On January 17, the Fifth Circuit released a highly anticipated decision, weighing in on the expanding circuit split concerning the enforceability of contractual make-whole provisions in loan indentures. A make-whole provision is a contractual substitute for interest lost on notes redeemed before the expected due date.[1] The provision, commonly found in a loan indenture, is often litigated in bankruptcy when a debtor seeks to refinance debt. Currently a circuit split exists, with the Second, Third and Fifth Circuits weighing in. While each circuit approached the issue differently, the same questions were asked: (1) Was there a redemption; (2) was the redemption voluntary; and (3) can the redemption be rescinded?
In re Energy Future Holdings (EFIH)
The Third Circuit was the first to weigh in on the make-whole payments and the applicability to accelerated notes upon bankruptcy filing. In In re Energy Future Holdings Corp., the Third Circuit reversed both the bankruptcy court and district court’s decisions, disallowing claims for make-whole premiums under indentures.
In an opinion by Judge Thomas L. Ambro, the court answered the three questions differently from the bankruptcy and district courts. First, the court determined that refinancing was a redemption, relying on New York and federal case law deeming redemption to include both pre- and post-maturity repayments of debt. Second, the court determined that the redemption was optional. The court discussed the actions taken prior to EFIH’s chapter 11 filing and stated, “Events leading up to the post-petition financing on June 19, 2014 demonstrate that the redemption was very much at EFIH’s option.”[2] Finally, the court determined that there was no conflict between the two indenture provisions. Judge Ambro stated, “We know no reason why we should choose between §§ 3.07 and 6.02 when both plainly apply. By its own terms, § 3.07 governs the optional redemption embedded in the refinancing and requires payment of the make-whole.”[3]
In re MPM Silicones (Momentive)
The Second Circuit, by the pen of Judge Barrington D. Parker, departed from the Third Circuit’s reasoning.[4] The court devoted a significant portion of its opinion to interest rates, and examined the lower court’s determination that below-market rates on replacement notes were adequate under § 1129(b). The court adopted the Sixth Circuit’s cramdown-interest-rate approach, which requires (1) the market rate where an efficient market exists or (2) the formula approach endorsed by the Till[5] plurality. The Second Circuit noted that the bankruptcy court only considered the formula approach as dictated by Till, dismissing the probative value of market rates of interest. The Second Circuit remanded to the bankruptcy court the determination of whether an efficient market exists, and if so, to apply that rate.
The Second Circuit then considered whether the noteholders were entitled to payment, using the same three-pronged approach endorsed by the Third Circuit. First, the court doubled down on its decision in In re AMR Corp.,[6] emphasizing that “acceleration brought about by a bankruptcy filing changes the date of maturity of the accelerated notes to the date of the petition.”[7] Therefore, any payment on accelerated notes would occur post-maturity. Given that the issuance of replacement notes occurred post-acceleration, the issuance of the notes could not have been a pre-payment and thus not a redemption. The court also noted that, even assuming that the issuance of replacement notes was a redemption, it was not optional. The court stated that “the obligation to issue the replacement notes came about automatically,” and that “a payment made mandatory by operation of an automatic acceleration clause is not made at MPM’s option.”[8] Finally, the court addressed the senior-lien noteholders’ right to rescind acceleration. The court again relied on its AMR decision, stating that this right to rescind is barred because it would be “an attempt to modify contract rights and would therefore be subject to the automatic stay.”[9] The court determined that the right to rescind acceleration would serve as “an end run around their bargain by rescission,” and upholds that the automatic stay barred rescission of the acceleration of notes.[10]
In re Ultra Petroleum Corp
The Fifth Circuit’s decision amounted to a rather narrow holding.[11] The court determined that a creditor is impaired under § 1124(1) only if the plan alters a claimant’s legal, equitable or contractual rights. The holding follows the Third Circuit’s holding in In re PPI Enterprises (U.S.) Inc.,[12] focusing on plan provisions rather than Code provisions to determine the impairment status of the noteholders. The court then examined an issue not discussed by the bankruptcy court: whether the Code disallows the make-whole amount and the post-petition interest at the contractual default rates sought by unsecured creditors. The court did not decide these issues but instead remanded them for further consideration by the bankruptcy court; however, the court did include interesting dicta that could shape Judge Isgur’s decision on remand.
More specifically, the court considered the historical origin in examining the “solvent-debtor exception” that the appellant encourages the court to adopt in this case. The need for consideration of this exception is somewhat unique, since the debtors in these cases became solvent during the pendency of the cases due to rising oil prices from the time of filing. As the court explained, English bankruptcy law carved out an exception for solvent debtors, allowing any interest to continue accruing if the creditor’s contract already provided for interest on the underlying debt. The court noted that the foundation for American bankruptcy law is English bankruptcy law and the principles that underlie it. Despite this, the court explained that in creating a new Bankruptcy Code, Congress codified § 502(b)(2), which bars post-petition interest that is part of an unsecured claim. Section 502(b)(2) requires a bankruptcy court to disallow a claim “to the extent that [it seeks] unmatured interest.” Therefore, in order to use the solvent-debtor exception, the exception must survive § 502(b)(2). The court expresses doubt about this survival, stating that the court “doubt[s] it did.”
The debtors contend that the make-whole claim qualifies as unmatured interest, and the court notes that it is persuaded by three aspects of the argument. First, the debtors claim that the make-whole amount is the economic equivalent of “interest” under the definition cited by Collier’s. Second, the interest was “unmatured” when the debtors filed their chapter 11 petitions. The court notes that the acceleration clause operates as an ipso factor clause by tying acceleration to the petition date. Third, the decisions adopting different reasoning were unpersuasive to the court.
The court also notes that the parties agree that creditors are entitled to some post-petition interest, although to what extent is still to be determined. The parties point to § 726(a)(5), but the court suggests that it only applies to impaired creditors. According to the court, this leaves two paths: (1) the general post-judgment interest statute under 18 U.S.C. § 1961; or (2) the rate determined by equity.
Conclusion
The Fifth Circuit left much for interpretation. While not expressly ruling on the solvent-debtor exception, the court expressed serious doubt that it would survive § 502(b)(2). Further, the bankruptcy court must determine the proper post-petition interest rate.[13] These decisions, notably the Fifth and Third Circuit, place further emphasis on the loan documents themselves. All creditors who rely on such make-whole provisions should ensure that the documents reflect the creditor’s intentions in respect to payments. Both the Third and Fifth Circuits note the importance of construing a contract by the intent of the parties, so the language will be particularly scrutinized going forward. The circuit split could encourage forum-shopping for parties with significant make-whole obligations. While certiorari was sought by parties to the Second and Third Circuits’ rulings, both petitions were denied. Should the circuit split grow wider, the Supreme Court could face increasing pressure to weigh in.
[1] In re Energy Future Holdings Corp., 842 F.3d 247, 251 (3d Cir. 2016).
[2] Id. at 255.
[3] Id. at 257.
[4] In re MPM Silicones LLC, 874 F.3d 787 (2d Cir. 2017).
[5] Till v. SCS Credit Corp., 541 U.S. 465 (2004).
[6] 730 F.3d 88 (2d Cir. 2013).
[7] Id. at 103 (2d Cir. 2013).
[8] In re MPM Silicones LLC, 874 F.3d 787, 803 (2d Cir. 2017).
[9] Id.
[10] Id. at 804.
[11] In re Ultra Petroleum Corp., 2019 WL237365 (5th Cir. Jan. 17, 2019).
[12] 324 F.3d 197 (3d Cir. 2003).
[13] Judge Drain conducted a trial on this issue in August 2018 and took matters under advisement. At the time of publication, no opinion had yet been released.