On September 12, 2013, in the American Airlines case, the US Court of Appeals for the Second Circuit affirmed an order of the United States Bankruptcy Court for the Southern District of New York (a) authorizing the debtor to use proceeds of postpetition financing to repay prepetition debt without payment of amake-whole amount, and (b) denying a creditor’s request for relief fromthe automatic stay.  

Background Facts

American Airlines and certain of its affiliates filed for Chapter 11 bankruptcy protection in late November 2011. American had entered into various prepetition financings secured by aircraft, including a secured note financing and two enhanced equipment trust certificates with U.S. Bank, as Loan Trustee. The indentures governing these financings included various events of default including failure tomake payment, failure to abide by covenants and conditions,material misrepresentations, and the filing of a voluntary petition for bankruptcy.  

Upon the occurrence of certain non-bankruptcy events of default, the loan trustee had the option to accelerate all amounts due under the indentures. A voluntary bankruptcy petition event of default, however, triggered automatic acceleration of the debt. Significantly, the indentures provided that no make-whole amount was payable upon the repayment of debt that had been accelerated under the terms of the indentures.  

After filing for bankruptcy, American obtained an order of the bankruptcy court authorizing American to enter into agreements under section 1110(a) of the Bankruptcy Code pursuant to which it committed to performall obligations under the indentures and to cure any defaults other than defaults specified under section 365(b)(2) of the Bankruptcy Code. Bymaking such “section 1110(a) elections,” American was afforded protection under the automatic stay for so long as American complied with its section 1110(a) agreements. American thereafter made regularly scheduled payments of principal and interest in accordance with the terms of the indentures. Some tenmonths into the case, American filed amotion for approval of postpetition financing and for authority to use the proceeds to pay amounts outstanding, and allegedly due, under the indentures without the payment of amake-whole amount.  

In a concerted effort to secure payment of themake-whole amount, the loan trustee objected to the proposed repayment on the following grounds:  

  1. American’s proposed repayment was “voluntary” within themeaning of the indentures thereby invoking themake-whole payment obligation under the indentures; 
  2. Default-on-bankruptcy and automatic acceleration provisions are unenforceable ipso facto clauses under section 365(e)(1) of the Bankruptcy Code;  
  3. The loan trustee was entitled to waive the bankruptcy event of default and rescind acceleration;  
  4. American’s section 1110(a) elections operated to decelerate the debt and, accordingly, American’s proposed repaymentmust include payment of themake-whole amount; and  
  5. If the debt was accelerated under the terms of the indentures and not decelerated by virtue of American’s section 1110(a) elections, American’s failure to pay the accelerated amount denied American the protection of the automatic stay with the consequence that the loan trustee was free to rescind acceleration.  

Rulings by the Bankruptcy Court  

The bankruptcy court (a) granted American’s financingmotion, (b) rejected the loan trustee’s arguments in support of themake-whole obligation, (c) authorized repayment of the indentures without payment of themake-whole amount, and (d) denied the loan trustee’smotion to lift the automatic stay.  

In so ruling, the bankruptcy court rejected the loan trustee’s argument that acceleration required an affirmative election by the loan trustee, finding instead that the plain language of the indentures provided for automatic acceleration upon the filing of a bankruptcy petition and that these contractual provisions were enforceable notwithstanding the loan trustee’s arguments to the contrary. In addition, the bankruptcy court concluded that the automatic stay enjoined the loan trustee fromwaiving the event of default and decelerating the debt, and that lifting the automatic stay was not warranted. Further, the bankruptcy court rejected the loan trustee’s contentions that the default-on-bankruptcy and automatic acceleration provisions of the indentures were unenforceable ipso facto provisions. The bankruptcy court also rejected the loan trustee’s argument that American’s 1110(a) elections decelerated the debt with the consequence that American’s proposed repayment constituted a voluntary redemption requiring payment of themake-whole amount.  

Rulings by the Second Circuit on Direct Appeal  

On direct appeal, the Second Circuit affirmed the bankruptcy court on all counts. The Second Circuit rejected the loan trustee’s efforts to refute the plain language of the indentures, finding instead that American’s voluntary petition triggered an event of default that accelerated debt, the subsequent repayment of which did not require payment of amake-whole amount. The Second Circuit also found that default-on-bankruptcy and automatic acceleration provisions in the indentures, while ipso facto clauses, are not within the scope of, and rendered unenforceable by, section 365(e)(1) of the Bankruptcy Code because the indentures are not executory contracts for which performance remains due on both sides. Further, the Second Circuit ruled that any attempt by the Loan Trustee effort to rescind acceleration would constitute an effort tomodify contract rights in violation of the automatic stay.

The Second Circuit also found unpersuasive the loan trustee’s arguments that (a) American’s section 1110(a) election to “performall obligations” under the indentures required it to pay the make-whole amount; (b) American’s section 1110(a) elections and subsequent payments pursuant to the elections had the effect of decelerating the debt; and (c) if the debt was indeed accelerated and the elections did not decelerate the debt, then American had not cured its defaults and was not entitled to the protection of the automatic stay thereby enabling the Loan Trustee to rescind acceleration.  

The Second Circuit rejected the first argument asmerely a reprise of the loan trustee’s efforts to refute the plain language of the indentures and flawed for the same reasons. The loan trustee’s contention that American’s section 1110(a) elections decelerated the debt was similarly overruled by the Second Circuit because section 1110(a) does notmodify contractual relationships but merely provides a way to gain the protection of the automatic stay. The Second Circuit also rejected the loan trustee’s final argument , finding that American was not required pursuant to section 1110(a) to cure the bankruptcy default specified in section 365(b)(2).  

Finally, the Second Circuit found that the bankruptcy court did not abuse its discretion in denying the loan trustee’smotion to lift the automatic stay in order to preserve the property of the estate for the benefit of all of America’s creditors.  

The Key Takeaways of the Decision

The Second Circuit itself highlighted the twomost significant questions addressed by the case: (a) whether default-on-bankruptcy and automatic acceleration indenture clauses are unenforceable ipso facto default provisions under section 365(e)(1) and other similar sections of the Bankruptcy Code; and (b) what the requirements and consequences of section 1110(a) elections are when the only outstanding default is an ipso facto default that triggered automatic acceleration of debt.  

As noted, default-on-bankruptcy and automatic acceleration clauses are outside the scope of the ipso facto prohibitions of section 365(e)(1) and similar sections of the Bankruptcy Code. Further, a debtor’s section 1110(a) elections and subsequent compliance do not operate to decelerate debt and a debtor need not, as a condition to obtaining the relief under section 1110(a), cure defaults of a kind specified in section 365(b)(2) of the Bankruptcy Code such as a default predicated solely on filing for bankruptcy protection.