The receipt of make-whole premiums, including during a bankruptcy after acceleration of the notes, is of paramount importance to noteholders. Decisions in some recent cases in New York and Delaware bankruptcy and federal district courts have held that note purchase agreements or indentures must include an express agreement that the make-whole premium (or similar prepayment premium) is payable upon acceleration (rather than prepayment) after the filing of a bankruptcy proceeding. In the recent Momentive decision (In re MPM Silicones, LLC), for example, the U.S. District Court for the Southern District of New York affirmed the finding of the bankruptcy court that the operative agreement did not require payment upon an acceleration since the language of the make-whole provision did not “clearly and unambiguously” provide for it.

In November, however, the Third Circuit Court of Appeals issued a decision that could halt the recent spate of decisions limiting the receipt of make-whole premiums after acceleration, at least in certain instances. In its Nov. 17 decision in Energy Future Holdings Inc., the court found that make-whole premiums were in fact payable upon a “redemption” (as opposed to a prepayment) even if the redemption occurred after a bankruptcy filing and the automatic acceleration of the underlying debt, where the applicable indentures did not expressly limit make-whole payments in those circumstances. The Third Circuit, in applying New York law, ruled that the proposed refinancings were “optional” redemptions, even though they occurred post-acceleration and during a bankruptcy case, and that the optional-redemption provisions of the indentures required payment of the make-whole premiums (in the amount of more than $400 million).

The Third Circuit was asked to rule on the issue on appeal from the lower bankruptcy court. The lower court case began in 2014, after Energy Future Intermediate Holding Co. LLC and EFIH Finance Inc. (Inc.) announced a plan, in connection with their bankruptcy, to refinance billions of dollars of first-lien notes issued in 2010 (due in 2020) and second-lien notes issued in 2011 and 2012 (due in 2021 and 2022, respectively) by Inc., pursuant to indentures with Delaware Trust Co. as trustee for the first-lien notes and with Computershare Trust Co. NA and Computershare Trust Co. of Canada as trustees for the second-lien notes. Inc. and its affiliates intended to refinance the notes while in bankruptcy without paying the make-whole amounts, which would otherwise have been payable upon a refinancing outside of a bankruptcy.

The indentures provided that Inc. could effect an “optional redemption” of the notes prior to a certain date only if it paid an “applicable premium” to compensate the holders for the future yield that would be lost upon redemption. In addition, as is commonly the case, the indentures provided that the notes would automatically accelerate upon a bankruptcy filing.

The bankruptcy court granted Inc. authority to effect the refinancings and, months later, ruled that the make-whole amounts were not triggered under the indentures by a post-acceleration repayment of the notes. The court reasoned that the notes were being repaid by reason of acceleration rather than as an optional redemption, and that the acceleration clause of the first-lien indenture did not specify that the make-whole amount was due upon or after acceleration of the notes. The court reached the same conclusion with respect to the second-lien notes, even though the second-lien indenture contained a different acceleration provision that required payment of “all principal of and premium, if any.” The district court agreed, and the trustees appealed to the Third Circuit.

In the absence of any language clearly stating that the make-whole premiums were not payable after acceleration, the Third Circuit found that the optional-redemption provisions and the acceleration provisions of the indentures could be read consistently together, giving effect to each, by requiring that the make-whole premiums be paid as a result of the refinancings. In reaching this conclusion, the court expressly rejected as unpersuasive the reasoning of the Momentive decision that would not enforce a make-whole provision post-acceleration without specific contractual language to that effect, stating that “the result in Momentive conflicts with that indenture’s text and fails to honor the parties’ bargain.”

The court also distinguished cases that refused to enforce “prepayment premiums” for post-acceleration repayment of debt from the facts of Energy Future, where the indentures provided for yield protection upon a voluntary redemption. While, by definition, there can be no prepayment after debt (and the maturity of that debt) is accelerated, the court reasoned that “redemption” of debt may still be effected post-acceleration, and make-whole provisions may be enforced post-acceleration when they are not styled as “prepayment premiums.”

While Inc. had asked the Third Circuit to reconsider its position, Inc. has now advised that it reached a proposed settlement with the holders to pay make-whole at a modest discount. Notwithstanding the proposed settlement, the decision is a positive step for noteholders expecting payment of make whole in connection with a bankruptcy. In short, the operative provisions of the note purchase agreement or indenture remain of utmost importance and whether a make-whole provision will be enforceable will continue to be determined upon the facts of that document and case. The operative note agreements should contain clear and unambiguous language providing when make-whole and other prepayment premiums are to be paid (including in connection with a bankruptcy).

The Momentive decision is also on appeal, so the question of whether the Second Circuit will follow the lead of the Third Circuit should soon be answered.