Restructuring

The United States Supreme Court recently declined to review the United States Court of Appeals for the Second Circuit’s opinion in Momentive Performance Materials Inc. v. BOKF, NA. BOKF and Wilmington Trust, indenture trustees for Momentive’s First Lien Notes and 1.5 Lien Notes (which we’ll refer to as the “Senior Notes”) respectively, each submitted certiorari petitions after the Second Circuit held that they were not entitled to receive make-whole premiums following Momentive’s bankruptcy.

What Is a Make-Whole?

Make-wholes are contractual provisions found in indentures that typically permit a borrower to redeem or repay notes before maturity but require the borrower to pay a lump sum amount derived from a formula based on the net present value of future coupon payments that will not be paid as a result of early redemption or repayment. Make-wholes are usually available only during a “no-call” period, or a period of time specified in the indenture during which the borrower is prohibited from repaying the debt before maturity. Outside of bankruptcy, whether a creditor is entitled to a make-whole is determined purely by looking to the underlying contract that governs the debt. In other words, the analysis is rooted in state law. Once a borrower is in bankruptcy, however, the Bankruptcy Code adds a layer of complexity that has, at times, led to contradictory decisions on a constellation of bankruptcy-related issues. For more on make-wholes, see our prior post on the topic, here.

The Second Circuit Denies Make-Whole Claim

The make-whole dispute in Momentive boiled down to the following: The indenture trustees for the holders of approximately $1.1 billion of First Lien Notes and $250 million of 1.5 Lien Notes asserted that they were entitled to a make-whole premium pursuant to their indentures as a result of the repayment (in the form of the issuance of replacement notes under Momentive’s plan of reorganization) of the Senior Notes before their stated contractual maturity date.

The debtors and Second Lien noteholders took the position that, as a result of the automatic acceleration of the Senior Notes that occurred when Momentive filed for chapter 11, the maturity date of the Senior Notes had been contractually advanced. In other words, the holders of Senior Notes had bargained for the early repayment of the Senior Notes upon Momentive’s bankruptcy and, therefore, forfeited their right to a prepayment premium, and the indentures lacked language that would otherwise “clearly and specifically” provide for the payment of the make-whole, notwithstanding the automatic acceleration.

The Second Circuit agreed with the debtors and Second Lien noteholders, and ruled in their favor.

Overview of Argument: Optionality and State Law

In the nearly identical petitions for certiorari, the indenture trustees for the First Lien Notes and 1.5 Lien Notes argued that the decision by the Second Circuit “disregarded basic bankruptcy law and created a circuit split” with the United States Court of Appeals for the Third Circuit regarding optional redemptions. As discussed further below, the petitions filed by the indenture trustees and the opposition filed by Momentive and Apollo Global Management, LLC largely focused on two themes — optionality and state law.

The indenture trustees argued that the Second Circuit’s holding that a debtor’s repayment of a debt that automatically accelerated upon a bankruptcy filing is not an optional redemption flies in the face of section 1124(2) of the Bankruptcy Code. Section 1124(2) permits the debtor to choose either to repay the debt upon its emergence from bankruptcy or to reinstate the debt’s original maturity date. The indenture trustees asserted that although the Bankruptcy Code permitted Momentive to maintain the original terms and maturity of the loans, Momentive instead chose to redeem the notes by refinancing the debt. The indenture trustees further contended that the Second Circuit’s resolution of the make-whole dispute without a single reference to the Bankruptcy Code or bankruptcy principles directly conflicts with the Third Circuit’s holding in In re Energy Futures Holding Corp., which “recognized that the application of indenture provisions in a bankruptcy case must take into account the debtor’s rights under the Bankruptcy Code.” According to the indenture trustees, the Third Circuit recognized that when a debtor’s bankruptcy triggered an automatic acceleration clause in an indenture to which it is a party, the Bankruptcy Code still leaves the debtor free to reinstate the notes rather than repay them pursuant to section 1124(2) of the Bankruptcy Code.

The opposition brief filed by Momentive and Apollo, on the other hand, focused on the lack of contradiction between the holdings in Momentive and In re Energy Futures Holding Corp. Momentive emphasized that the availability of a make-whole was decided by the Second Circuit and Third Circuit under state law and reiterated that an “optional redemption” triggering a make-whole obligation upon acceleration of a debt is neither a federal nor bankruptcy law concept. Momentive argued that where an agreement includes a make-whole, New York law prescribes that a lender forfeits the right to prepayment consideration by accelerating the balance of the loan, on the understanding that acceleration of the debt advances the maturity date of the loan, and any subsequent payment by definition cannot be a prepayment. Furthermore, Momentive contended that a lender can bargain for payment of a make-whole notwithstanding acceleration, however, in light of New York rules governing make-wholes, substantial authority requires an explicit agreement to allow a make-whole premium after acceleration. Regardless of the result reached, Momentive argued that the Second Circuit and Third Circuit analyzed whether the respective debtors effected an “optional redemption” triggering payment of a make-whole by applying state law precepts to the language of the contracts before them.

In light of the Supreme Court’s refusal to review the Second Circuit’s Momentive opinion, parties who agree with Momentive’s outcome will likely seek to litigate the make-whole issue in the Second Circuit. While we continue to monitor whether there will be any significant changes to traditional make-whole language in indentures for bonds, we have seen some lenders specifically provide that a make-whole is payable after a bankruptcy event of default in credit agreements for loans. It remains to be seen whether the Momentive decisions will ultimately result in a change in market terms.

Weil summer associate Leah Singer contributed to this post.