EFH Court Refuses to Entertain “Legal Fiction,” Dismisses First-Lien Trustee’s Turnover Action Against Second-Lien Noteholders to Recover Make-Whole Not Payable by Debtors

Earlier this month, Judge Sontchi dismissed an intercreditor adversary complaint filed in 2014 by the Energy Future Holdings (“EFH”) first-lien trustee against the second-lien noteholders.  At issue in this decision, Delaware Trust Co. v. Computershare Trust Co. (In re Energy Future Holdings Corp.) was whether the first-lien trustee could, pursuant to the terms of the intercreditor collateral trust agreement (“Collateral Trust Agreement”), recover from the second-lien noteholders (who had received a partial paydown of their notes by the debtors) approximately $488 million, the amount of a premium payable under the first-lien indenture upon an early, voluntary repayment of the first-lien notes (the “Applicable Premium”).  The court found that because the debtors had no obligation to pay the Applicable Premium, the Collateral Trust Agreement did not provide for turnover of the Applicable Premium amount from the second-lien noteholders. 
Crucial to the court’s decision were the court’s previous determinations in a separate adversary proceeding between the first-lien trustee and debtor Energy Future Intermediate Holding Co. LLC, which were covered in previous Bankruptcy Blog posts (See, What the Future Holds for Make-Whole Claims in Bankruptcy: Examining the Energy Future Holdings EFIH First Lien Make-Whole Decision – Part 1, Part 2, Part 3, and Part 4).  In that proceeding, the court found that: (i) pursuant to the first-lien indenture, the first-lien noteholders could only recover the Applicable Premium if there was an “Optional Redemption” of the first-lien notes, (ii) the partial paydown of the second-lien notes was not an “Optional Redemption” under the first-lien indenture, and (iii) the first-lien notes were automatically accelerated by the debtors’ bankruptcy filing, which acceleration did not constitute an “Optional Redemption” under the first-lien indenture.
Subsequently, in an attempt to revive the Applicable Premium, the first-lien trustee moved to lift the automatic stay in order to decelerate payments due under the first-lien notes.  The court denied the request and held that the Applicable Premium was therefore not owed by the debtors.  This left the court with two fundamental issues: (i) was the Applicable Premium an obligation rendered unenforceable by operation of the Bankruptcy Code, or was it a contingent obligation that failed to mature by operation of the Bankruptcy Code, and (ii) if the Applicable Premium obligation never matured as against the debtors, could the first-lien trustee nonetheless recover the Applicable Premium amount from the second-lien noteholders?
The court found in that decision that the operation of the automatic stay was not the sole reason the Applicable Premium was not owed by the debtors; the automatic stay prevented rescission of the automatic acceleration of the first-lien notes that had already occurred upon the debtors’ bankruptcy filing.  The Applicable Premium had been contingent only upon the lift-stay determination, and once the court denied the request to lift the stay, the first-lien notes were in fact accelerated and as a result the Applicable Premium obligation was not due.
The question in the court’s most recent decision, then, was whether the Applicable Premium constitutes an “Obligation” under the Collateral Trust Agreement that would enable the first-lien trustee to assert a claim for the Applicable Premium against the second-lien noteholders.  The Collateral Trust Agreement provides:
Obligations” means any principal, interest (including all interest accrued thereon after the commencement of any Insolvency or Liquidation Proceeding at the rate including any applicable post-default rate, specified in the Secured Debt Documents, even if such interest is not enforceable, allowable, or allowed as a claim in such proceedings), premium, penalties, fees, indemnifications, reimbursements, damages and other liabilities and guarantees of payment of such principal, interest, penalties, fees, indemnifications, reimbursements, damages and other liabilities, payable under the documentation governing the Indebtedness.
The second-lien trustee argued that the definition of “Obligations” does not include an obligation that is not actually payable under the first-lien indenture and therefore the Applicable Premium amount cannot be sought by the first-lien trustee.  The first-lien trustee responded that despite the fact that the Applicable Premium amount was not allowed or allowable as against the debtors, such amount was nevertheless “payable under the documentation.”
The court found that the words “not enforceable, allowable, or allowed as a claim in such proceedings” unambiguously referred only to interest and not to other obligations.  The court further noted that the parties clearly knew how to include such language and chose not to do so with respect to the other enumerated obligations in the definition.
The first-lien trustee further asserted that only the operation of section 362 of the Bankruptcy Code (as opposed to the provisions of the parties’ contract under state law) rendered the Applicable Premium unenforceable against the debtor, so the second-lien noteholders must turn over the collateral proceeds.  In response, the second-lien trustee argued that either the first-lien notes had been decelerated or they had not, and that the first-lien trustee is essentially arguing that the bankruptcy court may leave the stay in place as to the debtor while “deeming” such stayed action to have occurred for purposes of adjudicating others’ rights.
The court agreed with the second-lien trustee’s argument, stating that “[t]o deem the First Lien Notes decelerated as to the Second Lien Noteholders, even though they have not been decelerated as to the Debtors, would be a fiction.”  Slip Op. *21.  The court then held that the Applicable Premium was not an “Obligation” for which the first-lien could seek turnover from the second-lien noteholders.
Ultimately, the court based its ruling on (i) the fact that the first-lien indenture lacked express language requiring the Applicable Premium upon automatic acceleration rather than voluntary redemption and (ii) the actual facts of the case—namely, that the first-lien notes automatically accelerated upon the bankruptcy filing and could not be decelerated because the first-lien notes did not obtain relief from the automatic stay—rather than a counterfactual legal fiction.  The first-lien trustee is appealing the decision.
The bankruptcy court’s decision reiterates the importance of clear, explicit language to the enforceability of make-wholes in bankruptcy.  Savvy creditors who want to ensure the payment of make-wholes in bankruptcy should explicitly provide in their debt documents that make-whole premiums are due upon automatic acceleration; here, the lack of such express language cost the creditors $488 million, a costly omission.