What the Future Holds for Make-Whole Claims in Bankruptcy: Examining the Energy Future Holdings EFIH First Lien Make-Whole Decision – Part 1

Two recent decisions from large and highly contested chapter 11 cases add to the developing body of case law on the treatment of make-whole claims in bankruptcy.  First, in a two-part post, we discuss the United States Bankruptcy Court for the District of Delaware’s decision in Energy Future Holdings, and later, in a follow-up post, we discuss the United States District Court for the Southern District of New York’s affirmation of the United States Bankruptcy Court for the Southern District of New York’s make-whole rulings in Momentive.  (To access our previous post on the Southern District of New York bankruptcy court’s Momentive decision, click here).   
On March 26, 2015, in a highly anticipated decision, Judge Sontchi of the Delaware bankruptcy court issued an opinion resolving cross-motions for summary judgment filed by the EFIH Debtors and the Trustee for the EFIH First Lien Notes, granting summary judgment in part for the EFIH Debtors and denying summary judgment altogether for the Trustee.  Among other things, the bankruptcy court held that (i) the EFIH First Lien Noteholders were not entitled to a make-whole or other damages claim when the debt automatically accelerated upon a bankruptcy filing; (ii) the EFIH Debtors did not file for bankruptcy to default intentionally and avoid paying a make-whole on the EFIH First Lien Notes; (iii) if the automatic stay were lifted, the Trustee for the EFIH First Lien Notes could decelerate the Notes and the non-settling Noteholders would then be entitled to a make-whole; and (iv) a genuine issue of material fact existed as to whether the Trustee could establish cause to lift the automatic stay retroactively to decelerate the Notes.
In this first post, we focus on the bankruptcy court’s analysis of the contractual interpretation issues relevant to a make-whole analysis.  In our second post, we examine the bankruptcy court’s discussion of the automatic stay issues raised by the parties in connection with the make-whole litigation.
The Procedural History
Shortly after filing for bankruptcy, the EFIH Debtors sought bankruptcy court approval of a debtor-in-possession loan, the proceeds of which the EFIH Debtors would use to pay down the principal and interest on their prepetition 10% First Lien Notes due 2020 and to settle at a discount certain of the Noteholders’ claims for a make-whole premium.
Before the EFIH Debtors obtained bankruptcy court approval of the DIP loan, the Trustee filed an adversary complaint in which it alleged the Noteholders were entitled to a secured claim for “Applicable Premium” (otherwise known as the make-whole premium) for one or more of the following reasons: (i) the EFIH Debtors’ repayment of the Notes would trigger the Optional Redemption Clause in the EFIH First Lien Notes’ Indenture that requires payment of the Applicable Premium, (ii) the EFIH Debtors intentionally defaulted on the Notes by filing for bankruptcy to avoid paying the Applicable Premium, or (iii) the repayment would be a breach of the Noteholders’ right to rescind the automatic acceleration of the Notes.  Further, the Trustee alleged that if the Noteholders were not entitled to a secured claim for the “Applicable Premium,” they would otherwise be entitled to unsecured claims for (i) the breach of a purported “no call” covenant in the Indenture, (ii) the violation of the perfect tender in time rule, and (iii) the breach of the Trustee’s absolute right to rescind the acceleration.
Contemporaneously with the filing of its complaint, the Trustee filed a motion seeking a declaration that it could decelerate the Notes without violating the automatic stay (the “Lift Stay Motion”).  On June 4, 2014, the Trustee issued to the EFIH Debtors a notice purporting to exercise the Trustee’s right to decelerate the Notes under the Indenture.
On June 6, 2014, the bankruptcy court approved the DIP loan over the Trustee’s objection and the EFIH Debtors’ use of the DIP proceeds to repay the outstanding principal and interest on the Notes and the make-whole settlement.  The DIP loan was funded on June 19, 2014.  The Noteholders who refused the EFIH Debtors’ make-whole settlement offer continued to pursue their make-whole claims, worth approximately $431 million, in the adversary proceeding.
The bankruptcy court bifurcated the adversary proceeding into two phases. In Phase 1, the bankruptcy court would determine whether (i) the EFIH Debtors were liable for any claims under applicable law, including for the make-whole, damages under a breach of the no-call covenant or a breach of the Trustee’s right to decelerate, or otherwise and (ii) whether the EFIH Debtors intentionally defaulted to avoid paying the make-whole or other damages.  Except for the Trustee’s intentional default claim, the bankruptcy court would assume for purposes of Phase 1 that the EFIH Debtors were solvent and able to pay all allowed creditors’ claims in full.  In Phase 2, which has yet to occur, the bankruptcy court will determine (i) whether the EFIH Debtors are insolvent, and whether insolvency affects or limits the amount of any make-whole claim allowed and (ii) the amount of the allowed make-whole claim.
The Summary Judgment Opinion
The Indenture’s Plain Language Did Not Provide for a Make-Whole Upon a Bankruptcy Acceleration
To determine whether the Noteholders were entitled to a make-whole claim, the bankruptcy court analyzed the applicable debt document:  the Indenture, which was governed by New York law.  The bankruptcy court’s analysis focused on a few key provisions:

  • Section 3.07 – Optional Redemption Clause: “At any time prior to December 1, 2015, the Issuer may redeem all or a part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium as of, and accrued and unpaid interest to, the date of redemption….”
  • Section 6.02, Par. 2 – Automatic Acceleration Clause: “[I]n the case of an Event of Default arising under clause (6) or (7) of Section 6.01(a) hereof [including EFIH’s bankruptcy filing], all outstanding Notes shall be due and payable immediately without further action or notice.”
  • Section 6.02, Par. 3 – Rescission Clause: “The Holders of at least a majority in aggregate principal amount of the Notes by written notice to the Trustee may on behalf of all the Holders waive any existing Default and its consequences under the Indenture except a continuing Default in the payment of interest on, premium, if any, or the principal of any Note (held by a non consenting Holder) and rescind any acceleration with respect to the Notes and its consequences (so long as such rescission would not conflict with any judgment of a court of competent jurisdiction).”

Reviewing the key provisions and the Indenture as a whole, the bankruptcy court concluded the Indenture was unambiguous and did not require payment of the “Applicable Premium” upon an automatic acceleration of the Notes due to a bankruptcy filing.  The Automatic Acceleration Clause in section 6.02 did not refer explicitly to the payment of an “Applicable Premium,” nor did it incorporate the Optional Redemption Clause found in section 3.07, the only provision throughout the Indenture that referred to the concept of an “Applicable Premium.”  New York law is clear that, absent explicit language entitling a party to payment of a make-whole upon acceleration, the make-whole would not be owed.
The bankruptcy court noted that the Indenture was negotiated at arm’s-length between sophisticated parties who were represented by counsel, and if those parties had intended for a make-whole upon automatic acceleration, they could have easily bargained for language that would have clearly entitled them to it – as other parties have done in other cases.  In further support of its view, the bankruptcy court compared the language in the Automatic Acceleration Clause against substantially similar language in other cases where courts found no make-whole payable upon a bankruptcy acceleration, including cases such as Calpine, Premier, Momentive and Solutia.
Moreover, the bankruptcy court disagreed with the Trustee that the Optional Redemption Clause in section 3.07 acted as a wholesale bar to any repayment prior to December 1, 2015.  It also disagreed with the Trustee that because the Optional Redemption Clause did not disclaim the effect of the Automatic Acceleration Clause in section 6.02, the Optional Redemption Clause would control upon a bankruptcy filing.  To the contrary, the bankruptcy court concluded that the Indenture treated a voluntary redemption under the Optional Redemption Clause as an event separate and apart from an automatic acceleration.  The EFIH Debtors were required to follow specific procedures and a notice process to initiate a voluntary redemption, whereas an automatic acceleration required “no further action or notice.”  Additionally, other provisions in the Indenture listed “redemption” and “acceleration” as standalone concepts in provisions governing when an event of default is determined to have occurred and when payments on principal, premium and interest would be due.  Lastly, the bankruptcy court cited to a number of decisions where courts concluded that debt repaid after it matured upon an automatic acceleration could not have been “prepaid” in a voluntary redemption.  Because the Notes were repaid by the EFIH Debtors after they had already accelerated upon the bankruptcy filing, the bankruptcy court found the Notes could not have been redeemed “early” by the EFIH Debtors pursuant to the Optional Redemption Clause.
The Bankruptcy Filing Was Not an Intentional Default
The bankruptcy court also disagreed with the Trustee’s allegation that the EFIH Debtors filed for bankruptcy seeking to automatically accelerate their debt to avoid paying the make-whole.  As an initial matter, the bankruptcy court noted that the Indenture contained no language entitling the Noteholders to a make-whole if the EFIH Debtors intentionally defaulted on the debt.  Even viewing all the factual inferences in the light most favorable to the Trustee, the Trustee failed to present evidence sufficient to create a genuine issue of material fact that the EFIH Debtors filed for bankruptcy because of any reason other than they were running out of cash.  Accordingly, the bankruptcy court granted summary judgment in favor of the EFIH Debtors on this issue.
The Trustee Had No Claim for (i) Breach of a No-Call, (ii) Violation of the “Perfect Tender” Rule, or (iii) the Breach of the Right to Waive a Default and Decelerate the Notes
The bankruptcy court quickly disposed of the Trustee’s allegation that it was owed an unsecured claim for the EFIH Debtors’ breach of a no-call covenant in the Indenture.  Citing the Momentive decision which dealt with a “nearly identical provision,” the bankruptcy court noted that, like Momentive, the language of section 3.07 was insufficient to imply a no-call covenant.  The prohibition on repayment prior to December 1, 2015 found in section 3.07 was merely “an introduction or framing device” for the voluntary redemption provisions found in the Indenture and not an overall bar to repayment prior to a date certain.
The bankruptcy court similarly rejected the Trustee’s alleged unsecured claim for the EFIH Debtors’ violation of the “perfect tender” rule, a New York common law rule prohibiting a borrower from repaying its obligation prior to the stated maturity date in the absence of explicit permission to do so.  Again citing to Judge Drain’s analysis in Momentive, Judge Sontchi observed that, like in Momentive, the Automatic Acceleration Clause here directly modified the default “perfect tender” rule, because it explicitly made the outstanding debt due and payable immediately upon a bankruptcy filing, thus permitting the EFIH Debtors to repay the matured debt anytime thereafter.
Finally, the bankruptcy court rejected the Trustee’s argument it was entitled to damages for a breach of its right to rescind acceleration under the Indenture.  Section 506(b) of the Bankruptcy Code only permits oversecured creditors secured claims for “reasonable fees, costs, or charges” that are “provided for under the agreement…under which such claim arose.”  The bankruptcy court could find no provisions within the Indenture that provided for any fee, cost, or charge for the Trustee’s inability to exercise its rescission right.  Accordingly, the bankruptcy court determined the Trustee’s damages claim should not be allowed.
Judge Sontchi’s opinion on the contractual interpretation issues implicated by a make-whole analysis closely follows Judge Drain’s opinion in Momentive and, in this regard, holds few surprises.  Other courts have also reiterated that clear, explicit language is required for a creditor to successfully assert a make-whole claim, and the courts’ collective decisions provide growing guidance on the contours of what constitutes clear, explicit language.
More interesting to us, however, is Judge Sontchi’s discussion of whether the automatic stay should be lifted retroactively to allow the Trustee to decelerate the Notes and collect on the make-whole.  The bankruptcy court observed that if the automatic stay were lifted retroactively, the EFIH Debtors’ repayment of the Notes would have constituted an Optional Redemption entitling the non-settling Noteholders to a make-whole.  The bankruptcy court, however, stopped short of holding cause existed to lift the automatic stay, concluding that a genuine issue of material fact existed as to whether the Trustee could establish cause, leaving the issue unresolved pending a trial.  In our second post in this two-part series, we discuss in further detail the bankruptcy court’s opinion and the subsequent trial and briefing on the automatic stay issues – stay tuned!