While newly discovered Element 115 (or “ununpentium” as scientists are temporarily calling it) appears to have vanished quickly in a flash of radiation in front of the eyes of Swedish scientists, the United States Bankruptcy Court for the Western District of Oklahoma confirmed that make-whole is a well-established stable compound and here to stay. See the order here. As our loyal Basis Points followers know, one of our favorite topics of discussion and fodder for the blog is make-whole premiums. Our previous blogs on the American Airlines and Trico Marine make-whole decisions can be found here and here. In GMX Resources Inc., the Court overruled the Official Committee of Unsecured Creditor’s (the “Committee”) objection to the first lien lenders’ make-whole claim. While this decision may not be as groundbreaking as the newly discovered “Element 115,” it is a win for investors who rely on the make-whole to be made whole. Let’s be the first to call it “make-whole-ium”…
For those of you who aren’t science or bankruptcy geeks, make-whole premiums are intended to protect noteholders from the loss of future fixed coupon interest payments due to the early repayment of debt if market interest rates have declined between the date of issuance and the date of prepayment. Just as the Swedish research team bombarded the element Americium with Calcium to create Element 115, the GMX Committee experimented with the usual arguments when it objected to the first lien lenders’ make-whole claim. The Committee argued that (1) make-whole was unmatured interest and, therefore, disallowed under Section 502(b)(2) of the Bankruptcy Code; (2) make-whole was a penalty and, therefore, disallowed by Section 502(b)(1) of the Bankruptcy Code; and (3) given the secured position of the first lien lenders, make-whole was not reasonable under Section 506(b) of the Bankruptcy Code.
As to the first argument, the Committee asserted that since a make-whole premium constitutes compensation for future interest payments that the borrower/issuer failed to make, it stands to reason the make-whole premium must take on the characteristics of the missed payments and be classified on the periodic chart as unmatured interest. The Committee further argued that since the make-whole in this case became due only upon filing of the bankruptcy case (there was no prepetition acceleration) it was not owing as of the moment in time that GMX filed its bankruptcy petition. While the GMX Court’s slip opinion does not provide any scientific testing of this theory, the majority of courts that have addressed this issue disagree and, instead, conclude that a make-whole premium is more akin to liquidated damages because it fully matures at the time of the breach or prepayment.
The next argument the Committee made against the inclusion of make-whole in the first lien lenders’ claim was that it was unenforceable under New York state law because the premium was “plainly disproportionate” to the lenders’ possible loss and disregarded the principle of compensation. While Americium’s 95 protons plus Calcium’s 20 protons may result in a proportionate element containing 115 protons, the Committee argued that a discount rate based on applicable treasury rates plus 50 basis points equaled a disproportionate premium. Specifically, the Committee pointed to the small dollar difference between the absolute value and discounted value of the interest payments.
In defense of the make-whole, the first lien lenders’ noted that a number of courts have upheld make-whole formulas tied to comparable treasury rates. For example, in the recent School Specialty decision, the Delaware Bankruptcy Court noted that make-whole based on US treasury rates was not “plainly disproportionate” and refused to alter a parties agreement based on hindsight.
The Committee’s third argument was based on the fact that the first lien lenders were secured and Section 506(b) of the Bankruptcy Code only permits secured lenders to recover post-petition costs to the extent provided for in the agreement and to the extent that such costs are reasonable. To the extent that courts hold that make-whole is not an unenforceable penalty, the natural conclusion is that the same make-whole is reasonable and not prohibited by Section 506(b). While the GMX slip opinion did not lay out an analysis on this point, we can further hypothesize that if a court determined that the make-whole was earned as of the petition date and not prohibited under 502(b)(2), it would be impossible to at the same time categorize such amount as post-petition and, therefore, Section 506(b) should not even factor into the equation.
So while Mendeleev’s periodic table of elements has evolved since it was first published, new case law continues to affirm the existence, stability and entitlement of creditors to make-whole in bankruptcy. “Make-whole-ium” continues to survive lab testing.