On November 17, 2016, the Third Circuit Court of Appeals issued a highly anticipated ruling in the chapter 11 reorganization of Energy Future Holdings Corp. ("EFH"), invalidating one of the aspects of EFH’s confirmed chapter 11 plan. In Del. Tr. Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016), a three-judge panel of the Third Circuit reversed lower court rulings disallowing the claims of EFH’s noteholders for hundreds of millions of dollars in make-whole premiums allegedly due under their indentures. In so ruling, the court created a rift between courts in the Second and Third Circuits as to whether a company that redeems debt after filing for bankruptcy is obligated to pay make-whole premiums provided for in the governing debt instruments.

EFH filed for chapter 11 protection in the District of Delaware in 2014. The company’s pre-bankruptcy capital structure included first-lien and second-lien notes. The indentures for the notes included make-whole provisions designed to protect the noteholders from early redemption.

Specifically, in specifying what constitutes an "Optional Redemption," section 3.07 of each of the indentures provided that "the Issuer may redeem all or a part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium . . . and accrued and unpaid interest."

The "Applicable Premium"—or make-whole premium—was designed to compensate the noteholders for early redemption of the first- and second-lien notes by paying them a specified percentage of the outstanding principal and stream of anticipated interest payments on the notes until their stated maturity.

Section 6.02 of the first-lien indenture contained an acceleration provision that makes "all outstanding Notes . . . due and payable immediately" if EFH files a bankruptcy petition. The acceleration provision in the second-lien indenture (also section 6.02) was slightly different: it provided that, if EFH files for bankruptcy, "all principal of and premium, if any, interest . . .[,] and any other obligations on the outstanding Notes shall be due and payable immediately[.]" Both indentures gave noteholders the right to "rescind any acceleration [of] the Notes and its consequences."

After filing for bankruptcy, EFH proposed to refinance the notes without paying the make-whole premiums. Aligning itself with a number of Southern District of New York courts (see In re MPM Silicones, LLC, 2014 BL 250360 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 (S.D.N.Y. 2015)), the Delaware bankruptcy court ruled that, although EFH repaid the bonds prior to maturity, make-whole premiums were not payable under the bond indentures because the plain language of the indentures did not require the payment of a make-whole premium following a bankruptcy acceleration. It also held that EFH’s repayment of the bonds was not an "optional redemption" because, under New York law, a borrower’s repayment after acceleration is not considered "voluntary." Finally, the court ruled that EFH "did not file bankruptcy in an intentional effort to default under the Indenture so that the Applicable Premium would not be due." See Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 527 B.R. 178 (Bankr. D. Del. 2015); Computershare Tr. Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 539 B.R. 723 (Bankr. D. Del. 2015). The court later denied the noteholders’ request for retroactive relief from the automatic stay to rescind the acceleration and demand payment of the make-whole premium. See Del. Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 533 B.R. 106 (Bankr. D. Del. 2015). Those rulings were upheld on appeal to the district court. See Computershare Tr. Co. v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings Corp.), 2016 BL 113612 (D. Del. Apr. 11, 2016); Del. Tr. Co. v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings Corp.), 2016 BL 42871 (D. Del. Feb. 16, 2016).

The Third Circuit reversed the make-whole premium rulings. Writing for the panel, circuit judge Thomas L. Ambro stated:

These rulings put the . . . noteholders in a catch-22. When [EFH] filed for bankruptcy, the maturity of its debt accelerated. This, according to the bankruptcy court, cut off the . . . noteholders’ right to yield-protection. Rescission of the acceleration would have restored that right. But rescission was blocked by the automatic stay, which the court refused to lift.

The panel concluded that EFH’s refinancing of the notes after filing for bankruptcy was a "redemption" within section 3.07 of the indentures and that the redemption was optional. A chapter 11 debtor which has the ability to refinance debt on better terms, Judge Ambro explained, "cannot reasonably assert that its repayment of debt is not ‘voluntary’ " (citation omitted). Thus, the panel ruled, the indentures require EFH to pay the make-whole premiums.

The panel rejected the argument that sections 3.07 (redemption) and 6.02 (acceleration upon bankruptcy) of the indentures were in conflict. Judge Ambro stated, "We know no reason why we should choose between Sections 3.07 and 6.02 when both plainly apply." He explained that "[b]y its own terms, Section 3.07 governs the optional redemption embedded in the refinancing and requires payment of the make-whole."

The panel found MPM Silicones to be "unpersuasive" and also rejected EFH’s reliance on a New York Supreme Court decision—Northwestern Mutual Life Ins. Co. v. Uniondale Realty Assocs., 816 N.Y.S.2d 831 (N.Y. Sup. Ct. 2006)—to support EFH’s contention that it should not be required to pay a make-whole premium because section 6.02 of the indentures caused the notes’ maturity to accelerate before it redeemed them. Initially, the panel noted that Northwestern conflicts with the ruling in NML Capital v. Republic of Argentina, 952 N.E.2d 482, 492 (N.Y. 2011), where New York’s highest court wrote that "[w]hile it is understood that acceleration advances the maturity date of a debt, [the court was] unaware of any rule of New York law declaring that other terms of the contract not necessarily impacted by acceleration . . . automatically cease to be enforceable after acceleration."

Moreover, the panel noted that the court in Northwestern held that a mortgage lender which elected to foreclose following default was not entitled to a "prepayment premium" because foreclosure had advanced the maturity date of the debt. A lender should not be permitted to accelerate and seek immediate repayment and then "pile on" by also seeking to recover a prepayment premium prior to the original stated maturity.

Judge Ambro wrote that "while a premium contingent on ‘prepayment’ could not take effect after the debt’s maturity, . . . a premium tied to a ‘redemption’ would be unaffected by acceleration of a debt’s maturity." The judge summarized the "logical path" mapped out by the "Northwestern rule" as follows: "[P]repayments cannot occur when payment is now due by acceleration of the debt’s maturity. If parties want to mandate a ‘prepayment’ premium following acceleration, they must clearly state it in their agreement."

But in Energy Future, the panel concluded that: (i) "application of the rule is off point because § 3.07 . . . does not use the word ‘prepayment’ "; (ii) by avoiding the term "prepayment" and using "redemption" instead, the parties intended that the make-whole premium would apply without regard to the maturity of the notes; and (iii) the policy of Northwestern "does not reach this case" because the noteholders did not seek both immediate repayment and payment of the make-whole premiums, but instead, EFH voluntarily redeemed the notes, in fact over the noteholders’ objection.

Postscript

On December 1, 2016, EFH filed an amended chapter 11 plan with the bankruptcy court. The new plan removed language that conditioned the effectiveness of the plan on the disallowance of the first- and second-lien noteholders’ make-whole claims. The plan also removed a footnote that ensured recovery for unsecured payment-in-kind noteholders. Bankruptcy judge Christopher S. Sontchi directed that the confirmation hearing for the plan be delayed until February 14, 2017, to give the parties ample opportunity to address the proposed changes.

On December 15, 2016, EFH asked the Third Circuit to reconsider its ruling, arguing that the decision clashes with rulings from the Southern District of New York and that the question should be certified to the New York Court of Appeals.

On December 20, 2016, EFH announced that had it reached a settlement with the noteholders in the make-whole premium dispute. Under the proposed settlement, which must be approved by the bankruptcy court, first-lien noteholders would recover 95 percent of their make-whole claim ($574 million), unless unsecured noteholders reject EFH’s amended chapter 11 plan, in which case the first-lien noteholders’ recovery would be increased to 97 percent. Second-lien noteholders would receive 87.5 percent of their make-whole premium ($245 million), unless unsecured noteholders reject the amended plan, in which case the second-lien noteholders’ recovery would be increased to 92 percent. Another $1.7 billion in unpaid principal and $486 million in accrued unpaid interest would also be due to second-lien holders if the amended plan is effective by then.

On January 3, 2017, EFH announced that it would abandon the proposed settlement with the secured noteholders in favor of a deal with unsecured noteholders, a move which may prompt the noteholders to reject EFH’s amended chapter 11 plan.