee against the second-lien noteholders. At issue in this decision, Delaware Trust Co. v. Computershare Trust Co. (In re Energy Future Holdings Corp.) was whether the first-lien trustee could, pursuant to the terms of the intercreditor collateral trust agreement (“Collateral Trust Agreement”), recover from the second-lien noteholders (who had received a partial paydown of their notes by the debtors) approximately $488 million, the amount of a premium payable under the first-lien indenture upon an early, voluntary repayment of the first-lien notes (the “Applicable Premium”). The court found that because the debtors had no obligation to pay the Applicable Premium, the Collateral Trust Agreement did not provide for turnover of the Applicable Premium amount from the second-lien noteholders.

Background

Crucial to the court’s decision were the court’s previous determinations in a separate adversary proceeding between the first-lien trustee and debtor Energy Future Intermediate Holding Co. LLC, which were covered in previous Bankruptcy Blog posts (See, What the Future Holds for Make-Whole Claims in Bankruptcy: Examining the Energy Future Holdings EFIH First Lien Make-Whole Decision – Part 1, Part 2, Part 3, and Part 4). In that proceeding, the court found that: (i) pursuant to the first-lien indenture, the first-lien noteholders could only recover the Applicable Premium if there was an “Optional Redemption” of the first-lien notes, (ii) the partial paydown of the second-lien notes was not an “Optional Redemption” under the first-lien indenture, and (iii) the first-lien notes were automatically accelerated by the debtors’ bankruptcy filing, which acceleration did not constitute an “Optional Redemption” under the first-lien indenture.

Subsequently, in an attempt to revive the Applicable Premium, the first-lien trustee moved to lift the automatic stay in order to decelerate payments due under the first-lien notes. The court denied the request and held that the Applicable Premium was therefore not owed by the debtors. This left the court with two fundamental issues: (i) was the Applicable Premium an obligation rendered unenforceable by operation of the Bankruptcy Code, or was it a contingent obligation that failed to mature by operation of the Bankruptcy Code, and (ii) if the Applicable Premium obligation never matured as against the debtors, could the first-lien trustee nonetheless recover the Applicable Premium amount from the second-lien noteholders?

The court found in that decision that the operation of the automatic stay was not the sole reason the Applicable Premium was not owed by the debtors; the automatic stay prevented rescission of the automatic acceleration of the first-lien notes that had already occurred upon the debtors’ bankruptcy filing. The Applicable Premium had been contingent only upon the lift-stay determination, and once the court denied the request to lift the stay, the first-lien notes were in fact accelerated and as a result the Applicable Premium obligation was not due.

Analysis

The question in the court’s most recent decision, then, was whether the Applicable Premium constitutes an “Obligation” under the Collateral Trust Agreement that would enable the first-lien trustee to assert a claim for the Applicable Premium against the second-lien noteholders. The Collateral Trust Agreement provides:

Obligations” means any principal, interest (including all interest accrued thereon after the commencement of any Insolvency or Liquidation Proceeding at the rate including any applicable post-default rate, specified in the Secured Debt Documents, even if such interest is not enforceable, allowable, or allowed as a claim in such proceedings), premium, penalties, fees, indemnifications, reimbursements, damages and other liabilities and guarantees of payment of such principal, interest, penalties, fees, indemnifications, reimbursements, damages and other liabilities, payable under the documentation governing the Indebtedness.

The second-lien trustee argued that the definition of “Obligations” does not include an obligation that is not actually payable under the first-lien indenture and therefore the Applicable Premium amount cannot be sought by the first-lien trustee. The first-lien trustee responded that despite the fact that the Applicable Premium amount was not allowed or allowable as against the debtors, such amount was nevertheless “payable under the documentation.”

The court found that the words “not enforceable, allowable, or allowed as a claim in such proceedings” unambiguously referred only to interest and not to other obligations. The court further noted that the parties clearly knew how to include such language and chose not to do so with respect to the other enumerated obligations in the definition.

The first-lien trustee further asserted that only the operation of section 362 of the Bankruptcy Code (as opposed to the provisions of the parties’ contract under state law) rendered the Applicable Premium unenforceable against the debtor, so the second-lien noteholders must turn over the collateral proceeds. In response, the second-lien trustee argued that either the first-lien notes had been decelerated or they had not, and that the first-lien trustee is essentially arguing that the bankruptcy court may leave the stay in place as to the debtor while “deeming” such stayed action to have occurred for purposes of adjudicating others’ rights.

The court agreed with the second-lien trustee’s argument, stating that “[t]o deem the First Lien Notes decelerated as to the Second Lien Noteholders, even though they have not been decelerated as to the Debtors, would be a fiction.” Slip Op. *21. The court then held that the Applicable Premium was not an “Obligation” for which the first-lien could seek turnover from the second-lien noteholders.

Ultimately, the court based its ruling on (i) the fact that the first-lien indenture lacked express language requiring the Applicable Premium upon automatic acceleration rather than voluntary redemption and (ii) the actual facts of the case—namely, that the first-lien notes automatically accelerated upon the bankruptcy filing and could not be decelerated because the first-lien notes did not obtain relief from the automatic stay—rather than a counterfactual legal fiction. The first-lien trustee is appealing the decision.

Conclusion

The bankruptcy court’s decision reiterates the importance of clear, explicit language to the enforceability of make-wholes in bankruptcy. Savvy creditors who want to ensure the payment of make-wholes in bankruptcy should explicitly provide in their debt documents that make-whole premiums are due upon automatic acceleration; here, the lack of such express language cost the creditors $488 million, a costly omission.

Today, we follow up on our earlier post where we reviewed the United States Bankruptcy Court for the District of Delaware’s decision in Energy Future Holdings, focusing on the contractual interpretation issues implicated in a make-whole analysis. As promised, today’s post focuses on the automatic stay issues raised in the bankruptcy court’s decision. The bankruptcy court held that (i) if the automatic stay were lifted, the Trustee for the EFIH First Lien Notes could decelerate the EFIH First Lien Notes and the non-settling Noteholders would then be entitled to a make-whole and (ii) a genuine issue of material fact existed as to whether the Trustee could establish cause to lift the automatic stay retroactively to decelerate the Notes.

The Summary Judgment Opinion

The Trustee’s Qualified Right to Rescind the Acceleration Was Barred by the Automatic Stay

The Trustee alleged that it had an “absolute” right under the Indenture to rescind the acceleration of the Notes and was entitled to a secured claim as compensation for its inability to exercise this right. Reserving the damages issue for the latter part of its opinion, the bankruptcy court disagreed that the right was absolute. Section 6.02 of the Indenture provided that the Trustee could waive any default and rescind any acceleration “so long as [the] rescission would not conflict with any judgment of a court of competent jurisdiction.” As an initial matter, the bankruptcy court agreed with the Trustee that the Trustee’s right to rescission was not barred under that provision as a result of the imposition of the automatic stay because, contrary to the EFIH Debtors’ argument, the automatic stay was not a “judgment of a court of competent jurisdiction” but a statutorily imposed protection.

On the other hand, the Trustee’s issuance of a rescission notice on June 4, 2014, was barred by the automatic stay. Consistent with courts in other cases such as Momentive, AMR Corp., and Solutia, the bankruptcy court found here that the Trustee’s issuance of a notice of rescission was an act to collect, assess or recover on a claim in violation of section 362(a)(6) of the Bankruptcy Code.

Interestingly, the bankruptcy court noted that, if the Trustee was able to lift the automatic stay retroactively to a date before the Notes were repaid on June 19, 2014 in the bankruptcy, the Trustee could give effect to its notice of rescission and thereby waive the default and decelerate the Notes. Under those circumstances, the bankruptcy court held that the non-settling Noteholders would be entitled to the “Applicable Premium” or make-whole, because the EFIH Debtors’ repayment of the Notes with the DIP loan proceeds after the rescission notice was issued would have constituted an “Optional Redemption.” Section 3.07 of the Indenture included an “Optional Redemption” that required any redemption of the Notes pursuant to that section before December 1, 2015, to include payment of principal, accrued interest and the make-whole.

A Genuine Issue of Material Fact Exists as to Whether the Automatic Stay Should Be Lifted

Whether cause existed to lift the automatic stay nunc pro tunc to a date before the Optional Redemption, however, was another issue and one that raised a genuine issue of material fact for the bankruptcy court. A determination of cause required the bankruptcy court to examine the “totality of the circumstances” and apply a three-factor balancing test: (i) whether any great prejudice to either the debtor or the estate would result from lifting the stay, (ii) whether the hardship to the non-debtor party in maintaining the stay would “considerably outweigh” the hardship to the debtor, and (iii) the probability that the creditor would prevail on the merits of any litigation. The Trustee alleged that cause existed because the EFIH Debtors were presumed to be solvent and that holding the EFIH Debtors to the terms of the Indenture would do no harm to a solvent estate. The bankruptcy court disagreed, holding that a presumption of solvency alone would not be sufficient to resolve the cause question. It denied summary judgment in favor of either party on this issue, paving the way for a trial to determine the issue of whether cause exists.

The Lift Stay Litigation

To lift the automatic stay in the Third Circuit, the bankruptcy court must ultimately find that the harm to the Noteholders from maintaining the automatic stay “considerably outweighs” the harm to the EFIH Debtors from lifting the automatic stay. The bankruptcy court presided over a three-day trial on the issue of “cause,” which ended on April 22, 2015. Last week, the parties filed their post-trial briefs defending their respective positions, the main points of which are summarized below.

Whether Lifting the Stay Results in Any Great Prejudice to the EFIH Debtors or Their Estates

The Noteholders argue that the EFIH Debtors’ estates will not be greatly prejudiced by lifting the automatic stay. First, as holding companies, the EFIH Debtors have no physical operations, employees or customers that will be harmed by the allowance of an additional $431 million of make-whole claims. Second, the EFIH Debtors’ assets will not be harmed because EFIH will continue to maintain its interest in its primary asset, the equity of its subsidiary, Oncor, and the value of that equity interest is not otherwise impacted by lifting the stay. Third, the EFIH Debtors’ creditors will not be harmed because the EFIH Debtors are presumed to be solvent and will continue to be able to pay all their creditors in full even after the make-whole claim is allowed.

In opposition, the EFIH Debtors assert that they will suffer great harm from lifting the automatic stay because every penny of the $431 million in make-whole claim allowed will reduce the recovery of another stakeholder, including the EIFH Debtors’ equityholders. Moreover, allowing the Noteholders to lift the automatic stay has broader implications. Other similarly situated creditors, like the EFIH Second Lien Noteholders and PIK Noteholders, would likely follow suit, seeking to lift the stay and collect on their make-wholes. In the aggregate, the EFIH Debtors’ estates could see approximately $900 million in additional claims.

The Noteholders in turn argue that, contrary to the EFIH Debtors’ assertions, requiring a solvent debtor to satisfy the claims of its creditors before paying a dividend to shareholders does not constitute a great prejudice. They argue that the interests of shareholders become subordinated to the interests of creditors in bankruptcy; that the absolute priority rule mandates that creditors must be paid in full before value is distributed to equity. The Noteholders also cite to other instances in bankruptcy where courts have determined there was no great prejudice in lifting the stay against solvent debtors and assert that the bankruptcy law limitations on a creditor enforcing its state-law rights, which may be necessary to protect other creditors in an insolvent case, need no longer apply in a solvent debtor case where all creditors’ claims will be satisfied. Lastly, the Noteholders distinguish the impact of lifting the stay with respect to the EFIH First Lien Notes on the EFIH Second Lien or PIK Notes, arguing that the other noteholders have not yet filed motions to lift the automatic stay and not all the noteholders will have been or will be repaid in such a way that triggers their respective make-whole premiums.

Whether Maintaining the Stay Results in Harm to the Noteholders That Considerably Outweighs the Hardship to the EFIH Debtors

The Noteholders argue that, for several reasons, considerable harm is imposed on them as a result of maintaining the stay. First, the approximately $431 million economic hit to the Noteholders represents about 20% of their principal investment, whereas it represents only about 5% of the EFIH Debtors’ total outstanding debt. Second, the make-whole was a critical part of the rights bargained for by the Noteholders to protect them from the potential loss of yield due to early repayment of the debt. If the EFIH Debtors paid the Noteholders the 10% interest the Noteholders bargained for under the Indenture, the Noteholders would have earned payments of about $454 million through December 1, 2015. According to the Noteholders, due to the low interest rate environment, had they reinvested their repaid $2.3 billion in funds into comparable bonds yielding 1.74%, it would have led to an actual economic loss of approximately $396 million. The Noteholders argue that allowing them to exercise their right to rescind acceleration under the Indenture would allow them to protect against these actual losses.

On the other hand, the EFIH Debtors counter that the harm to the Noteholders and the harm to the EFIH Debtors are equal in dollar amount: $431 million. As for the percentage harm to the individual Noteholders as compared against the percentage harm to the EFIH Debtors, the EFIH Debtors highlight that the lost premium represented in some cases .5% or .25% of the individual Noteholders’ assets under management. From the EFIH Debtors’ perspective, if the bankruptcy court were to look at “arbitrary percentages” at all in considering harm, then it should determine based upon these percentages that the harm to the EFIH Debtors considerably outweighs the harm to the Noteholders. The Debtors further argue that the Noteholders were not able to demonstrate that they had any reasonable expectation that they would still be entitled to a make-whole claim after automatic acceleration upon a bankruptcy filing.

Probability That the Noteholders Would Prevail on the Litigation

Lastly, the EFIH Debtors argue that the Noteholders cannot succeed on the third prong of the lift-stay analysis because the Bankruptcy Code itself automatically accelerated the Noteholders’ debt by operation of law, thus precluding the Trustee from contractually decelerating the debt in an attempt to increase the Noteholders’ claim size. In the words of the EFIH Debtors, the Noteholders’ rescission attempts amount to a reinstatement of debt, which is only permitted under section 1124(2)(B) of the Bankruptcy Code. Section 1124(2)(B) provides that claims are impaired unless a plan of reorganization “reinstates the maturity of such claim or interest as such maturity existed before such default.” Because the Noteholders are not seeking reinstatement pursuant to a plan, they should be barred from effectuating the same result through lifting the automatic stay.

In contrast, the Noteholders argue that the third factor clearly favors them. They assert that the law of the case is that the Noteholders have the right to rescind acceleration of the Notes and that, upon rescission, the make-whole claim would be owed. In support, they point to the bankruptcy court’s explicit language in the summary judgment opinion summarized above. Furthermore, the Noteholders disagree that acceleration by operation of the Bankruptcy Code precludes their ability to seek a make-whole claim. They argue that acceleration by operation of law does not make the Notes immediately due and payable. In fact, the definition of “claim” in the Bankruptcy Code, which includes any right to payment whether or not such right is matured or unmatured, and section 502(b) of the Bankruptcy Code, which permits a creditors’ proof of claim to be allowed even if such claim is unmatured, both demonstrate that the Bankruptcy Code does not contemplate that the maturity date of all debts will automatically advance to the petition date upon a bankruptcy filing. Instead, the Noteholders explain that acceleration of debt by operation of law merely permits a creditor to file a proof claim for its full debt, even if the debt is unmatured.

Conclusion

Unlike prior cases where courts have denied a creditor the ability to lift the automatic stay to decelerate contractually accelerated debt, here, the EFIH Debtors were presumed to be solvent – a fact that could influence the bankruptcy court’s finding as to “cause”. Whether the unique facts of this case will ultimately tip the scales in favor of the bankruptcy court lifting the automatic stay, however, remains to be seen. The bankruptcy court’s opinion did not resolve the issue of whether cause exists to lift the stay on summary judgment and a subsequent three-day trial and further pre- and post-trial briefing on the issue concluded with Judge Sontchi taking the matter under advisement with no clear indication of when he would hand down a decision. If Judge Sontchi finds cause exists to lift the automatic stay, the EFIH Second Lien noteholders whose claims have also been repaid in chapter 11 will almost certainly rely on the ruling to seek payment of their make-whole claims. Such a ruling undoubtedly would also be used as leverage by other noteholders, whether repaid or not, throughout the EFIH capital structure in pursuit of their make-whole claims and it would have larger implications for other chapter 11 cases with solvent debtors. As such, we eagerly await Judge Sontchi’s decision on the lift stay litigation and will be sure to update you when it is issued.