Many indentures contain “make-whole provisions,” which protect a noteholder’s right to receive bargained-for interest payments by requiring compensation for lost interest when accrued principal and interest are paid early. Make-whole provisions permit a borrower to redeem or repay notes before maturity, but require the borrower to make a payment that is calculated to compensate noteholders for a loss of expected interest payments. Outside of bankruptcy, whether a creditor is entitled to a make-whole is determined purely by looking to the underlying contract (i.e., the indenture that governs the debt), as well as applicable law. The Bankruptcy Code then adds a second layer of analysis. While different bankruptcy courts have taken a variety of different approaches, a general analysis for determining whether a make-whole claim is allowable in a bankruptcy case has developed.
The first layer of the make-whole analysis mandates analyzing the underlying contract (the indenture, for example) under applicable state law to determine (i) whether there is a make-whole provision; (ii) whether the make-whole has been triggered; and, (iii) if provided for and triggered, is the make-whole enforceable under applicable state law. The second layer of analysis implicates bankruptcy law, including (i) whether a bankruptcy filing automatically accelerates the obligations under the controlling contract; (ii) whether such acceleration, in fact, triggers the make-whole; (iii) should the make-whole be disallowed as a claim for “unmatured interest,” and (iv) whether the indenture trustee or lender is able to decelerate the acceleration caused by the bankruptcy filing. The issue of whether a make-whole provision is enforceable in a Chapter 11 bankruptcy case was recently considered by the United States Bankruptcy Court for the Southern District of New York in In re MPM Silicones, LLC, Case No. 14-22503 (RDD) (Momentive). In that case, the Bankruptcy Court held that, because filing for bankruptcy results in the automatic acceleration of the payment obligations under an indenture, the enforceability of “make-whole” provisions in bankruptcy is uncertain and — under the specific facts presented in Momentive — was unenforceable.
On April 13, 2014, MPM Silicones, LLC and certain debtor affiliates (the Debtors) filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. The Debtors filed their plan of reorganization (the Plan) about a month later. Under the Plan, the senior noteholders would have been repaid in full, in cash, but without the interest through the original 2015 maturity of the notes. In other words, the notes were to be paid in full, but the plan did not provide for payment of a make-whole premium to the noteholders, so the noteholders would not receive the full total amount of interest that they bargained for under the applicable indenture.
Because the Plan did not provide for payment of the make-whole premium, which amounted to over $200 million, the senior noteholders objected to confirmation of the Plan, arguing that it violated the terms of the applicable indenture. According to the senior noteholders, the governing indenture provided for payment of such a make-whole premium in the event of any redemption of the notes before October 2015. The senior noteholders argued that the automatic acceleration of the notes that occurred upon the filing of the Debtors’ bankruptcy cases constituted redemption of the notes under the indenture, which triggered the make-whole obligation.
The Debtors, on the other hand, argued that because the bankruptcy filing accelerated the maturity date of the debt — which is different than a voluntary redemption of the notes as provided for in the indenture — they were not liable for the make-whole premium. Specifically, the Debtors asserted that no make-whole premium was due because the language of the indenture did not expressly require a payment following automatic acceleration of the maturity date. Thus, since the automatic acceleration of the maturity date precluded any “redemption” (which, by definition, could only occur if the noteholders were paid prior to maturity), and since early payment of the notes as a result of the Debtors’ bankruptcy was per se involuntary, an optional redemption as provided for in the indenture was not triggered.
At the Plan confirmation hearing, the Bankruptcy Court ruled against the senior noteholders. The ruling was based predominately on the fact that the language in the indenture relating to the make-whole premium lacked specificity. According to Judge Robert D. Drain, in order for the make-whole premium to apply, the indenture needed to specifically provide that such a payment was due in the event of automatic acceleration of the maturity date. Judge Drain stated that the right of the senior noteholders to a make-whole “hinges on whether the relevant sections of their indentures and notes provide with sufficient clarity for the payment of such premium after the maturity of the notes has been accelerated.” Absent such specificity, which the Bankruptcy Court found was lacking in this case, the noteholders had no enforceable claim to the make-whole premium.
The Bankruptcy Court also disagreed with the senior noteholders in finding that the senior noteholders did not have a claim for breach of the no-call provision prohibiting early repayment of the debt. The Bankruptcy Court disagreed with the senior noteholders’ characterization of the language in the notes as a no-call, which provided that the notes could not be redeemed before October 2015, and instead found that the relevant language was merely a mechanism to introduce a provision that provided for a make-whole under certain circumstances, none of which were triggered here. The Bankruptcy Court, in denying the make-whole claim, agreed with the Debtors that the automatic acceleration of the maturity of the notes as a result of the bankruptcy filing was a bargained-for protection, which protection resulted in the forfeiture of the senior noteholders’ right to a prepayment premium.
Finally, the Bankruptcy Court did not allow the senior noteholders to rescind the automatic acceleration of the notes that occurred upon the bankruptcy filing, holding that the automatic stay barred the deceleration of the debt.
The Bankruptcy Court issued an oral ruling and has not published an opinion on this issue.
Thoughts and Solutions
This ruling in the Momentive case is consistent with other recent decisions on the topic of enforceability of a make-whole provision in the context of a bankruptcy. At the center of the make-whole dispute lays the explicit and specific language of the governing contracts and, in this case, the indenture and notes. Make-whole provisions generally are enforced by bankruptcy courts where the premium is triggered by the express contract terms, the make-whole provision is a valid liquidated damages provision under state law, and the premium is reasonable under section 506(b) of the Bankruptcy Code. Therefore, while the decision is garnering significant attention, it does not alter existing law.
Rather, this ruling should serve as a guide when drafting make-whole provisions in indentures. The language that specifies when a payment is triggered should be clear and unambiguous. Specifically, such provisions should explicitly require payment even upon acceleration of maturity as a result of a bankruptcy filing or other enforcement actions taken by the indenture trustee or holders. Parties should also be careful to limit the amount of the make-whole provision so that it is proportionate to the expected loss due to early repayment (i.e., not an impermissible penalty). As a practical matter, it may be difficult — upon initial issuance of debt obligations — to negotiate for a make-whole that is triggered on an automatic acceleration upon a bankruptcy filing. Raising an issue that is only implicated upon a bankruptcy filing will not be a popular position around the drafting table. But, when an issuer turns the corner and heads towards distress, and comes to its debtholders and their agents (such as an indenture trustee) for a forbearance or other relief, it would be prudent to shore up the debtholders’ entitlement to a make-whole in the event that the issuer’s efforts to stay out of bankruptcy are not successful.