The Bottom Line:

Make-whole provisions occupy considerable attention in bankruptcy cases because they address the extent of a creditor’s claim and, when the claim is oversecured, impact the amount of “equity” in the collateral available to the estate. In In re AMR Corp., 13-1204-CV, 2013 WL 4840474 (2d Cir. Sept. 12, 2013), the Second Circuit recently upheld the inapplicability of a make-whole premium, ruling that, under the plain language of the bond indenture at issue, (i) the bankruptcy filing triggered an event of default and the bond debt was automatically accelerated and (ii) because the debt was accelerated, the “make-whole premium” was not due and that payment after acceleration constituted payment after maturity and not “prepayment.” The decision discusses numerous arguments made by the trustee on the scope of the automatic stay, rights under section 1110, and ipso facto provisions of executory contracts. The decision also analyzes the requirements and consequences of an election under section 1110(a) when the only outstanding default is an ipso facto bankruptcy default. 

What Happened: 

AMR Corp. and a number of its affiliates (the “Debtors”) filed for bankruptcy protection on November 29, 2011 (Editor’s Note: Kramer Levin represents a group of municipal bondholders in these Chapter 11 cases). Prior to the petition date, the Debtors owed approximately $1.4 billion in bond debt under three facilities for which U.S. Bank was (variously) loan trustee, trustee, and security agent. The bonds were collateralized by various equipment and aircraft. 

Although the bond indentures at issue provided that the Debtors would have to pay a “make-whole premium” if they repaid the bonds prior to their maturity dates, the indentures also expressly provided that the Debtors’ bankruptcy petitions would constitute an event of default – triggering an automatic acceleration of its bond debt without the requirement to pay the “make-whole premium.” The make-whole amount is the present value of any remaining scheduled principal and interest payments through the contractual maturity date using a discount rate linked to the Treasury yield. 

The Debtors made a motion in October 2012 for approval of $1.5 billion in lower-rate post-petition financing, primarily to pay off the secured bond debt (yielding savings of about $200 million for the Debtors). They argued that the make-whole premium was not due based on the plain language of the indentures, which expressly provides that the make-whole premium was not due upon a repayment in connection with an acceleration based on a bankruptcy filing. The trustee, U.S. Bank, filed an objection and related adversary proceedings, arguing that the Debtors could not prepay the secured debt without the make-whole premium. It argued that (i) the debt was not automatically accelerated upon the Debtors’ bankruptcy filing because bankruptcy-triggered events of default are unenforceable ipso facto clauses, (ii) even if the debt was automatically accelerated, U.S. Bank had the right to rescind the trigger and decelerate the debt, and (iii) because the Debtors elected under section 1110(a) of the Bankruptcy Code to fulfill all of their obligations under the indentures (and, in fact, made principal and interest payments on the debt), they could not treat the debt as accelerated to avoid the make-whole premium. (In summary fashion, when an airline debtor leases, finances on a secured basis, or enters into a conditional sale agreement for aircraft equipment and vessels, section 1110 of the Bankruptcy Code obligates the debtor to continue to perform all obligations or the stay is lifted.) 

The Bankruptcy Court, rejecting U.S. Bank’s arguments, approved the Debtors’ motion, holding that the indentures did not provide for a make-whole premium in the event of repayment following a bankruptcy filing. Specifically, the Bankruptcy Court held that (i) the bond debt was automatically accelerated because of the Debtors’ bankruptcy filing, (ii) the Debtors’ continuing principal and interest payments pursuant to their “1110(a) election” to stay the exercise of remedies by U.S. Bank did not prevent them from repaying the accelerated debt, and (iii) U.S. Bank could not rescind and decelerate the debt, because that act would violate the automatic stay. Accordingly, the court characterized the Debtors’ repayment as apayment at maturity (upon acceleration), rather than a prepayment, such that no make-whole premium was due under the indentures. U.S. Bank appealed the Bankruptcy Court’s order directly to the Second Circuit Court of Appeals. 

The Second Circuit affirmed, holding that (i) the express language of the indentures provide that, upon a bankruptcy filing, the bonds were automatically accelerated and no make-whole premium was due, (ii) the Bankruptcy Court did not abuse its discretion in declining to lift the automatic stay to permit U.S. Bank to decelerate the debt (i.e., waive the bankruptcy default) and (iii) the Debtors’ election and payments under section 1110(a) did not waive or cure the ipso facto default. 

The Court also rejected U.S. Bank’s argument that the indenture provisions providing for the automatic acceleration of the Debtors’ debt were unenforceable ipso facto clauses. An ipso facto clause is one which purports to modify contract parties’ rights based on a bankruptcy filing. The court explained that the only potentially applicable Bankruptcy Code section invalidating ipso facto clauses (section 365(e) of the Bankruptcy Code) applies only to executory contracts and that the indentures governing the U.S. Bank debt are not executory contracts (though the parties did not dispute this point). As a result, the bankruptcy filing was an enforceable trigger causing a default and accelerating the debt. 

On the scope of section 1110, the Second Circuit found that “American was not required to pay off its accelerated debt to obtain the benefit of the automatic stay pursuant to [section] 1110(a)(2) if the failure to do so is a default ‘of a kind specified in’ [section] 365(b)(2) [i.e., a bankruptcy trigger].” Therefore, the Debtors were not required to pay off the accelerated debt to gain the protection of the automatic stay afforded by section 1110. Important to the analysis, the Court said “Section 1110(a)(2)(B) does not negate such defaults, but it does permit the debtor to postpone their consequences[.]”.

Why the Case is Interesting:

An interesting aspect of the argument was whether a bankruptcy trigger that automatically defaulted and accelerated the debt applied or was subject to treatment as an unenforceable ipso facto clause. The Court declined to invalidate the ipso facto clause, holding that it did not apply to a debt instrument, as opposed to an executory contract. The decision also held that the automatic stay precluded the indenture trustee from rescinding the event of default and automatic acceleration. The decision further analyzes the requirements and consequences of an election under section 1110(a), reasoning that, so long as the Debtor complies with the payment requirements of section 1110(a), the effect is merely to extend the stay. However, section 1110 does not otherwise cure a bankruptcy default, nor is the Debtor required to cure a bankruptcy default.