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13 Nov 2017

(Make) Wholly Moly: U.S. Court of Appeals for the Second Circuit Upholds Ruling Denying Noteholders’ Entitlement to a Make-Whole Payment

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On October 20, 2017, the United States Court of Appeals for the Second Circuit issued a decision which, among other things,[1] affirmed the lower courts’ holding that certain noteholders were not entitled to payment of a make-whole premium. The Second Circuit held that the make-whole premium only was due in the case of an optional redemption, and not in the case of an acceleration brought about by a bankruptcy filing. This decision results in a split between the Second and Third Circuits regarding the entitlement of a noteholder to payment of a make-whole in the case of a voluntary bankruptcy filing, with the Second Circuit holding that there cannot be a voluntary redemption after a bankruptcy acceleration and the Third Circuit holding that there can be a voluntary redemption triggering a make-whole post-acceleration.

Background

Between 2006 and 2012, MPM Silicones, LLC and its affiliates (collectively, “Momentive”) incurred substantial debt obligations pursuant to various note indentures. One such incurrence was in the form of two classes of senior secured notes (the “Senior Lien Notes”). The governing indentures called for the recovery of a make-whole premium[2] if Momentive opted to redeem the notes prior to their maturity date, which was a fixed date stated in the indenture. The indentures also contained provisions for the automatic acceleration of the principal, premium, if any, and interest on the notes upon a default triggered by a bankruptcy filing. Although most events of default would allow the Senior Lien Noteholders the option of accelerating payment, the indentures provided that a default brought about by Momentive’s voluntary bankruptcy petition would cause an automatic acceleration under the indentures.

In April 2014, Momentive filed a chapter 11 petition. Their proposed plan of reorganization issued replacement notes to the Senior Lien Noteholders that did not account for the make-whole premium. Momentive sought a judicial determination that the Noteholders were not entitled to payment of the make-whole. The Noteholders primarily argued that (i) under the terms of their indentures, which provided for the payment of, among other things, “premium, if any” upon a bankruptcy acceleration, the make-whole premium was expressly due upon any early redemption whether or not there was acceleration; (ii) the indentures provided that the Noteholders could rescind any bankruptcy acceleration, and either the automatic stay did not apply or they should be granted relief from the automatic stay to rescind; and (iii) the redemption was voluntary because Momentive had the option of reinstating the Senior Lien Notes under its chapter 11 plan, thereby eliminating any acceleration, or consenting to relief from the automatic stay. Momentive, on the other hand, primarily argued that: (i) the bankruptcy filing caused the automatic acceleration of the maturity of the obligations under the notes, and so the postpetition repayment of the notes could not constitute a “redemption;” (ii) even if it could be construed as a redemption, the repayment could not be deemed voluntary; and (iii) the acceleration provision did not contain the requisite specificity to entitle the noteholders to payment of the make-whole premiums following acceleration.[3]

The Bankruptcy Court sided with Momentive and confirmed the Plan over the dissent of the Noteholders, holding, among other things, that the Senior Lien Noteholders were not entitled to the make-whole premium because the indentures were not sufficiently explicit, citing numerous cases applying New York law. The Bankruptcy Court further noted that the Second Circuit has made clear that a contractual automatic acceleration is not voluntary on the issuer’s part.[4] Finally, the Bankruptcy Court, relying in part on AMR, concluded that the automatic stay applied to de-acceleration of the Senior Lien Notes, and that relief from the automatic stay was not warranted, because it would harm the debtors’ estates by increasing the Noteholders’ claims by hundreds of millions of dollars.

The Senior Lien Noteholders (among others) appealed, and the United States District Court for the Southern District of New York affirmed the decision.[5] The District Court found that the make-whole provision did not clearly and unambiguously call for the payment of a make-whole premium, notwithstanding both the reference to a date certain—October 15, 2015—as well as language in the acceleration provision that provided for the payment of, among other things, “premium, if any.” The District Court distinguished Chemtura,[6] where it was determined that language was clear and unambiguous because the indenture required a make-whole payment if the debt was repaid prior to its original “Maturity Date.” Additionally, the District Court noted that the Senior Lien Noteholders bargained for exactly this result by electing to have an automatic acceleration upon a bankruptcy event of default. Moreover, because it was the automatic stay—and not Momentive—that prevented the Senior Lien Noteholders from exercising their right to rescind acceleration, Momentive could not be liable to the Noteholders for breach of contract. Certain parties, including the Senior Lien Noteholders, appealed to the Second Circuit.

Decision

The Second Circuit affirmed the decisions of the lower courts with respect to the make-whole premium. The Second Circuit rejected the Senior Noteholders’ argument that when Momentive issued the replacement notes under the Plan, it redeemed the notes prior to their maturity, for the same reason that argument was rejected in AMR. The bankruptcy filing triggered a default, which in turn automatically accelerated the debt, and that acceleration changed the maturity of the debt from a point in the future to the date of the bankruptcy filing. Therefore, the Second Circuit noted, even assuming issuance of replacement notes was a redemption, any subsequent redemption post-acceleration could not be voluntary or optional in nature; instead, the obligation to issue the replacement notes came automatically by operation of the automatic acceleration clauses of the indentures. As a result, a payment made mandatory by operation of an automatic acceleration clause is not one made at Momentive’s option.

The Second Circuit also held that the automatic stay barred the Senior Noteholders’ ability to rescind the acceleration of the Notes. The Second Circuit again cited to AMR in concluding that a creditor’s post-bankruptcy invocation of a contractual right to rescind an acceleration triggered automatically by a bankruptcy filing is barred because it would be an attempt to modify contractual rights, and therefore is subject to the automatic stay. As a result, the Second Circuit found that the make-whole payment was not owed to the Senior Lien Noteholders.

Discussion

As a result of the Second Circuit’s decision in Momentive, there is a circuit split on the issue of entitlement to a make-whole premium under facts similar to those at issue here. The Third Circuit recently issued a decision[7] in November of 2016 that was critical of the Momentive decision at the Bankruptcy Court level, and held that certain noteholders were entitled to payment of make-whole claims (our alert on the EFIH decision can be found here). Notably, the indentures at issue involved similar acceleration provisions to those in the indentures in Momentive.[8] It will be up to the Supreme Court to resolve the split between the circuits if it chooses to do so, but for now, the Second and Third Circuits have spoken.

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[1] This alert is limited to the make-whole dispute; click here to read our alert regarding the aspects of the decision addressing the appropriate interest rate for the replacement notes.
[2] A make-whole provision is a clause typically contained in an indenture that compensates noteholders for the loss of future interest payments in situations where the borrower voluntarily prepays its debt obligations (for example, because of declining interest rates). Make-whole provisions protect lenders by allowing for prepayment in exchange for a sum which is intended to compensate the lender for the loss of its bargained-for investment yield.
[3] Under New York law, because such acceleration advances the maturity date of the loan, any subsequent payment is, by definition, not a prepayment. There is an exception, however, when a make-whole clause clearly and unambiguously provides for a prepayment. For example, courts have found that language similar to the following would be sufficient to all for payment of a make-whole premium: “The make-whole premium is due and payable, notwithstanding automatic acceleration for any event (including, but not limited to, a bankruptcy filing), if the notes are repaid at any time before their original maturity date of December 29, 2025.
[4] In re AMR Corp., 730 F.3d 88 (2d Cir. 2013).
[5] [Cite to decision]. Our alert regarding that decision can be found here.
[6] In re Chemtura Corp., 439 B.R. 561 (Bankr. S.D.N.Y. 2010).
[7] In re Energy Future Holdings Corp., et al., Case No. 16-1351 (3d Cir. November 17, 2016).
[8] EFIH also argued that the acceleration provision caused the notes’ maturity to accelerate before EFIH repaid the notes, and as a result, the make-whole provision no longer was applicable. The Third Circuit disagreed, finding that the two sections simply address different matters, and concluded that the optional redemption provision, which was applicable before the acceleration provision went into effect, remains applicable after acceleration.

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