An Adroitly Drafted Makewhole Is Allowable in Bankruptcy, New York Judge Says

A borrower and a lender can contract around BOKF NA v. Momentive Performance Materials Inc. (In re MPM Silicones LLC), 874 F.3d 787 (2d Cir. 2017), a recent Second Circuit opinion commonly thought to disallow makewhole premiums in bankruptcy, according to Bankruptcy Judge Stuart M. Bernstein of Manhattan.

Judge Bernstein’s March 18 opinion is more in line with the Third Circuit, which held the year before MPM Silicones that makewholes are allowable in bankruptcy. Delaware Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016).

Judge Bernstein said that the key to making makewholes enforceable “even after acceleration is to render acceleration irrelevant and . . . make the premium contingent on any post-default payment.”

What Is a Makewhole?

Makewholes come in different forms. However worded, a makewhole typically kicks in if interest rates have fallen and the debt is paid before maturity. The makewhole compensates the lender for being forced to reinvest at a lower rate of interest.

The debtor in Judge Bernstein’s case is the owner of a hotel in Manhattan. Before bankruptcy, the lender served a notice of default and acceleration based on the debtor’s lack of a valid liquor license. Later faced with appointment of a receiver, the debtor filed a chapter 11 petition and filed a reorganization plan to pay the lender in full with proceeds from exit financing.

The secured lender filed a claim for about $32 million, including a $3.1 million makewhole premium. The debtor objected to the allowance of the makewhole but lost.

The Key to an Enforceable Makewhole

Judge Bernstein explained that the loan agreement imposed “the makewhole premium in connection with any payment after an Event of Default, not just a prepayment made after an event of default but before acceleration.” [Emphasis in original.]

“In fact,” Judge Bernstein said, “the word acceleration does not appear in that clause. Instead, the clause deems the post-default payment, whenever made, to be a ‘voluntary prepayment’ for the purpose of the [makewhole premium].” [Emphasis in original.]

“Generally,” Judge Bernstein said, acceleration followed by “default forfeits the right to a prepayment premium because the acceleration advances the maturity date, and by definition, the loan cannot be prepaid,” citing U.S. Bank Tr. Nat’l Ass’n v. AMR Corp. (In re AMR Corp.), 730 F.3d 88, 103 (2d Cir. 2013). However, there are two exceptions to the general rule.

The first exception governed the outcome. A makewhole “will be analyzed as a liquidated damages clause” under New York law, Judge Bernstein said, “if a clear and unambiguous clause requires the payment of the prepayment premium even after default and acceleration.”

“As a result,” Judge Bernstein said, the clause in the loan agreement calling for a makewhole “must be analyzed as a liquidated damages provision.” In turn, the enforceability of liquidated damages is a question of state law.

In New York, liquidated damages are enforceable if actual damages are difficult to determine and if liquidated damages are not “plainly disproportionate” to the possible loss, based on the circumstances when the agreement was negotiated.

Judge Bernstein said that the debtor had not carried the burden of showing that the premium was “conspicuously disproportionate” to the “lender’s foreseeable losses.”

Allowing the premium, Judge Bernstein favorably cited a bankruptcy court decision from Chicago involving a similar makewhole clause. In the Chicago case, Bankruptcy Judge A. Benjamin Goldgar said that the parties may agree that a makewhole is due after acceleration, even though a lender typically foregoes the premium by accelerating the debt. In re AE Hotel Venture, 321 B.R. 209 (Bankr. N.D. Ill. 2005).

To rule in favor of the lender, Judge Bernstein distinguished MPM Silicones where, he said, the Second Circuit held that “a lender forfeits a prepayment premium as a matter of law by accelerating the debt.”

In the case at bar, the “parties can and here did contract around the general rule,” Judge Bernstein said, because the lender’s rights “depend on the term of the loan agreement, not upon the wholly different argument in MPM and AMR.” In AMR, he said, the loan agreement “explicitly stated that in the event of an automatic acceleration [caused by the occurrence of a bankruptcy filing], no makewhole premium was due.”

MPM Silicones was also different, he said. The case did not entail an optional redemption, because the payment was mandatory by operation of an automatic acceleration clause.”

For a makewhole to be enforceable in bankruptcy, Judge Bernstein said the loan agreement should “render acceleration irrelevant” and “make the premium contingent on any post-default payment.”

N.B.: Judge Bernstein’s opinion is akin to the result in Energy Future, where the Third Circuit held that a makewhole was enforceable in bankruptcy on facts strikingly similar to MPM Silicones. Writing for the Philadelphia-based appeals court, Circuit Judge Thomas Ambro relied in large part on New York law, the same approach that Judge Bernstein employed.

To read ABI’s discussion of MPM Silicones and Energy Future, click here and here.