In re MPM Silicones: SDNY Bankruptcy Court Denies Make-whole Claim and Approves Cramdown of Secured Creditors with Below-market Replacement Notes

Practical Law Legal Update 1-580-3268 (Approx. 9 pages)

In re MPM Silicones: SDNY Bankruptcy Court Denies Make-whole Claim and Approves Cramdown of Secured Creditors with Below-market Replacement Notes

by Practical Law Finance

Background

In 2012, Momentive Performance Materials and its affiliates (Debtors) issued $1.1 billion of first-lien notes and $250 million of "1.5-lien" notes due 2020 (the Notes, and the holders of the Notes, the Noteholders) under indentures with substantially similar terms and governed by New York law. Each indenture included an Optional Redemption provision which contained introductory language providing that, except for in circumstances triggering payment of the make-whole, the Noteholders could not voluntarily redeem the Notes before October 15, 2015 ("No-call" Provision).

The Debtors filed Chapter 11 petitions in April 2014, and shortly thereafter filed declaratory judgment actions challenging the Noteholders' right to more than $200 million in claims for make-whole premiums. The Debtors proposed a plan which provided that the Noteholders would receive:

Payment of their claims in full in cash, without a make-whole premium, if they voted in favor of the plan.
Seven-year replacement notes in the face amount of their allowed claims, bearing a below-market interest rate equal to the applicable Treasury rate plus a modest risk premium, and the right to litigate their entitlement to the make-whole premiums, if they rejected the plan.

The Noteholders overwhelmingly voted to reject the plan and filed confirmation objections arguing that:

They were entitled to the make-whole premiums based on the automatic acceleration of their debt resulting from the bankruptcy filing and the Debtors' early repayment of this debt in the form of the replacement notes issued under the plan.
Their treatment under the plan as a result of their rejection was not "fair and equitable" because the plan did not apply the market interest rate to the replacement notes. Therefore, the Debtors could not cram down the plan over their objection.

After the confirmation hearing, but before the Court issued a ruling, the Noteholders sought permission to change their votes to accept the plan and concede the make-whole premium argument.

Outcome

The Court held that:

The Noteholders were not entitled to the make-whole premiums.
The proposed replacement notes satisfied the cramdown requirements of section 1129(b) of the Bankruptcy Code, if the risk premium was increased by an additional 0.5% for the first-lien notes and an additional 0.75% for the 1.5 lien notes, which still resulted in a below-market interest rate.

The Court also denied the Noteholders' request to change their votes.

Make-whole Premium

The Court rejected the Noteholders' entitlement to the make-whole premiums, holding that:

The plain language of the indentures did not provide for a valid make-whole claim.
There was no claim for breach of a purported "no-call" provision under the indentures.
The automatic stay barred deceleration of the debt.

Make-whole Provision Was Not Sufficiently Explicit

The Court noted that under New York law, a lender loses the right to consideration for early payment by accelerating the balance of a loan because it no longer needs to be compensated with interest for later payment. However, a lender does not forfeit this right when:

A borrower intentionally defaults to trigger acceleration and avoid paying the premium.
The contract contains clear and unambiguous language providing for payment of the premium even after acceleration caused by a bankruptcy filing, or whenever debt is repaid before its original maturity date.

In this case, the Court found that the bankruptcy filing triggered automatic acceleration of the debt but the indentures lacked the specificity required under New York law to allow for payment of a premium in these circumstances.

The Court also held that the Optional Redemption provisions in the indentures did not apply because:

A prepayment cannot occur after an accelerated maturity date.
Prepayment caused by an automatic acceleration provision is not voluntary.

No Claim for Breach of "No-call" Provision

The Noteholders argued that they were entitled to damages for the breach of the "No-call" Provision. However, the Court held that there was no specific contractual no-call provision prohibiting prepayment of the indentures, because the indentures were silent on what would occur if the Notes were prepaid in any way other than by optional redemption, and acceleration of the Notes caused by the bankruptcy filing was not an optional redemption. Instead, the Court explained that this was merely language introducing the Notes' Optional Redemption provisions providing the Debtors with the opportunity to redeem the Notes in exchange for payment of the make-whole premium.

Next, the Noteholders asserted a claim for damages for the Debtors' breach of New York's "perfect tender" rule, under which borrowers are precluded from paying debts early. While the Court acknowledged that outside of bankruptcy, the Noteholders would at least have a claim for specific performance, the Court explained that the Bankruptcy Code would disallow such a claim because:

Prohibiting the early repayment of debt is not specifically enforceable in bankruptcy.
Damages for breach of the perfect tender rule would amount to a claim for unmatured interest, which is disallowed under section 502(b) of the Bankruptcy Code.

Automatic Stay Bars Rescission of Automatic Acceleration

Alternatively, the Noteholders sought to lift the automatic stay so they could send a notice to rescind the automatic acceleration of the Notes. The Court denied this request, holding that this would violate both:

Section 362(a)(3) of the Bankruptcy Code, which prohibits any act to obtain possession of property of the estate or to exercise control over property of the estate. The Court explained that the purpose of sending the notice would be to "resurrect" the make-whole claim through deceleration of the debt. This would amount to seeking to control property of the estate by exercising a contract right to the estate's detriment and using deceleration to recover a claim against the Debtors. The Court cited to the US Court of Appeal's recent decision in In re AMR Corp., in which it held in a similar context that sending a rescission notice would be subject to the automatic stay (see 730 F.3d 88, 102-03 (2d Cir, 2013) and Legal Update, In re AMR: Second Circuit Affirms Rejection of Make-whole Claim for Repayment of Accelerated Debt)).
Section 362(a)(6) of the Bankruptcy Code, which prohibits any act to collect, assess or recover a claim against the debtor that arose before the filing of the bankruptcy case, as the purpose of sending a rescission notice would be to take the first step in recovering the make-whole claim against the Debtors.

In addition, the Court rejected the Noteholders' argument that sending a rescission notice was permitted under section 555 of the Bankruptcy Code as an act to liquidate a securities contract. The Court disagreed that an indenture is a securities contract as defined in section 741(7)(A) of the Bankruptcy Code, and further held that sending a rescission notice is not an act to liquidate the make-whole claim, but rather serves to create a new and different claim.

Finally, the Court found that there was no "cause" to lift the stay under 362(d)(1) of the Bankruptcy Code. The Court noted that permitting the Noteholders to send a rescission notice and decelerate the debt would significantly impact the Debtors' estate and other creditors by increasing claims potentially by hundreds of millions of dollars, and is the type of action that courts have routinely refused to permit under section 362(d)(1).

Cramdown

Because the Noteholders rejected the plan, the Debtors were required to satisfy the cramdown requirements of section 1129(b)(2)(A)(i) of the Bankruptcy Code, which provides that a plan is "fair and equitable" to a non-accepting class of secured creditors if it provides that these creditors:

Retain the liens securing their claims.
Receive deferred cash payments with a present value at least equal to the allowed amount of their claims.

The Debtors argued that their plan satisfied the present value standard set out by the US Supreme Court in Till v. SCS Credit Corp. (see 541 U.S. 465 (2004)). In the context of a Chapter 13 case, the US Supreme Court applied a "formula" approach under which the proper interest rate is determined by taking a risk-free base rate, such as the prime rate or the Treasury rate, and adding a risk premium to reflect the repayment risks unique to that debtor, which is generally between 1-3%.

The Noteholders argued that it was not proper to apply Till's formula approach, based on footnote 14 in Till, which they interpreted as requiring a market interest rate when the market rate is readily apparent. In this case, the Noteholders argued that the market rate was easily identifiable, as evidenced by the higher interest rate in the Debtors' exit financing commitment.

In response, the Debtors argued that Till "is not intended to put current creditors on par with market lenders" but rather to provide a base rate of interest "plus some compensation for the risk that such replacement notes are not repaid as scheduled." Therefore, under the Debtors' theory, it followed that the formula set out in Till is not subject to a market check, even if one is available.

The Court agreed with the Debtors that the formula approach is the correct way to calculate the cramdown interest rate for secured creditors in a Chapter 11 case. However, because the Treasury rate rather than the prime rate was used, the Court held that the risk premium had to be slightly increased to make the plan confirmable, with the interest rate still remaining well below market rates.

In unambiguously supporting use of the formula approach in this context, the Court concluded that:

A cramdown interest rate should not include any profit or cost element, as both are inconsistent with the present value calculation required for cramdown.
Market testimony or evidence is only relevant to determining the proper risk premium to apply in the formula approach.
Creditors should not use the risk premium as a way to obtain a market interest rate on their replacement notes.

Practical Implications

Concerning the make-whole issue, this decision continues the trend of courts denying make-whole provisions after automatic acceleration unless clearly and unambiguously provided for in the governing documents (see Legal Updates, In re Denver Merchandise Mart: Fifth Circuit Rejects Prepayment Premium on Debt Accelerated but Not Prepaid and In re AMR: Second Circuit Affirms Rejection of Make-whole Claim for Repayment of Accelerated Debt). This decision serves as a reminder of the importance of careful drafting. To ensure that there is no ambiguity regarding the application of a make-whole provision, financing agreements should:

Not make any exceptions from the payment of a make-whole premium after acceleration under any circumstances except for payment on the original stated maturity date.
Add a provision explicitly stating that the make-whole premium will be due following acceleration.
Ensure that the term "maturity date" is clearly defined as the original stated maturity date. If not, there is potential to interpret the term maturity date as the date on which payment becomes due following acceleration, which could avoid enforcement of the make-whole provision.

However, the question as to whether make-whole premiums are generally enforceable in bankruptcy has not been answered in this case because the court's decision was based only on its interpretation of the specific contractual provisions before it. Therefore, the issue still remains unresolved.

Concerning the cramdown issue, this decision may shift leverage to debtors and unsecured creditors in negotiating consensual plans, allowing them to threaten secured creditors with replacement notes bearing below-market interest rates as payment for their claims. In cramdown plans, the ability to satisfy secured creditors with below-market replacement notes may mean less exit financing is needed to refinance the secured debt, therefore providing more value to unsecured creditors. This may result in secured lenders increasing interest rates generally to reflect the risk of receiving below-market replacement notes in a bankruptcy. However, the decision is likely to be appealed and, even if it stands, it remains to be seen whether it will be adopted by other courts.

For more information on make-whole provisions in bankruptcy, see Practice Note, Treatment of Make-whole and No-call Provisions in Bankruptcy and Chemtura Roadmap: Analysis of Make-whole and No-call Provisions in Bankruptcy.

For more information on cramdown, see Practice Note, Chapter 11 Plan Process: Overview: Confirmation of a Plan: Cramdown Plans.

In re MPM Silicones: SDNY Bankruptcy Court Denies Make-whole Claim and Approves Cramdown of Secured Creditors with Below-market Replacement Notes | Practical Law