January 25, 2017

The enforceability of the so-called “make-whole” premium–the contractual yield-protection payment included in certain debt documents that is calculated to offset lost future interest payments when term debt is repaid before maturity–has been analyzed in several decisions in recent years.  The latest installment in the make-whole case law is the Third Circuit’s recent ruling in the Energy Future Holdings bankruptcy cases.

In Delaware Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.),[1] the Third Circuit held that Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (collectively, “EFIH“) are required to pay the make-whole obligation that was triggered when EFIH opted to redeem outstanding notes as part of its post-petition refinancing.  Although the notes were automatically accelerated when EFIH filed for bankruptcy, the Third Circuit found that the note indentures do not cancel EFIH’s obligation to pay the redemption premium in the event of acceleration.

An analysis of the Third Circuit’s decision is provided in “Possible Make-Over for Make-Wholes After EFH Decision,” an article authored by Gibson Dunn associate Sabina Jacobs that is published in the January 2017 issue of the American Bankruptcy Institute Journal.

Gibson Dunn also invites you to The Enforceability of “Make-Whole” Premiums after Momentive and EFH, a complimentary webcast on February 1, 2017 with a panel of seasoned Gibson Dunn bankruptcy practitioners who will discuss the current landscape affecting the recovery of “make-whole” premiums and provide legal and practical guidance in the aftermath of Momentive, Energy Future Holdings, and other key cases.  To register for this webcast, please click here.

I.     Summary of the Third Circuit’s Decision in Energy Future Holdings

Reversing the decisions of both the district court and the bankruptcy court, the Third Circuit held that holders of first lien and second lien notes are, in fact, entitled to payment of the make-whole premiums that became due when EFIH opted to redeem these notes shortly after filing its bankruptcy petition.[2]  Each indenture contains a redemption provision that entitles the holders of the notes to the payment of a make-whole premium if EFIH opts to redeem the notes in advance of the notes’ respective maturity dates.[3]  Therefore, the decision by EFIH to redeem the notes before their respective original maturity dates triggered the make-whole redemption premium, notwithstanding the fact that the debt had been accelerated.[4]

The Third Circuit distinguished between a “redemption” premium and a “prepayment” premium:  linguistically, a “redemption” premium survives acceleration whereas a “prepayment” premium does not.[5]  For this reason, the automatic acceleration of the notes did not automatically cancel EFIH’s obligation to pay the make-whole premium triggered by early redemption.[6]  That is not to say that a debt document cannot accomplish this result.  Indeed, debt documents can explicitly provide that acceleration terminates the availability of any make-whole premiums (including optional redemption premiums).[7]  EFIH’s indentures, however, did not contain such language.[8]

Following the Third Circuit’s decision, EFIH petitioned the Third Circuit for a rehearing on the issue of whether “redemption” premiums, unlike “prepayment” premiums, may become due after acceleration under New York law.[9]  At issue:  approximately $900 million in premiums, according to EFIH.[10]  Specifically, EFIH requested the Third Circuit to certify this state-law issue to the New York Court of Appeals, or alternatively, hold the petition until the Second Circuit Court of Appeals has decided the Momentive appeal (discussed below).[11]  No further decision by the Third Circuit has yet been made.

Since the Third Circuit’s decision, EFIH has amended its chapter 11 plan and disclosure statement three times to address the allowance of the make-whole premiums.  The Fifth Amended Chapter 11 Plan guaranteed a full recovery of the make-whole premiums to first lien and second lien note holders.[12]  The Sixth Amended Chapter 11 Plan provided for the substantial but not total recovery of the make-whole premiums to holders, in connection with a settlement that EFIH struck with the holders.[13]  This settlement was described in the Form 8-K filed by Energy Future Holdings Corp. on December 16, 2016 and would have terminated the make-whole appellate litigation.  Specifically, (a) holders of the first lien notes would receive either (i) 95% recovery on their make-whole claims if holders of EFIH’s general unsecured claims vote to accept the plan or (ii) 97% recovery if these holders vote to reject the plan; and (b) holders of the second lien notes would receive either (i) 87.5% recovery on their make-whole claims if holders of EFIH’s general unsecured claims vote to accept the plan or (ii) 92% recovery if these holders vote to reject the plan.[14]  The Seventh–and current–Amended Chapter 11 Plan no longer includes the settlements with the holders of the first lien and second lien notes incorporated in the Sixth Amended Plan.[15] Instead, the plan provides for a claims reserve to cover the full amount of the holders’ make-whole claims, but also contemplates a “make-whole litigation committee” to continue to vigorously oppose the Third Circuit’s decision.[16]  The confirmation hearing concerning the Seventh Amended Plan as it applies to the EFIH has been scheduled to begin on February 14, 2017.[17]

II.     Summary of the Momentive Decision in the Second Circuit

In 2014, the Bankruptcy Court for the Southern District of New York in In re MPM Silicones, LLC (“Momentive“), held that a lender forfeits the right to demand a prepayment premium if the lender has accelerated the loan, unless (i) a debtor has intentionally defaulted to trigger acceleration or (ii) the debt documents contain a clear and unambiguous clause that requires the payment of the prepayment premium notwithstanding acceleration.[18]  The indentures in Momentive contain optional redemption provisions substantially similar to the optional redemption provisions contained in the indentures in Energy Future Holdings.[19]  Although the make-whole premium at issue arose on account of these redemption provisions, the bankruptcy court applied its analysis of make-whole prepayment premiums interchangeably to the make-whole redemption premium in Momentive, and ultimately concluded that the debtors owed no make-whole redemption premium.[20]

In 2015, the District Court for the Southern District of New York affirmed the bankruptcy court’s decision in Momentive and held that the note holders were not entitled to the make-whole premium following the acceleration of the notes.[21]  The district court reasoned that to remain effective following acceleration (including the automatic acceleration that was triggered by the debtor’s bankruptcy filing), the operative indentures must clearly and unambiguously preserve the holder’s entitlement to the make-whole premium in the event of acceleration.[22]  It is noteworthy that the acceleration in the indenture provided that the “premium, if any” would become immediately payable upon acceleration, yet the district court found this language to be ambiguous.  The holders argued that this language must relate to the make-whole premium because the indenture included no other premiums.[23]  It is also noteworthy that the district court, like the bankruptcy court, treated prepayment and optional redemption interchangeably.[24]

In Energy Future Holdings, the Third Circuit criticized the Momentive decision for unreasonably stretching existing New Yok case law beyond its language.  Specifically, the Third Circuit disagreed that the “clear and unambiguous” rule–which was established with respect to “prepayment” premiums–should be applied equally to “redemption” premium or other premiums not styled as “prepayment” premiums.[25]  The Third Circuit found Momentive unpersuasive for failing to adhere to the language in the indenture.[26]

The Momentive decision is currently pending on appeal in the Second Circuit.[27]  Appealing the district court’s ruling, the note holders are seeking, inter alia, to convince the Second Circuit that (a) the acceleration triggered by the debtor’s bankruptcy filing did not cancel the holders’ right to receive the make-whole redemption premium and (b) the holders’ contractual right to rescind the acceleration should not have been prevented by the automatic stay.[28]  Arguments in the case were heard on November 9, 2016.  Following the Third Circuit’s Energy Future Holdings decision, each side submitted letters to the Second Circuit in further support of their respective positions.  The Second Circuit has not yet issued its decision.

III.     Lessons Learned from Energy Future Holdings and Momentive

Based on the current state of the case law across all jurisdictions, we have assembled the followings lessons for borrowers/issuers and lenders/noteholders when negotiating and reviewing debt documents:

[1]              842 F.3d 247 (3d Cir. 2016).

[2]              Id. at 261.

[3]              Id. at 254.

[4]              Id. at 255-56.

[5]              Id. at 259-60.

[6]              Id. at 260.

[7]              Id. at 261.

[8]              Id. at 260.

[9]              In re Energy Future Holdings Corp., Case No. 16-1926 (3d Cir. Dec. 15, 2016), Document No. 3112490304.

[10]             Id.

[11]             Id.

[12]             In re Energy Future Holdings Corp., Case No. 14-10979-CSS (Dec. 1, 2016), Docket Nos. 10290, 10291, 10293, 10294.

[13]             In re Energy Future Holdings Corp., Case No. 14-10979-CSS (Dec. 28, 2016), Docket Nos. 10446, 10447, 10453, 10454.

[14]             Id.

[15]             In re Energy Future Holdings Corp., Case No. 14-10979-CSS (Jan. 3, 2017), Docket Nos. 10518, 10519, 10520, 10521.

[16]             Id.

[17]             In re Energy Future Holdings Corp., Case No. 14-10979-CSS (Jan. 4, 2017), Docket No. 10566.

[18]             2014 WL 4436335, at *12-13 (Sept. 9, 2014).

[19]             Id. at *11-12.

[20]             Id. at *16.

[21]             U.S. Bank National Association v. Wilmington Savings Fund Society, FSB (In re MPM Silicones, LLC), 531 B.R. 321, 335 (S.D.N.Y. 2015).

[22]             Id. at 336.

[23]             Id.

[24]             Id. at 336-37.

[25]             In re Energy Future Holdings, 842 F.3d at 259-60.

[26]             Id. at 257, 260.

[27]             Momentive Performance Materials, Inc. v. BOKF, NA (In re MPM Silicones, L.L.C.), Case No. 15-1682 (2d Cir.).

[28]             Momentive Performance Materials, Inc. v. BOKF, NA (In re MPM Silicones, L.L.C.), Case No. 15-1682 (2d Cir. Sept. 4, 2015), Document Nos. 61, 64.

The following Gibson Dunn lawyers assisted in the preparation of this client alert:  Sabina Jacobs, Jeffrey Krause and Alan Bannister.

Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following members of the firm’s Business Restructuring and Reorganization and Global Finance practice groups:

Business Restructuring and Reorganization Group:
Michael A. Rosenthal – New York (+1 212-351-3969, [email protected])
Jeffrey C. Krause – Los Angeles (+1 213-229-7995, [email protected])
Robert A. Klyman – Los Angeles (+1 213-229-7562, [email protected])
David M. Feldman – New York (+1 212-351-2366, [email protected])
Matthew J. Williams – New York (+1 212-351-2322, [email protected])
Sabina Jacobs – Los Angeles (+1 213-229-7381, [email protected]).

Global Finance Group:
Thomas M. Budd – London (+44 (0)20 7071 4234, [email protected])
Linda L. Curtis – Los Angeles (+1 213-229-7582, [email protected])
Stephen Gillespie – London (+44 (0)20 7071 4230, [email protected])
J. Alan Bannister – New York (+1 212-351-2310, [email protected])

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