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Third Circuit Requires 'Make-Whole' Payments For Accelerated Bankruptcy Notes

Rudolph J. Di Massa Jr. and Drew S. McGherin
December 30, 2016
The Legal Intelligencer

Third Circuit Requires 'Make-Whole' Payments For Accelerated Bankruptcy Notes

Rudolph J. Di Massa Jr. and Drew S. McGherin
December 30, 2016
The Legal Intelligencer

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Rudolph Di Massa Jr.

Drew McGherin

In a much awaited ruling from In re Energy Future Holdings Corp., 2016 No. 16-1351 (3d Cir. 2016), the U.S. Court of Appeals for the Third Circuit overturned decisions of both the Delaware District and Bankruptcy Courts in ­addressing whether refinancing debts through bankruptcy ­obligates payment of certain "make-whole" premiums. In ruling that such premiums were due, the court of ­appeals created precedent that will likely resonate in pending bankruptcy cases, ­future loan agreements and the minds of attorneys drafting these contracts.


In 2010, Energy Future Intermediate Holding Co. and EFIH Finance Inc. (collectively, EFIH) borrowed approximately $4 billion at a 10 percent interest rate through notes secured by a first-priority lien on their assets. The indenture governing this loan contained an "optional redemption" clause allowing for EFIH to redeem all or part of the notes before their maturity at a redemption price equal to 100 percent of the outstanding principal balance plus an "applicable premium." The applicable premium under the indenture was a make-whole ­payment, designed to protect the lenders' anticipated interest rate yield. This applicable premium was to be paid in full if redemption occurred before Dec. 1, 2015, and it decreased each year on a sliding scale until Nov. 30, 2018. The notes also contained an acceleration clause, making them "due and payable immediately" upon EFIH's filing for bankruptcy.

In 2011, EFIH entered into a second loan transaction pursuant to which EFIH provided a second-priority lien on its assets. The indentures governing this transaction contained make-whole and acceleration-upon-bankruptcy provisions substantially the same as the corresponding provisions of the first-lien $4 billion in indebtedness.

Later, as interest rates continued to drop, EFIH sought to refinance its obligations; however, refinancing the notes would have required EFIH pay the make-whole premiums associated with each note. By filing for bankruptcy, however, EFIH believed that it might be able to avoid these considerable premiums. Accordingly, in November 2013, in an 8-K filing with the Securities and Exchange Commission, EFIH publicly announced its intention to file for bankruptcy and refinance the notes without paying any applicable premium.

In April 2013, EFIH filed for Chapter 11 bankruptcy protection and repaid the first lien notes with funds from a new loan approved by the Bankruptcy Court. This new loan imposed an interest rate of only 4.25 percent, allowing EFIH to save about $13 million in interest payments per month. EFIH thereafter refinanced a portion of the second lien notes. In both of the refinancing transactions, EFIH did not make any make-whole payments to either set of noteholders. In response, both classes of noteholders commenced actions seeking determinations that they were entitled to the ­make-whole ­payments by virtue of the court-approved refinancings.

Addressing the issues under New York law, the Delaware Bankruptcy Court (and, on appeal, the district court) held in favor of EFIH. In so holding, the court ­focused solely on the bankruptcy acceleration ­provisions contained in the notes and found that, as there was no mention of any ­make-whole payments due after acceleration, the ­premium was not owed. Further, any attempt by the noteholders to rescind the acceleration of the notes was blocked, the court ruled, by operation of the ­automatic stay, which the court refused to lift.

Opinion of the Court of Appeals

The Third Circuit Court of Appeals characterized the issue in this case as placing the noteholders in a "catch 22." When EFIH filed for bankruptcy, the maturity of the debt accelerated, thereby (according to the lower courts) cutting off the noteholders' anticipated yield rate through receipt of the make-whole premiums. While the noteholders' rescission of the acceleration would have restored that right, such action was blocked by the automatic stay. Addressing this predicament, the court of appeals split its analysis of the matter into three separate considerations: whether a redemption had occurred when EFIH refinanced the notes; if so, whether the redemption payment was "optional;" and whether the redemption occurred prior to the dates specified in the indentures.

First, the court concluded that EFIH's ­refinancing of the notes did in fact constitute a redemption despite EFIH's arguments that a redemption should be limited to ­payments that occur before maturity. According to EFIH, since the repayment at issue here occurred after the principal of the debt had been accelerated, it could not qualify as a redemption payment. Rejecting these arguments, the court found that, under New York law, a redemption can occur through both pre- and post-maturity ­repayments of debt, citing various New York federal and state case precedent speaking to the very issue. Therefore, according to the appellate court, EFIH's post-bankruptcy refinancing ­constituted a redemption under both indentures.

Next, the court found the redemption to be voluntary, and thus optional, for EFIH. Despite the fact that the acceleration of the debt required its immediate payment, the court noted that EFIH had filed for chapter 11 protection—the cause of this acceleration—voluntarily. Furthermore, even after filing, EFIH had the option under Code section 1124(2)(B) to reinstate the accelerated notes' original maturity date, but it chose not to do so. The court highlighted EFIH's own words in a later 8-K filing, in which EFIH stated that it might, "but was under no obligation to," redeem the notes. Finally, the court emphasized the fact that the noteholders themselves did not wish to be paid back upon EFIH's bankruptcy filing; rather, their attempts to rescind the acceleration of the notes were ­neutralized by operation of the automatic stay. Accordingly, considering this ­"nonconsensual" repayment with the other factors in totality, the court found that "logic leaves no doubt that this redemption ... was optional."

Therefore, the optional redemption provisions of the notes would be triggered provided the payments occurred before the dates specified in the indentures for the make-whole premiums to be applicable. The court found that the refinancings all occurred before these specified dates, thus requiring EFIH to pay the applicable premium to the noteholders.

The court also examined the relationship between the make-whole provisions and the acceleration provisions of the indentures, dismissing EFIH's assertions that each poses two exclusive and alternative "pathways." Instead, the court found that the clauses address discrete issues that, when read together, provide "a map to guide the parties through a post-acceleration redemption." While reaching the same conclusion for each set of notes, the court's analysis for each differed.

The court focused largely on the specific language contained in the indentures. With respect to the first lien notes, the acceleration clause was silent as to its effect on the make-whole payment; the court held, ­however, that this silence did not nullify the provision. The provision should instead remain viable as the court found no rule under New York law rendering inoperable provisions of a contract after acceleration merely because they were unaffected by that acceleration.

Addressing the second lien notes, the court again began with the specific ­language of the indenture and noted that it explicitly required payment of "all principal of, and premium if any" on obligations owing under the indenture upon acceleration. The court understood the addition of "premium, if any" to clearly reference the make-whole premiums. This was so despite a New York Bankruptcy Court's prior interpretation of the same language in In re MPM Silicones No. 14-22503-RDD, at *13, (Bankr. S.D.N.Y. Sept. 9, 2014) aff'd, 531 B.R. 321 (S.D.N.Y. 2015), which found "premium, if any" not specific enough to require payment of make-whole provisions under similar ­circumstances. The court of appeals found this precedent to conflict with the plain meaning of the indenture's text, and fail to honor what the court viewed as the parties' intentions. Thus, the court declined to follow the ruling in In re MPM Silicones.

Based on the foregoing reasoning, the court found that the redemption and ­acceleration clauses were complementary of each other and held that they operated together to require payment of the make-whole premiums, even in the event of a post-bankruptcy refinancing.


In In re Energy Future Holdings, the U.S. Court of Appeals for the Third Circuit firmly established that any make-whole provisions in loan documents will be carefully scrutinized if contested. As a result, attorneys drafting such provisions should do so with specificity as to substance and applicability. Parties and their counsel are well advised to clearly address certain situations of possible redemption, including the occurrence of refinancing notes following an acceleration through bankruptcy.

Notwithstanding these cautionary advisements, the appellate court's ruling may not have as far-reaching an effect as one may assume. Rather than vastly expanding the viability of make-whole payments, the court's opinion underscores the importance of precisely drafting indenture provisions, and lawyers who skillfully draft these provisions will certainly be able to avoid the headaches visited upon EFIH and its ­noteholders as a result of EFIH's ­post-petition refinancing.

Rudolph J. Di Massa, Jr., a partner at Duane Morris, is a member of the business reorganization and financial restructuring practice group. He concentrates his practice in the areas of commercial litigation and creditors' rights.

Drew S. McGehrin practices in the area of business reorganization and financial restructuring at the firm.

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.