In recent months, bankruptcy courts and nonbankruptcy courts have addressed the enforceability of make-whole premiums (“make-wholes”) where borrowers have sought to repay loans prior to maturity, including In re Energy Future Holdings, Inc., et al. (EFH) pending before Judge Christopher S. Sontchi of the U.S. Bankruptcy Court for the District of Delaware, and the Second Circuit’s ruling in Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., issued in November 2014, which was a nonbankruptcy appeal from the Southern District of New York. Like prior decisions, Chesapeake and EFH demonstrate the need for careful, precise drafting that takes into consideration the likelihood that the make-whole will be analyzed in the context of distressed or bankruptcy litigation.
Make-whole premiums appear in various forms and names — such as “yield maintenance premium” or “prepayment consideration” — but generally, they seek to compensate a lender in the event that a borrower repays the loan before maturity because the lender loses a bargained-for stream of income. The calculation and amount of make-whole payments also vary, including a percentage of outstanding principal or formulas based on the remaining term of the loan, base interest rate and the U.S. Treasury rate.[1] Make-wholes also show up in various types of loans, including bonds and commercial loans that are later securitized and comprise commercial mortgage-backed securities certificates.[2] Both EFH and Chesapeake reiterate that, in a distressed situation, make-wholes raise numerous issues that require close inspection of the governing documents and careful consideration of the timing of an existing or impending default.
Energy Future Holdings
On March 26, 2015, Judge Sontchi issued his opinion in EFH, holding that the indenture trustee, on behalf of certain noteholders, was not entitled to a make-whole premium valued at nearly $400 million, where the refinancing saved the debtor $13 million per month in interest payments.[3] The affected notes were issued in 2010, due in 2020, bore interest at 10 percent and were secured by first liens; these notes refinanced existing obligations in excess of $2 billion.[4] In EFH, the debtors filed in late April 2014, and the DIP loan, which bears interest at 4.25 percent, paid the noteholders their full principal and accrued interest. However, nonsettling noteholders, through the indenture trustee, filed an adversary complaint seeking payment of a make-whole premium, denoted the “applicable premium.”
Applying New York law, Judge Sontchi held “that the acceleration provision in the indenture does not include clear and unambiguous language that a make-whole premium ... is due upon the repayment of the Notes following a bankruptcy acceleration.”[5] While the indenture deemed a bankruptcy filing an event of default, the relevant provision did not require payment of the make-whole after acceleration of the indebtedness due to a bankruptcy or insolvency default.[6] Judge Sontchi examined closely the key sections of the indenture to reach his conclusion, and in doing so contrasted a nonbankruptcy default with a bankruptcy default. Critically, a nonbankruptcy default afforded the trustee the optional right to accelerate the indebtedness, which was not the case for a bankruptcy default. Upon a bankruptcy default, on the petition date, the notes were automatically accelerated. The indenture, however, made no reference to payment of the make-whole in the event of an automatic acceleration.[7]
Judge Sontchi relied on principles of contract interpretation and cited prior decisions on make-wholes under New York law to conclude that the applicable indenture lacked “express language requiring payment of a prepayment premium upon acceleration....”[8] While the court found that there was a disputed material fact concerning cause under § 362 to retroactively lift the stay and permit the indenture trustee to waive the debtors’ default and decelerate the notes, Judge Sontchi disposed of the indenture trustee’s other arguments, including the notion that the debtor triggered the make-whole through an intentional default.[9]
Chesapeake Energy Corp. v. Bank of New York Mellon
Earlier, on Nov. 25, 2014, in a 2-1 decision, a Second Circuit panel held that a borrower, Chesapeake, failed to give proper notice of an early redemption of notes with a face value of $1.3 billion, potentially triggering a make-whole payment that would exceed $400 million.[10] Chesapeake issued the relevant notes in early 2012, which bore interest at 6.775 percent and matured in 2019. The notes were governed by two indentures, a base indenture from 2010 that applied to several series of notes, and a supplemental indenture dated Feb. 16, 2012, that applied only to these 6.775 percent notes. The critical provision of the supplemental indenture provided that Chesapeake could redeem or repay the notes during a special early redemption period, between Nov. 15, 2012, and March 15, 2013, by paying 100 percent of the principal plus accrued and unpaid interest, with a caveat concerning partial repayment.[11] The supplemental indenture further provided that any early redemption must provide 30 to 60 days’ notice pursuant to a provision of the base indenture during the special early redemption period. If Chesapeake wished to redeem the notes after March 15, 2013, then the supplemental indenture required that it pay a make-whole price, in addition to principal and accrued and unpaid interest.[12]
On Feb. 20, 2013, seeking to redeem the notes and avoid the make-whole price during the special early redemption period, Chesapeake informed Bank of New York Mellon, the indenture trustee, of its intended early redemption. Mellon promptly responded that (1) it would not participate in the redemption, and (2) if Chesapeake issued a notice of redemption, then it “might deem the notice as having triggered redemption at the Make-Whole Price.”[13] On March 8, 2013, Chesapeake filed a civil suit against Mellon in the Southern District of New York, seeking a declaratory judgment that its notice complied with the supplemental indenture such that it would not owe the make-whole price. The district court held a bench trial on an expedited basis and issued a nearly-100-page opinion on May 8, 2013,[14] holding that Chesapeake complied with the March 15, 2013, deadline for notice of redemption and could, thereafter, redeem the notes within 30 to 60 days without paying the make-whole price.[15]
Mellon, however, appealed successfully, and the Second Circuit reversed and remanded the case to the district court to consider “that the redemption notice given by Chesapeake on March 15, 2013 should not be deemed to have noticed redemption at the Make-Whole Price.”[16] In finding in favor of Mellon, the Second Circuit, applying New York law, held that the relevant provisions of the base and supplemental indentures required that Chesapeake provide notice of the redemption no later than Feb. 13, 2013, so that it could actually complete the redemption and prepay the notes before the final day of the special early redemption period, March 15, 2013.[17]
Like Judge Sontchi in EFH, the majority of the Second Circuit panel applied basic principles of contract interpretation. The opinion parses closely two particular sentences of the supplemental indenture, including an extended analysis of the phrase “so long as” that serves as a qualifier on Chesapeake’s redemption rights.[18] Chesapeake could redeem the notes during the special early redemption period, so long as it provided 30 to 60 days’ notice, which necessarily required that the notice be provided no less than 30 days prior to the final day of that period, not, as Chesapeake argued and the district court held, if the notice were merely issued during the period. The act of redemption itself must have occurred within the special early redemption period.[19] The dissent in Chesapeake, however, stated that the text of the supplemental indenture was ambiguous and required review of extrinsic evidence, namely statements made by Chesapeake after the execution of the supplemental indenture.[20] Absent review of extrinsic evidence, the ambiguity of the two particular sentences in the supplemental indenture could not be harmonized.
Conclusion and Takeaway
As EFH shows, where acceleration and default may trigger the right to a make-whole payment, that language must be express with regards to a bankruptcy default. In Chesapeake, the language concerning the relevant notice provision, which the majority of the Second Circuit held to be “clear and unambiguous,” was nonetheless subject to a much different interpretation by the district court, as well as the dissenting judge on the circuit court’s panel.
Regardless of whether the dispute between a borrower and lender or trustee lands in bankruptcy court, courts are not shying away from the need to examine and parse the complex language in the governing documents. These decisions offer clear lessons for corporate lawyers who are drafting the notes and indentures, who must be express with acceleration and notice provisions, and workout and bankruptcy lawyers that litigate these provisions in the face of a default.
[1] See, e.g., In re School Specialty, No. 13-10125, 2013 Bankr. LEXIS 1897, at *4 (Bankr. D. Del. April 22, 2013).
[2] See, e.g., In re South Side House LLC, 451 B.R. 248, 272 (Bankr. E.D.N.Y. 2011) (disallowing make-whole payment where debtor defaulted and debt was accelerated prepetition).
[3] Delaware Trust Co. as Indenture Trustee v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings Corp.), No. 14-10979, 2015 Bankr. LEXIS 979, at *24, *39 (Bankr. D. Del. March 26, 2015).
[4] EFH, 2015 Bankr. LEXIS 979, at *10-13.
[5] Id. at *31-32.
[6] Id. at *5.
[7] Id. at *28.
[8] Id.
[9] On April 6, 2015, the trustee filed with the court a motion seeking clarification as to whether Judge Sontchi’s summary judgment order on the make-whole issue was a final order that triggered the trustee’s appellate rights (Bankr. D. Del. No. 14-10979-CSS, ECF Doc. No. 4065, filed April 6, 2015).
[10] Chesapeake Energy Corp. v. The Bank of New York Mellon Trust Co. N.A., 773 F.3d 110 (2d Cir. 2014); see also Chesapeake Energy Corp. v. The Bank of New York Mellon Trust Co. N.A., 957 F. Supp. 2d 316, 324-25 (S.D.N.Y. 2013) (“That payment would exceed by nearly $400 million the amount required to redeem the 2019 Notes pursuant to the special early redemption provision.”).
[11] Chesapeake, 773 F.3d at 112.
[12] Id.
[13] Id. at 113.
[14] Chesapeake Energy Corp. v. The Bank of New York Mellon Trust Co. N.A., 957 F. Supp. 2d 316, 324-25 (S.D.N.Y. 2013).
[15] Chesapeake, 773 F.3d at 113.
[16] Id. at 117.
[17] Id.
[18] Id. at 115-16.
[19] Id. at 117.
[20] Id. at 121.