On Aug. 26, 2014, Judge Robert Drain of the U.S. Bankruptcy Court for the Southern District of New York denied the payment of a $200 million make-whole premium. See Corrected and Modified Bench Ruling on Confirmation of Debtors’ Joint Chapter Plan of Reorganization for Momentive Performance Materials Inc. and its Affiliated Debtors, In re MPM Silicones, LLC, No. 14-22503 (Bankr. S.D.N.Y. Sept. 9, 2014) [D.I. 979] (“Transcript,” or “Tr.”).[1] The debtors had proposed a plan that would pay creditors with new notes even though the governing agreements provided for a premium upon a “voluntary redemption” of the notes prior to October 2015. The court reasoned that: (1) the indenture provided for the automatic acceleration of the debt upon the debtors’ bankruptcy filing; (2) the acceleration constituted a waiver of the right to a prepayment premium, as a matter of New York law, unless the entitlement to a post-acceleration prepayment premium was “clear and unambiguous”; (3) the language of the operative documents here was not sufficiently clear; and (4) the automatic stay prevented the creditors from serving a notice to decelerate the debt. The decision has been appealed.

Facts

Momentive Performance Materials Inc. (collectively with its affiliates, the “Debtors”) had issued: (1) first lien notes in the aggregate amount of $1.1 billion due Oct. 15, 2020; and (2) so-called “1.5 lien” notes in the aggregate amount of $250 million due Oct. 15, 2020 (collectively, the “Notes”) pursuant to their respective indentures (the “Indentures”). Each of the Notes provided, among other things, that the borrower could voluntarily redeem the Notes prior to October 2015 by paying a premium (the “Make-Whole Premium”). Tr. at 31-32. [2]

The Debtors filed chapter 11 petitions in April 2014 and proposed a plan that provided for the issuance of new notes (the “Replacement Notes”) to the holders of the Notes. The indenture trustees under the applicable Indentures (the “Indenture Trustees”), on behalf of the noteholders, argued that payment of the Notes with Replacement Notes prior to October 2015 constituted either: (1) a voluntary redemption that triggered the Debtors’ obligation to pay the Make-Whole Premium (of approximately $200 million); or (2) a breach of the provision prohibiting voluntary redemption before October 2015 (the “no-call” provision), warranting the payment of money damages equal to the Make-Whole Premium.Id. at 32-33. The Indenture Trustees also sought relief from the automatic stay to rescind the automatic acceleration resulting from the commencement of the Debtors’ cases.

In response, the Debtors argued that: (1) no Make-Whole Premium was due because the noteholders forfeited their right to payment of the Make-Whole Premium by accelerating the debt (id. at 37); (2) any attempt to rescind the acceleration was barred by the automatic stay (id. at 52); and (3) the repayment of the Notes in the bankruptcy was not voluntary and therefore was not a “voluntary” redemption under the Indentures. Id. at 37-38.

Decision

Post-Acceleration Entitlement to Make-Whole Must Be “Clear and Unambiguous”

When considering the allowance of a claim in bankruptcy, “the court first considers whether the claim would be valid under applicable nonbankruptcy law [here New York law], and then second … whether there is any limitation on or provision for disallowance under the Bankruptcy Code.” Tr. at 33. Under the New York rule of “perfect tender,” a borrower cannot prepay debt. Id. at 34. The parties to a loan, however, can amend this rule to provide for a specific prepayment right for the borrower. Id. at 33-34. The parties can also provide for the payment of a premium in the event of early payment so long as the premium is not “plainly disproportionate to the possible loss.” In re Madison 92nd Street Associates LLC, 472 B.R. 189, 196 (Bankr. S.D.N.Y. 2012) (internal quotations omitted).

The court noted that it is “well-settled law in New York that a lender forfeits the right to … consideration for early payment if the lender accelerates the balance of the loan” because when a lender accelerates the maturity of a debt, the lender has chosen to be paid early, “rather than being compensated under the contract for the frustration of its desire to be paid interest over the life of the loan.” Trat 34. There are two exceptions: A lender does not forfeit the right to a prepayment premium when: (1) a borrower purposely defaults to trigger acceleration in order to avoid payment of a make-whole; or (2) “when a clear and unambiguous clause calls for the payment of a prepayment premium or make-whole even in the event of acceleration of, or the establishment of a new maturity date for, the debt.” Id. at 35.

Here, the court found that the operative documents provided for automatic acceleration of the Notes upon the Debtors’ bankruptcy filing, thereby forfeiting the noteholders’ right to the Make-Whole Premium. Id. at 37. It is “well-settled law” that when debt is accelerated, “a make-whole will not be owed … unless the parties have clearly and specifically provided for payment of a make-whole.” Tr. at 38. Thus, the provision requiring payment of the Make-Whole Premium upon a voluntary “redemption” prior to October 2015 was not implicated because a prepayment cannot occur after the accelerated maturity date. Id. at 34.

The court observed that “language that would be explicit enough to overcome the waiver of the make-whole upon acceleration” would be “either an explicit recognition that the make-whole would be payable notwithstanding acceleration of the loan or … a provision that requires the borrower to pay a make-whole whenever debt is repaid prior to its original maturity.” Id. at 41. The court focused on the following provision: In the event of a bankruptcy, then, “the principal of, premium, if any, and interest on all of the notes shall become immediately due and payable.” This provision, the court found, was insufficient to “overcome or satisfy the requirement under New York law that a make-whole be payable specifically notwithstanding acceleration or payment prior to the original maturity date under the terms of the parties’ agreements.” Id. at 42-45. Thus, the noteholders were not entitled to the Applicable Premium by virtue of the automatic acceleration. Id. at 44-45.[3]  

No Cognizable Claim for Breach of No-Call Provision in Bankruptcy Context 

The court also held that the noteholders were not entitled to damages for either breach of what they read as a “no-call” provision in the Indentures or for breaching the rule of “perfect tender” under New York law, because the Indentures were silent on what would happen if the Notes were prepaid in any way other than by optional redemption, and the Bankruptcy Code operates to automatically accelerate debt upon a filing regardless of a no-call provision or the perfect tender rule. Id. at 45-47. The court further held that a breach of a no-call is not “enforceable by specific performance in a bankruptcy case.” Id. at 46-47 (citing HSBC Bank USA v. Calpine Corp., 2010 U.S. Dist. LEXIS 96792, at *11-14 (S.D.N.Y. Sept. 15, 2012)). Further, any damages for breach of a no-call provision would consist of lost interest accruing in the future and thus would be disallowed by Bankruptcy Code Section 502(b)’s prohibition on claims for unmatured interest. Id. at 48.    

Automatic Stay Bars Notice of Deceleration to Restore Right to Premium

Citing the Second Circuit’s holding in AMR, Judge Drain also did not allow the Indenture Trustees to issue a notice of deceleration because it would alter and diminish the Debtors’ contract rights under the Indentures in violation of the automatic stay, nor would he allow the stay to be lifted to allow the Indenture Trustees to send a notice of deceleration. Id. at 53-65.  

Observations

Judge Drain’s decision is consistent with the general trend of recent decisions evaluating the allowance of make-whole premiums in bankruptcy cases, which have required that the contractual language giving rise to the payment of a make-whole, especially in a post-acceleration context, be clear and unambiguous. See, e.g., Bank of New York Mellon v. GC Merchandise Mart, LLC (In re Denver Merchandise Mart, Inc.), 740 F.3d 1052, 1059 (5th Cir. 2014) (affirming the lower courts’ application of state law, the court held that “the plain language of the contract does not require the payment of the Prepayment Consideration in the event of mere acceleration”); In re AMR Corp., 730 F.3d 88, 103 (2d Cir. 2013) (denial of make-whole premium was based entirely on contract interpretation; “American’s attempt to repay the debt [after automatic acceleration] … was not a voluntary prepayment because [p]repayment can only occur prior to the maturity date”).