'Make Whole' Payment Approved in School Specialty Case
By Michael R. Lastowski and Christopher M. Winter
May 15, 2013
Delaware Business Court Insider
In In re School Specialty, (Bankr. Del. April 22, 2013), Case No. 13-10125, the debtors had stipulated in an interim DIP order that they were liable to Bayside Finance LLC in the approximate amount of $95 million. That amount included an "early payment fee" (the "make whole payment") of about $23.7 million. The creditors' committee filed a motion to disallow the make-whole payment. Acknowledging that there is a split of authority as to whether such payments constitute unmatured interest under 11 U.S.C. § 502(b)(2), U.S. Bankruptcy Judge Kevin J. Carey of the District of Delaware nevertheless overruled the committee's objection.
Prepetition, the debtors and Bayside had entered into a loan agreement, which provided that the make-whole payment would be due upon prepayment or acceleration of the loan. The debtors breached a loan covenant, which triggered the obligation for the make-whole payment. In the context of a forbearance agreement, the debtors agreed to the acceleration of the loan upon default. The accelerated balance included the make-whole payment.
Carey noted that the issue of whether a prepayment provision is enforceable is governed by state law (in this instance, New York law). Under New York law, prepayment provisions are characterized as liquidated damages and are enforceable so long as: (1) actual damages are difficult to determine; and (2) the liquidated damages are not "plainly disproportionate" to the actual loss. The committee focused on the latter criterion and argued that the make-whole payment was not consistent with "marketplace" practices and was "disproportionate."
Under New York law, a finding that a payment is disproportionate requires an examination of whether (1) the parties engaged in an arm's-length transaction; and (2) whether the prepayment is designed to provide the lender with its "bargained-for yield."
The parties had engaged in an arm's-length transaction. With regard to the "bargained-for yield," the committee noted that the loan matured on October 31, 2014, unless the debtors were able to refinance certain debentures. In the latter case, the maturity was extended to December 2015. The make-whole payment was calculated based upon the extended maturity date. The committee argued that the calculation should have assumed the earlier maturity date.
Carey rejected this argument, noting that refinancing remained open during the life of the loan and Bayside was obligated to "keep funds available through 2015" and concluded that the "court cannot, with the benefit of hindsight, alter the agreement based on subsequent operational results and managerial decisions."
Although the parties disputed whether the reasonableness standard of 11 U.S.C. § 506(b) applies to prepetition fees, the court did not address this issue, noting that, having established that the make-whole fee was not "plainly disproportionate," the debtors had satisfied any "reasonableness" requirement. Further, under a liquidated damages provision, there is no duty to mitigate.
Finally, the committee argued that the make-whole payment should be disallowed under 11 U.S.C. § 502(b)(2) as unmatured interest. Carey observed that U.S. Bankruptcy Judge Brendan L. Shannon of the District of Delaware had noted a split among bankruptcy courts on this issue. (See In re Trico Marine Servicesre, 450 B.R. 474 (Bankr. D.Del 2011).) Carey decided to join Shannon and the majority of courts and concluded that the make-whole payment represented a claim for liquidated damages, "not a claim for unmatured interest."
Christopher M. Winter, a partner with the firm, is a Delaware business lawyer who focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial and corporate finance and transactions and Delaware corporate and alternative entity law.
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