In In re Calpine Corporation, 2007 WL 685595 (Bankr. S.D.N.Y. 2007), the Bankruptcy Court for the Southern District of New York considered the issue of whether secured creditors whose debt was being paid prior to its original maturity date were entitled to a prepayment premium.

There, the debtors sought to refinance both pre- and post-petition secured debt through a debtor in possession financing. The creditors committee, the equity committee and the second lien committee strongly supported the debtors’ motion to obtain the refinancing. A group of prepetition secured creditors and their representatives (e.g., indenture trustees) alleged that payment of their claims should include a prepayment penalty as well as payment of a default rate of interest.

The debtors had issued over $2.6 billion of secured debt from one of its largest operating subsidiaries, Calpine Generating Company, LLC (“CalGen”), of which approximately $2.5 billion was outstanding. The secured debt was issued through a series of first, second and third lien financings (“CalGen Secured Debt”). Most of the CalGen Secured Debt contained prepayment prohibitions or “nocall” provisions. Unlike more current indenture forms, none of the agreements governing the CalGen Secured Debt required prepayment premiums for payments made during the initial “no-call period,” which was defined as prior to April 1, 2007. The operative agreements also provided for automatic acceleration after an event of default, which included a bankruptcy filing.

The Court began its analysis by repeating the presumably well-accepted conclusion (no significant contrary authority was cited) that “no-call provisions that purport to prohibit optional repayment of debt are unenforceable in chapter 11 cases.” Id. at 3. (In fact, the first lien debt had been prepaid despite such a provision.) The Court also explained that the underlying documents provided for automatic acceleration upon a bankruptcy, making the debt immediately due and payable. The Court concluded that, because the provisions of the operative agreements did not provide for a prepayment penalty or have other liquidated damages clauses, such “fees, costs or charges” could not be included in the secured claim of the CalGen secured creditors pursuant to section 506(b) of the Bankruptcy Code.

The Court found that the CalGen secured creditors were nevertheless entitled to damages in the form of an unsecured claim. The Court rejected the argument of the debtors and the creditors’ committee that the absence of a prepayment penalty provision left these creditors without any remedy, since they would be paid the full amount of their loans plus accrued interest. The Court explained that, while the agreements do not provide for a premium or for liquidated damages which would give rise to a secured claim, CalGen secured creditors nevertheless have an unsecured claim. The CalGen secured lenders were entitled to a breach of contract claim because their “expectation of an uninterrupted payment stream has been dashed giving rise to damages, albeit not measurable as the Lenders would wish.” Id. at 5. The Court thus concluded that a 2.5% premium for the First Lien Notes, and a 3.5% premium for the Second and Third Lien Notes, was an appropriate level of damages.

The CalGen secured lenders also asked the Court to award them default rates of interest. The Court found that, in determining whether a default rate of interest should be granted, courts “balance the equities.” Among the factors to consider are the relative injustice to the concept of equitable distribution, the purpose of the higher interest rate and the reasonableness of the difference between the default rate and the non-default rate. As part of this balancing process, courts should also consider a company’s solvency. Because the issue of solvency of the debtors could not yet be determined, the Court found that the case was not ripe for a decision.