Parting company with decisions from New York, the Third Circuit in Philadelphia reversed the lower courts in Delaware and ruled that so-called make-whole premiums must be paid to bondholders, at least when prepayment is voluntary in chapter 11 and the language of the indenture is not to the contrary.
In a Nov. 17 decision in the wake of the reorganization of electric energy giant Energy Future Holdings Corp., the Third Circuit distinguished a Second Circuit decision and eviscerated a New York bankruptcy court opinion that favored large corporate debtors by holding that make-whole premiums are not owing if the debt was automatically accelerated by a bankruptcy filing. The Third Circuit opinion is important because that court makes law governing Delaware, where many of the country’s largest reorganizations are filed.
Litigation in the Lower Courts
Energy Future needed bankruptcy relief but also had designs on using chapter 11 to refinance secured bonds bearing interest rates well above the current market. However, more than $400 million in make-whole premiums on first and second lien bonds would be due in refinancings outside of bankruptcy.
A make-whole premium is a payment required in some indentures to compensate lenders for being forced to reinvest at lower interest rates when bonds are paid before maturity.
Immediately after the chapter 11 filing in Delaware, Energy Future refinanced the debt with court approval, leaving open the question of whether make-whole premiums were owing. Later, the bankruptcy court ruled that the premiums were not owing. The decisions by the bankruptcy court were upheld this year by a district judge in Delaware.
Reversal in the Third Circuit
Writing for the appeals court, Circuit Judge Thomas Ambro reversed the lower courts and reinstated the liability to pay the make-whole premiums. According to Judge Ambro, the result turned on the language of the indentures. His decision cannot be understood as a blanket ruling on make-whole premiums generally in bankruptcy, except to the extent that indentures have the same language.
For the first lien bondholders, pivotal Section 3.07 of the indenture, entitled “Optional Redemption,” said that the company could “redeem” the notes by paying the principal and accrued interest “plus the Applicable Premium.”
The bankruptcy court disallowed the make-whole premium, focusing on another provision in the indenture, Section 6.02, which automatically accelerated the notes in the event of bankruptcy. The bankruptcy judge reasoned that no premium was due in bankruptcy because the acceleration clause made no mention of the premium.
Judge Ambro said that Section 3.07 raised three questions: (1) was there a redemption; (2) was it optional; and (3) did it occur before the specified date? He answered all three questions in the affirmative.
First, Judge Ambro cited governing New York law for the proposition that a redemption includes “both pre- and post-maturity repayments.” Next, he said the “redemption was very much optional” because the debtor could have reinstated the debt in a chapter 11 plan, even though the acceleration was automatic.
Judge Ambro therefore concluded that Section 3.07, “on its face,” required paying the premium.
In opposition, the debtor relied on a 2013 Second Circuit decision in the American Airlines reorganization. Judge Ambro made short shrift of that argument by pointing to language in the indenture in the American Airlines case explicitly saying that no premium was due in an acceleration resulting from bankruptcy.
Rebutting the bankruptcy court’s reliance on Section 6.02, Judge Ambro said “it surpasses strange to hold that silence in Section 6.02 supersedes Section 3.07’s simple script.”
Judge Ambro Rejects MPM Silicones
The second lien indenture was similar but not identical. In it, Section 6.02 said that bankruptcy automatically accelerated all principal “and premium, if any.”
To escape the seemingly explicit requirement to pay the premium in bankruptcy, the Delaware bankruptcy court followed a 2014 New York bankruptcy court decision called MPM Silicones, which involved a similar indenture. There, the judge in Manhattan said that the reference to “premium” was not adequately specific to invoke the “Applicable Premium,” which was the defined term for a make-whole premium.
With respect to the second lien bonds, Judge Ambro reversed the bankruptcy court because the words “premium, if any” left “no doubt” that a make-whole was required.
Further undercutting MPM Silicones and cases that adopted its reasoning, Judge Ambro used the remainder of his opinion to explain why the New York bankruptcy court misinterpreted New York law, which governed the indentures. He said that the Manhattan court stretched a New York Court of Appeals decision “beyond its language.” The Delaware bankruptcy court, he said, adopted the same misinterpretation of New York law.
Judge Ambro said the New York Court of Appeals decision, called Northwestern, reflected a “policy concern that lenders should not be permitted ‘to recover prepayment premiums after default and acceleration’” outside of bankruptcy. In the Energy Future case, he said the noteholders “did not seek immediate payment.” Indeed, the noteholders attempted to deaccelerate and reinstate the debt.
By refusing to enforce Section 3.07 after acceleration, Judge Ambro said that the bankruptcy court “ran afoul of New York authority by failing to enforce a contract provision” that was “not affected by acceleration.”
Judge Ambro was a bankruptcy lawyer before ascending to the circuit bench in 2000.