On Sept. 12, 2013, the United States Court of Appeals for the Second Circuit affirmed the bankruptcy court’s decision to deny payment of a make-whole premium (the “Make-Whole Amount”) to bondholders under three separate indentures (the “Indentures”) based on the plain language of those agreements. U.S. Bank Trust Nat’l Ass’n v. AMR Corp. et al. (In re AMR Corp.), __ F.3d __, 2013 WL 4840474 (2d Cir. Sept. 12, 2013) (“In re AMR Corp. II”). The ability to recover a make-whole premium in a bankruptcy case has been the subject of debate over the past few years. Although the bankruptcy court denied recovery of the Make-Whole Amount, its decision was based entirely on contract interpretation and it expressly held that “there is no dispute that make-whole amounts are permissible.” 485 B.R. 279, 303 (Bankr. S.D.N.Y. 2013) (“In re AMR Corp. I”). The Second Circuit’s decision did not change this landscape.[1] The ruling was focused on the Indentures’ plain language, which expressly and unambiguously excused American Airlines and its affiliates (collectively, “American”) from paying the Make-Whole Amount if the debt was automatically accelerated by virtue of a bankruptcy filing.

Facts American filed Chapter 11 petitions on Nov. 29, 2011. See In re AMR Corp. II, 2013 WL 4840474, at *1. Before the bankruptcy, American had entered into three separate financing transactions, each of which was secured by a discrete aircraft pool (the “Prepetition Financing”). Id. at *1. The plain language of the Indentures governing each financing provided, among other things, that:

  • The Make-Whole Amount was due if American voluntarily redeemed the notes before the maturity date (id. at *2);[2]
  • A bankruptcy filing constituted an event of default, which, in turn, resulted in automatic acceleration of the debt (id. at *2-3); and
  • If the debt was automatically accelerated by a virtue of a bankruptcy filing, then no Make-Whole Amount was due from American (id. at *3).  

Nearly a year into its case, American sought court approval to obtain new post-petition financing in the amount of $1.5 billion, the proceeds of which would be used to repay the Prepetition Financing. Id. at *3. American admitted that the purpose of the new financing was to take advantage of low interest rates and other favorable market conditions. Id. at *7. The interest savings alone were estimated to be in excess of $200 million. In re AMR Corp. I, 485 B.R. at 287. The trustee under the Indentures (the “Trustee”) objected and argued that American’s “early redemption” required it to pay the Make-Whole Amount. In re AMR Corp. II, 2013 WL 4840474, at *3. American countered that its bankruptcy filing had triggered an event of default under the Indentures, which resulted in an automatic acceleration that, pursuant to Section 4.02(a)(i) of the Indentures, did not contractually require payment of the Make-Whole Amount. In re AMR Corp. I, 485 B.R. at 287.

The bankruptcy court agreed with American and held that, under the plain language of the Indentures, the Make-Whole Amount was not due. In re AMR Corp. II, 2013 WL 4840474, at *4. The Trustee appealed directly to the Second Circuit, which rejected all the Trustee’s arguments and affirmed the bankruptcy court’s ruling.

Plain Language Controls

The Second Circuit began its review with the “plain language” of the relevant provisions of the Indentures. Id. at *5. Like the lower court, the Second Circuit found that American’s bankruptcy filing constituted an “Event of Default,” which in turn triggered an “automatic acceleration” of the debt. Id. at *6. In such a circumstance, the Indentures expressly and unambiguously provided that no Make-Whole Amount would be due. Id. at *6.[3] The Second Circuit then addressed each argument raised by the Trustee and found that none of those arguments could “refute the plain language of the Indentures.” Id. at *7.

  1. Enforceability of Automatic Debt Acceleration Provision. The Trustee tried to avoid the consequences of automatic acceleration under the Indenture and argued that it “never elected to accelerate the debt, and that such action [was] required under New York law.” Id. at *7. The Second Circuit disagreed and affirmed the principle under New York law that “parties to a loan agreement are free to include provisions directing what will happen in the event of default . . . of the debt, supplying specific terms that super[s]ede other provisions in the contract if those events occur.” Id. at *7 (citations and internal quotation marks omitted). The court also recognized the enforceability of self-operative automatic acceleration provisions. Id. at *7.[4]
  2. Automatic Stay Barred Trustee’s Effort to Rescind Automatic Acceleration. The Trustee further argued that “even if acceleration took place, [it] can rescind this acceleration, obliging American to pay a Make-Whole Amount in connection with its refinancing, and that the bankruptcy court erred in concluding that such rescission is barred by the automatic stay.” Id. at *7. The Second Circuit disagreed, and held that any attempt to rescind the acceleration would be an attempt to modify American’s contract rights and therefore was subject to the automatic stay. Id. at *8-9
  3. Post-Maturity Payment Not a Voluntary Redemption. Finally, the Trustee argued that regardless of whether American’s debt was accelerated upon the bankruptcy filing, “American’s attempt to capitalize on favorable market conditions by paying off the debt nearly one year later, properly understood, [was] a voluntary redemption . . . requiring payment of the Make-Whole Amount.” Id. at *7. The Second Circuit rejected this argument because the automatic acceleration “changed the date of maturity from some point in the future . . . to an earlier date based on the debtor’s default under the contract.’” Id. at *9 (quoting Analytical Surveys, Inc. v. Tonga Partners, L.P., 684 F.3d 36, 44 (2d Cir. 2012)). The new maturity date, by virtue of the automatic acceleration, was Nov. 29, 2011 (the petition date). Id. at *9. Consequently, American’s attempt to repay the debt in October 2012 was not a “voluntary repayment because ‘[p]repayment can only occur prior to the maturity date.’” Id. at *9 (citing In re Solutia Inc., 379 B.R. 473, 488 (Bankr. S.D.N.Y. 2007)).

Section 1110 of Bankruptcy Code Did Not Require Make-Whole Payment

The Trustee also raised arguments under § 1110 of the Code. Section 1110 generally relates to the rights of a secured party with a lien on aircraft equipment. A debtor, like American, gets the benefit of the automatic stay only if it elects, within 60 days of the filing, to: (i) perform all obligations under the agreement with the secured party; and (ii) cure any defaults, other than defaults of the kind specified in § 365(b)(2) of the Code. Id. at *3; U.S.C. § 365(b)(2) (excusing debtor from curing defaults triggered by, among other things, the filing of a bankruptcy petition).

The Trustee argued that: (i) American’s election under § 1110(a)(2) required payment of the Make-Whole Amount; (ii) to the extent that acceleration of the debt was automatic, American’s elections under § 1110(a) and regular payments of principal and interest pursuant to those elections had the effect of decelerating the debt; and (iii) to the extent the debt was accelerated and not decelerated, then by failing to pay the accelerated debt in full when it made the § 1110 election, American had failed to cure all defaults as required by § 1110(a)(2), and accordingly, was not entitled to the benefit of the automatic stay. Id. at *13.

The Second Circuit rejected each of these arguments, holding that: (i) because the Make-Whole Amount was not due under the terms of the Indentures (as discussed above), that amount was not required to be paid under § 1110(a)(2); (ii) American’s election under § 1110(a) did not alter its right to repay the accelerated debt pursuant to the terms of the Indentures; and (iii) American was not required by § 1110(a) to cure bankruptcy defaults or pay off the accelerated debt in order to obtain the protection of the automatic stay. Id. at *13-16.

Practical Observations

The Second Circuit’s ruling highlights the significant role that contract drafting plays in a creditor’s right to recover a make-whole premium. As we wrote in an earlier article, to maximize the likelihood of recovering a make-whole premium in the bankruptcy context, lenders should, among other things, avoid any ambiguity on the events that give rise to the payment of the make-whole amount. Lenders should also expressly require payment of the make-whole amount if the debt is repaid for any reason prior to the “stated maturity,” which should be a fixed date in the contract and distinguished from “maturity” (which might occur before the stated maturity by reason of acceleration).