On November 17, 2016, the United States Court of Appeals for the Third Circuit issued a decision in which it held that holders of first lien notes and second lien notes of Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (together, “EFIH”) are entitled to payment of make-whole claims. In its reversal of the Delaware Bankruptcy Court and Delaware District Court, the Third Circuit focused largely on the distinction that the payment in question was tied to a “redemption” of the bonds, and was not a “prepayment” premium. The Third Circuit held, among other things, that while a premium based on “prepayment” cannot take effect after the debt’s maturity upon an automatic acceleration, a premium tied to a “redemption” before a fixed date is unaffected by the acceleration of the debt’s maturity. 

Background

Between 2010 and 2012, EFIH issued the first lien notes and second lien notes under separate indentures.^[1] The indentures for both the first and second lien notes contain substantially similar optional redemption provisions (the “Optional Redemption Provision”) that allow EFIH to redeem the notes at a redemption price equal to 100% of principal amount of the notes, plus the make-whole amount, which is intended to provide compensation to noteholders for interest lost on the notes redeemed before their expected due date (such additional amount, the “Make-Whole”). As is typical, both indentures also contain an acceleration provision (the “Acceleration Provision”) that provides for all outstanding notes to be due and payable immediately upon the filing of a bankruptcy petition by EFIH, although the language of the first lien indenture and the second lien indenture varies on this point (with the second lien indenture requiring, among other things, payment of “premium, if any” upon acceleration; a provision that is absent from the first lien indenture). Both indentures also give noteholders the right to rescind any acceleration of the notes.

On April 29, 2014, EFIH and certain affiliates filed voluntary chapter 11 bankruptcy petitions in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”). In order to take advantage of highly favorable market conditions, EFIH sought to refinance its debt. The indenture trustees for both sets of notes filed separate adversary proceedings seeking a declaration that the proposed refinancing would trigger entitlement to the Make-Whole. Prior to ruling on the adversary proceedings, the Bankruptcy Court granted EFIH’s motions to refinance, after which EFIH paid off the notes and refinanced its debt at a much lower interest rate without paying the Make-Whole. The Bankruptcy Court later held that EFIH was not required to pay the Make-Whole under the indentures, reasoning that when EFIH filed for bankruptcy, the maturity of its debt accelerated, thus cutting off the noteholders’ rights to the Make-Whole. The Bankruptcy Court also held that any rescission of the acceleration by the noteholders was blocked by the automatic stay, which the Bankruptcy Court declined to lift. The District Court affirmed. After both trustees separately appealed, the appeals were consolidated by the Third Circuit.

Decision

The Third Circuit first focused on the Optional Redemption Provision. EFIH argued that a redemption refers to a repayment of debt that predates the debt’s maturity, and that because EFIH’s post-bankruptcy refinancing occurred after the automatic acceleration of the notes, it was not a redemption (and, as a result, the Make-Whole was not triggered). The Third Circuit disagreed. The Third Circuit made clear that the issue was a matter of contractual interpretation under New York law,^[2] and that New York courts, and federal courts interpreting New York law, deem redemption to include both pre- and post-maturity repayments of debt. The Third Circuit concluded that applying New York contract principles to the indentures, EFIH’s refinancing, which occurred post-bankruptcy, was a “redemption” within the meaning of the indentures. The Third Circuit also rejected EFIH’s argument that the refinancing was not optional because the Acceleration Provisions made the notes due and payable immediately. In doing so, the Third Circuit noted first that EFIH’s bankruptcy filing was voluntary, and moreover, EFIH had the option to reinstate the notes’ original maturity date (rather than paying them off immediately), but it chose not to do so.^[3] The Third Circuit further held that because the redemptions occurred prior to the dates certain referenced in the indentures, the Optional Redemption Provision, on its face, requires that EFIH pay the Make-Whole.

Next, the Third Circuit addressed EFIH’s argument that the Acceleration Provision, in effect, superseded the Early Redemption Provision. Specifically, EFIH 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. While the Optional Redemption Provision causes the Make-Whole to become due when there is an optional redemption before the dates certain referenced in the indentures, the Acceleration Provision causes the maturity of EFIH’s debt to automatically accelerate upon an EFIH bankruptcy. Moreover, the Optional Redemption Provision specifically addresses redemptions, whereas the Acceleration Provision makes no mention of the Make-Whole. The Third Circuit cited the New York Court of Appeals’ decision in NML Capital v. Republic of Argentina^[4] for the proposition that while acceleration advances the maturity date of the debt, other terms of the contract are not necessarily impacted by acceleration, and therefore they do not automatically cease to be enforceable after acceleration. In other words, the Third Circuit concluded that the Optional Redemption Provision, which was applicable before the Acceleration Provision went into effect, remains applicable after acceleration. 

Although the Third Circuit’s decision made clear that the Acceleration Provision did not supersede the Early Redemption Provision, the court nevertheless did observe that the language in the second lien indenture further supported the conclusion that the intent of that indenture was to make the Make-Whole payable even if the Acceleration Provision were applicable. The court noted that the second lien language, which referenced “premiums, if any,” was meant to include the Make-Whole even upon an acceleration. That argument had been rejected by the Bankruptcy Court, which concluded that the “premium, if any” language lacked specificity that it was intending to have the Make-Whole payable upon the triggering of the Acceleration Provision. 

In reaching its decision, the Third Circuit made an important distinction between the concept of prepayment and redemption. The Third Circuit observed that although a premium contingent on prepayment cannot become payable after the debt’s maturity has been accelerated (because, by definition, as a result of the new maturity date, it is no longer possible to prepay the debt before maturity), a premium tied to redemption before a date certain is unaffected by such acceleration. For EFIH, the voluntary redemptions occurred prior to the dates certain stated in the Indentures, and as a result, the Third Circuit found that acceleration had no bearing on whether and when the Make-Whole is due. And while EFIH argued that the Make-Whole, although described as a redemption premium, was in substance a prepayment premium, the Third Circuit stated that it must give effect to the words and phrases the parties choose. The court concluded that by avoiding the word “prepayment” and using the word “redemption,” the parties decided that the Make-Whole is payable without regard to the notes’ maturity.^[5]

Discussion

The Third Circuit emphasized that it was giving effect to the intent of the parties as revealed by the language of their agreement. The indentures require EFIH to pay the Make-Whole if it redeems the notes, at its option, before dates certain. The Third Circuit refused to rely on lower court decisions that have denied make-whole claims by relying on cases dealing with “prepayments” post-acceleration of the relevant maturity date, and instead focused on what it found to be a clear distinction between such “prepayments” (which would foreclose payment of a premium absent clear language to the contrary) and “redemptions” before dates fixed in the relevant indentures (which, according to the Third Circuit, do not require clear language providing that such premiums are payable following an automatic acceleration due to bankruptcy). The opinion makes clear that the Third Circuit found the issues to be fairly straightforward: redemptions occurred, at the election of EFIH, before the respective dates noted in the Indentures, which under the terms of the indenture made the Make-Wholes payable, regardless of whether an automatic acceleration occurred. The Third Circuit also noted that the lower court rulings put the noteholders in a Catch-22: the bankruptcy acceleration cut off the right to a make-whole premium, but rescission of that acceleration, which would have restored that right, was blocked by the automatic stay (which stay the Bankruptcy Court refused to modify).

Notably, the Third Circuit in several instances stated its disagreement with the result in Momentive.^[6] In Momentive, the Bankruptcy Court for the Southern District of New York held that the words “premium, if any” were not specific enough to require payment of the make-whole in similar circumstances.^[7] The Third Circuit found the Momentive holding unpersuasive and in conflict with New York law on contractual interpretation, because according to the Third Circuit, the Momentive decision was inconsistent with the text of that indenture, and, therefore, failed to honor the parties’ bargain. The Momentive decision, which was affirmed by the United States District Court for the Southern District of New York, currently is on appeal to the Second Circuit Court of Appeals, and whether a circuit split will result from the ruling remains to be seen. 

This decision should provide some comfort to creditors in bankruptcies filed in Delaware and elsewhere within the Third Circuit that make-whole premiums payable following a redemption before a fixed date, as opposed to prepayments, in an indenture or other debt document will not be disallowed as a claim merely due to an automatic acceleration on account of the obligor’s bankruptcy.