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Third Circuit Upholds Make-Whole Payments in Energy Future Holdings Corp.


The Business Advisor

December 2016

Make-whole premiums are a common yield protection feature of fixed rate bonds that remove a borrower’s incentive to refinance the bonds if interest rates drop. Many lenders bargain for such premiums because they must carefully match investment income to maturing liabilities. On November 17, 2016, the U.S. Court of Appeals for the Third Circuit (the “Third Circuit”) reversed the decision of the U.S. Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”), and held that Energy Futures Intermediate Holdings Company LLC and EFIH Finance Inc., (collectively, EFIH), is required to pay make-whole payments to its noteholders. In re Energy Future Holdings Corp., 16-1351, __ F.3d (3d Cir. Nov. 17, 2016).

Summary of Facts
In 2010, EFIH borrowed approximately $4 billion. In return, EFIH issued notes secured by a first priority lien on their assets. The indenture governing the loan (the “First Lien Indenture”) allowed for an early redemption, exercisable prior to December 1, 2015, on the condition that EFIH paid a “redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium [i.e., the make-whole] . . . and accrued and unpaid interest” (the “Optional Redemption Provision”). The First Lien Indenture also provided for an immediate acceleration of “all outstanding Notes” in the event that EFIH filed for bankruptcy (the “Acceleration Provision”). The Acceleration Provision gave the First Lien Noteholders the right to “rescind any acceleration [of] the Notes and its consequences[.]”

In 2011 and 2012, EFIH borrowed additional funds and issued notes secured by a second priority lien on their assets. The indenture governing the notes (the “Second Lien Indenture”) contained a redemption provision similar to the one contained in the First Lien Indenture, described above. The Second Lien Indenture, however, contained an acceleration provision that provided that “all principal of and premium, if any, interest . . . [,] and any other monetary obligations on the outstanding Notes shall be due and payable immediately” if EFIH filed for bankruptcy.

On April 29, 2014, EFIH and certain affiliates filed for bankruptcy in Delaware. EFIH sought, among other things, to refinance the notes issued under both financings (the “Notes”), at a lower interest rate, without incurring the obligation to pay the make-whole premium. This particular strategy had been upheld in Momentive,1 a bankruptcy case filed in the U.S. Bankruptcy Court for the Southern District of New York.

In June 2014, with the Bankruptcy Court’s approval, EFIH repaid the first lien notes with proceeds from a new debt issuance at a lower interest rate, resulting in cost savings of approximately $13 million of interest expense per month. EFIH however, did not pay the make-whole amount, calculated to be approximately $430 million at the time of repayment. One year later, EFIH refinanced a portion of the second lien notes, also without paying any make-whole premium and with Bankruptcy Court approval.

The Bankruptcy Court and District Court Opinions
In two separate opinions following the analysis of Momentive, the Bankruptcy Court held that the Noteholders were not entitled to the make-whole payments. Specifically, the Bankruptcy Court found that when EFIH filed for bankruptcy, the Notes were automatically accelerated and became due immediately. The Bankruptcy Court concluded that no make-whole payment was due because payment of debt after its accelerated maturity date is not a “prepayment,” and the acceleration provision itself did not contain an express statement that the make-whole was due after acceleration. Finally, the Bankruptcy Court held that the automatic stay prevented the indenture trustees from rescinding the acceleration of the Notes. The U.S. District Court for the District of Delaware affirmed the decisions of the bankruptcy court. The indenture trustees appealed to the Third Circuit.

The Third Circuit Opinion
On appeal, the Third Circuit reversed the opinions of the courts below and repudiated the reasoning behind the holding in Momentive. Specifically, the Third Circuit rejected the view that the make-whole provision did not apply once the debt was accelerated. The Third Circuit, looking to New York and federal law, concluded that “redemption” encompassed both pre- and post-maturity repayments of debt. The Third Circuit further concluded that the redemption was “optional,” because the debtors voluntarily filed for chapter 11 protection, intending to “refinance the Notes without paying any make-whole amount,” and had opposed the Noteholders’ attempt to lift the automatic stay and rescind the acceleration of the Notes. Finding that the refinancing of the Notes constituted “optional redemptions” that occurred prior to December 1, 2015, the Third Circuit concluded that EFIH was obligated to pay the make-whole payments. In reaching this conclusion, the Third Circuit rejected the debtor’s argument that only the Acceleration Provision applied on a bankruptcy filing. The Third Circuit reasoned that the Optional Redemption and the Acceleration Provisions “address different things” and “provide the map to guide the parties through a post-acceleration redemption.” Moreover, according to the Third Circuit, the holding of the Second Circuit in In re AMR Corp.2 was inapplicable because the indenture in that case explicitly stated that upon acceleration, the make-whole would not be due.

The Third Circuit’s opinion is at odds with recent case law finding that make-whole claims are due only if the indenture clearly provides for them. Nevertheless, as a result of the Third Circuit’s opinion, if properly drafted, make-whole premiums are much more likely to be enforced, potentially making it much more difficult and expensive for a debtor with such indebtedness to confirm a plan of reorganization.

1 In re MPM Silicones, LLC, No. 14-22503, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 (S.D.N.Y. 2015). The decision is currently on appeal to the United States Court of Appeals for the Second Circuit.
2 In re AMR Corp., 730 F.3d 88 (2d Cir. 2013).