Some courts are disinclined to allow a secured lender’s claim for a makewhole premium, particularly when the debtor’s chapter 11 filing was not a calculated strategy to refinance secured debt at a lower interest rate.
The debtor had borrowed about $13 million secured by commercial real property in a chapter 11 reorganization before Bankruptcy Judge Patrick M. Flatley, sitting in Clarksburg, W.Va. Catastrophic flooding cut off the only access to the property, and the debtor’s income along with it. A few months later, the lender noticed a default, accelerated the debt, and sought appointment of a receiver in state court.
The debtor responded by filing a chapter 11 petition. The debtor’s plan proposed to pay the mortgage over several years, with a balloon payment on maturity to be extended by the plan to a date beyond the stated maturity in the mortgage.
The lender filed a proof of secured claim, including more than $3 million variously characterized by the mortgagee as a prepayment premium or a yield-maintenance premium. A makewhole premium is a term sometimes used in similar situations. Whatever the name, the premium is designed to compensate the lender for being forced to reinvest at a lower interest rate when the loan is paid off before scheduled maturity and interest rates have fallen in the meantime.
Judge Flatley used the term “prepayment premium,” saying the nomenclature made no difference given the facts of the case. In terms of the outcome, however, the facts were pivotal. The mortgage note required the debtor to pay the premium “[i]f, during the continuation of any Event of Default, prepayment . . . is tendered by” the debtor.
With a looming confirmation hearing, Judge Flatley disallowed the claim for the premium in his September 19 opinion.
Naturally, Judge Flatley cited and briefly summarized both Delaware Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016), and BOKF NA v. Momentive Performance Materials Inc. (In re MPM Silicones LLC), 874 F.3d 787 (2d Cir. 2017), where the Second and Third Circuits reached diametrically opposite results on the validity of a secured lender’s claim for a makewhole premium.
Both cases in the circuit courts involved trust indentures with similar language governed by New York law. The appeals courts read similar language to reach opposite results. The Third Circuit allowed the makewhole premium, but the Second Circuit did not. The debtors in both cases were using chapter 11 to refinance secured debt at lower interest rates. To read ABI’s discussions of the cases, click here and here.
However, Judge Flatley avoided taking sides in the circuit split. While he reached the same result as the Second Circuit, he noted that the facts before the Third Circuit were “significantly different” because the lender had not accelerated the debt and the debtor was voluntarily refinancing when the debt could have been reinstated in a chapter 11 plan.
Judge Flatley focused on the language in the loan documents. The agreement, he said, did “not specifically” require payment of the premium following acceleration. Rather, the payment was conditioned upon “prepayment” during the “continuation” of an event of default. The default, he said, ended when the lender accelerated the due date of the loan, disabling the debtor from curing the default.
Judge Flatley said that the lender was not entitled to the premium because the debtor could not “prepay” the note that the lender had accelerated. Disallowing the claim for the premium, he saw “no cause to depart from the general rule that acceleration neuters a makewhole provision,” citing the Third Circuit.