On August 26, 2014, Judge Robert D. Drain of the Bankruptcy Court for the Southern District of New York issued a bench ruling in In re MPM Silicones, LLC, Case No. 14-22503 (RDD), on several aspects of the plan of reorganization filed by debtor Momentive Performance Materials, Inc., a specialty chemicals manufacturing company, and its affiliated debtors. As part of his ruling, Judge Drain held that the debtors were not required to pay senior noteholders a make-whole payment provided for in their notes and that the debtors could satisfy the cramdown provisions of 1129(b) without providing a market rate of interest.
In the Chapter 11 case, the holders of $1 billion of First Lien Notes and $250 million of so-called 1.5 Lien Notes were oversecured and asserted that they were entitled to a “make whole” premium – a type of call provision on a bond allowing the borrower to pay off remaining debt prior to maturity subject to payment of the premium – in addition to unpaid principal and accrued interest. The debtors’ plan provided that if the noteholders voted in favor of the plan and agreed to waive their make-whole claim they would receive cash in the full amount of their claims (except for the make-whole payment claim). However, if the noteholders rejected the plan, the debtors sought to “cram down” the noteholders and satisfy their claims with replacement notes, but the noteholders would maintain their right to argue for the make-whole payments. The debtors proposed that the replacement notes for the First Lien noteholders would have a principal amount equal to the noteholders’ allowed claims, provide for first-priority liens, and have a seven-year maturity with interest equal to the treasury rate plus 1.5 percent. Similarly, the debtors proposed that the replacement notes for the 1.5 Lien noteholders would have a principal amount equal to the noteholders’ allowed claims, provide for second priority liens, and have a seven-and-a-half year maturity with an interest rate equal to the treasury rate plus 2 percent. All the First Lien and 1.5 Lien noteholders voted to reject the plan and filed objections to confirmation of the plan, arguing they were entitled to receive the make-whole payments and that their treatment under the plan was not “fair and equitable” as required by section 1129(b).
The noteholders argued that they were entitled to make-whole payments based on the automatic acceleration of their debt after the debtors’ bankruptcy filings. Judge Drain ruled that the noteholders were not entitled to receive make-whole payments because the indentures did not expressly provide for the make-whole premium upon the automatic acceleration of debt as a result of a bankruptcy filing. He reasoned that bankruptcy default and automatic acceleration were not the same as a prepayment of the debt and therefore, by the express terms of the indentures, the noteholders were not entitled to the make-whole payment. Judge Drain further noted that by agreeing to the automatic acceleration provision in the
indentures, the noteholders had voluntarily forfeited their right to the make-whole premium based on the debtors’ bankruptcy filing. Judge Drain, however, left open the possibility that a future agreement might provide for a make-whole payment as part of a bankruptcy claim, but he stated that this language must be expressly set forth in the contract.
Judge Drain also addressed the noteholders’ argument that the debtors breached the agreement once the acceleration occurred because the indentures included a no-call provision stating that the notes were not redeemable. Judge Drain noted that this provision was not specifically a no-call provision but instead provided the noteholders the option to redeem in return for payment of the applicable make-whole payment. Although recognizing the noteholders may be entitled to damages available under applicable state law, Judge Drain stated that such a damages claim would be disallowed as a claim for unmatured interest under section 502(b)(2) of the Bankruptcy Code.
The noteholders also argued that they should be able to decelerate the notes and thus increase their bankruptcy claim because sending such a deceleration notice was not prohibited by the automatic stay. More specifically, the noteholders argued that the sending of a rescission notice to decelerate the First and 1.5 Lien notes would merely be liquidating a securities contract, which is permissible under section 555 of the Bankruptcy Code notwithstanding the automatic stay under section 362(a). Judge Drain dismissed this argument on a number of grounds. First, Judge Drain stated that he had “serious doubts” that the indenture itself is a securities contract under section 741(7)(A) of the Bankruptcy Code. Second, Judge Drain suggested that deceleration of the notes to permit the increase of a claim against the debtors is not a “liquidation” as contemplated by section 555. Third, Judge Drain determined that the rescission right the noteholders sought to exercise was not a right automatically arising upon the commencement of the debtors’ bankruptcy cases and, thus, he reasoned, is not covered by section 365(e) of the Bankruptcy Code as contemplated by the plain language of section 555.
Finally, the noteholders alternatively requested that the automatic stay be lifted so that they could provide notice rescinding the automatic acceleration of their notes. Judge Drain explained that the purpose of sending the notice would be to “resurrect the make-whole claim,” which the Second Circuit recently held would be subject to the automatic stay. See In re AMR Corp., 730 F.3d 88 (2d Cir. 2013). Moreover, Judge Drain determined that lifting the automatic stay to allow the noteholders to send a rescission notice would have a material adverse effect on the estate and its creditors. Accordingly, Judge Drain held that the automatic stay should not be lifted to allow the noteholders to rescind the automatic acceleration.
Below Market Interest Rate
The noteholders also asserted that their plan treatment was not fair and equitable because the interest rate was below market and therefore did not satisfy section 1129(b) of the Bankruptcy Code, which requires that if a rejecting class of secured creditors is not paid in full in cash on the effective date, their treatment must have a present value equal to the value of their secured claims. The noteholders argued that the replacement notes with a below market interest rate were not worth the value of their secured claims. As evidence that the debtors’ proposed interest rate was below market, the noteholders pointed to the debtors’ two exit credit facilities with the same lien priority as the replacement notes that both provided for higher interest rates, specifically LIBOR plus 4 percent (with a LIBOR floor of 1 percent) and LIBOR plus 6 percent (with a LIBOR floor of 1 percent).
The parties’ arguments and Judge Drain’s decision focused on two cases: Till v. SCS Credit Corp., 541 U.S. 465 (2004) and In re Valenti, 105 F.3d 55 (2d Cir. 1997), which both analyzed the proper interest rate to apply to replacement notes distributed to secured creditors under Chapter 13 of the Bankruptcy Code – which contains a substantially similar cramdown provision to Chapter 11. In Till, a plurality of the U.S. Supreme Court held that the cramdown interest on replacement notes should be the “prime plus” or “formula” method, which is calculated by using the prime rate and adjusting upward to reflect credit and collateral risk. The plurality further noted with approval that courts applying this method typically set a risk premium of between 1 percent and 3 percent over the prime rate. In a footnote, however, the plurality opinion stated that the cramdown interest in a Chapter 11 might be calculated differently because, unlike the Chapter 13 context, there was a free market of willing cramdown lenders and thus it “might make sense to ask what rate an efficient market would produce.” Citing this footnote, the noteholders argued that the appropriate interest rate for their replacement notes should be the market interest rate for loans of equivalent priority. Alternatively, the noteholders argued that even applying the Till approach of calculating interest, the interest rate of the replacement notes was too low because it was based on the treasury rate as opposed to the prime rate.
Judge Drain adopted the Till formula approach for calculating the interest rate on the replacement notes but held that, just as in Till, the prime rate – not the treasury rate – was the appropriate benchmark rate. He therefore refused to confirm the plan of reorganization unless the interest rate of the replacement notes was increased by 0.50 percent for the First Lien replacement notes and 0.75 percent for the 1.5 Lien replacement notes, which still resulted in a below market interest rate. In so holding, Judge Drain rejected the noteholders’ argument that footnote 14 of the Till decision suggested that the appropriate interest rate for replacement notes in a cramdown context should be set by the market. Judge Drain reasoned that the Till plurality and the Second Circuit in Valenti had specifically rejected an approach that would require bankruptcy courts to consider evidence about market interest rates because, according to Till, such an approach “overcompensates creditors because the market lending rate must be high enough to cover factors . . . like lenders’ transaction costs and overall profits.” Judge Drain extended this reasoning from Chapter 13 cramdown rates to Chapter 11 cramdown rates, which he stated should likewise “not contain any profit or cost element.”
The Momentive decision is significant on many levels. It illustrates the requirement for careful drafting if lenders intend to argue for a make-whole payment but it also concludes that such payments constitute unmatured interest and are not allowable in a bankruptcy case. The decision also rejects an expansive view of what constitutes a “liquidation” under section 555 of the Bankruptcy Code. This interpretation is consistent with the statute, which also provides for acceleration, but not deceleration. Judge Drain’s finding that the indenture is not a “securities contract” could be contested in future cases on the grounds that the indenture is part of the integrated transaction providing for the purchase and sale of a security. Finally, although Judge Drain, citing to Till and Valenti,1 applied a formula approach rather than a market-based approach, section 1129(b) speaks in terms of “value” and it might be argued that “value” is dictated by, and cannot be separated from, a market rate of return.