A New York bankruptcy court has determined that original issue discount (OID) on a note is effectively interest—and therefore even though the OID at issue was secured, the amount that accrued after acceleration is not recoverable. The decision has been appealed.

In In re Solutia, Inc., et al., 2007 Bankr. LEXIS 3921 (Bankr. S.D.N.Y., Nov. 9, 2007), bankruptcy Judge Prudence Carter Beatty issued a decision denying certain claims brought by the holders of 2009 Notes (“Noteholders”). The claims were dictated in large part by the Indenture, which provided for the automatic default and acceleration of maturity upon the filing of Solutia’s chapter 11 petition in 2003

The debtor’s plan of reorganization (which was filed prior to the issuance of the court’s opinion) treated the Noteholders’ claims as fully secured. The plan provided for payment of the allowed Noteholders’ claims in full on the effective date of the plan, and further directed substantially all of the equity to be distributed to the creditors. Understanding that the “automatic acceleration” might be an impediment to the Noteholders’ claims for, inter alia, full repayment of OID and damages for pre-payment, the Noteholders sent a deacceleration notice in 2007.

The court determined that the deacceleration notice was ineffective because (i) acceleration was automatic and not a default that could be waived under the Indenture; and (ii) the deacceleration Post-Petition OID Not Recoverable—continued from page 1notice violated the automatic stay.1 From there, the court decided that OID that accrued after the effective date (arguably the petition date2) until the original maturity date could not be paid because “under New York law, upon acceleration a creditor may not retain or recover any unearned portion of the interest charged even if the collateral is sufficient—the fact that the OID was fully secured does not result in a different conclusion under the Bankruptcy Code.”

Similarly, the Noteholders demanded interest at the contract rate through the original maturity date - the “expectancy” claims of future income stream (a la “Calpine”3). The court held that by “incorporating a provision for automatic acceleration upon the bankruptcy filing, the 2009 Noteholders made a decision to give up their future income stream.” Judge Beatty disagreed with the conclusion reached in Calpine, refusing to imply terms that “sophisticated parties” had not included in the Indenture—and possibly for good reason. The court also held that the Noteholders’ arguments for damages based on “defeasance” provisions, alternatively the “no-call” provisions, were not relevant since the court determined that the maturity date was accelerated, there was no “pre-payment.”

The Noteholders also sought payment of a “Change of Control premium” as authorized under the Indenture.

The court denied this request as well, holding that “§502(b) of the Bankruptcy Code requires the claims be determined as of the filing date,” and the change of control only was set to occur on the plan effective date.