In re Energy Future Holdings Corp: Delaware Bankruptcy Court Extends SDNY's Momentive Ruling in Denying Make-whole Claims

Practical Law Legal Update 6-608-2930 (Approx. 7 pages)

In re Energy Future Holdings Corp: Delaware Bankruptcy Court Extends SDNY's Momentive Ruling in Denying Make-whole Claims

by Practical Law Bankruptcy & Restructuring and Practical Law Finance

Background

Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (collectively, Debtors) issued a series of 10% first lien notes due 2020 (the Notes, and the holders of the Notes, the Noteholders) under an indenture dated August 17, 2010 (Indenture). Under the Indenture, the commencement of bankruptcy proceedings by EFIH qualified as an "event of default," which caused the automatic acceleration of the Notes.

The Debtors filed Chapter 11 petitions in April 2014, and soon after sought approval of DIP financing, in part to repay all of the outstanding Notes and settle certain Noteholders' claims (DIP Motion). On May 13, 2014, the trustee for the Noteholders (Trustee) objected to the DIP Motion, arguing that the Noteholders were entitled to a secured claim for an amount described in the Indenture as the "Applicable Premium" (make-whole premium) because:

An Optional Redemption would occur when the Debtors repaid the Notes.
The Debtors intentionally defaulted by filing for bankruptcy to avoid paying the make-whole premium.
By repaying, the Debtors breached the Noteholders' purported right to rescind the Notes' acceleration.

On May 15, 2014, the Trustee initiated an adversary proceeding. The Trustee's complaint contained:

A repeat of the claims from the May 13 objection.
An unsecured claim for breach of a purported "no-call" covenant in the Indenture.
Three unsecured claims, one for each of the three counts raised in the May 13 objection.

The Trustee also simultaneously filed a motion seeking a declaration that it could retroactively decelerate the Notes without violating the automatic stay, or alternatively that the automatic stay should be modified to permit the Trustee to rescind the acceleration. On June 4, 2014, the Trustee sent a purported notice of deceleration to the Debtors.

On June 6, 2014, the Court approved the DIP financing and the Debtors' use of the DIP financing proceeds to pay the outstanding Notes and the settlement resolving certain Noteholders' claims for the make-whole premium. The Trustee continued to prosecute the adversary proceeding on behalf of those Noteholders who chose not to accept the settlement. The non-settling Noteholders were paid their full principal and accrued interest from the DIP financing, which was funded on June 19, 2014. However, they continued to pursue the full amount of the make-whole premium in the amount of $431 million, or 19% of the principal held by the non-settling Noteholders.

On September 12, 2014, the Court bifurcated the adversary proceeding, so that in this phase of the litigation, the Court only considered whether the Debtors:

Are liable under applicable non-bankruptcy law for a "Redemption Claim," including the make-whole.
Intentionally defaulted to avoid paying an alleged make-whole premium or other damages.

The bifurcation order also provided that for purposes of the first consideration, the Court would assume that the Debtors were solvent and able to pay all allowed claims of their creditors in full.

Following discovery, the Trustee and the Debtors each moved for summary judgment, seeking to resolve all claims raised in the contested matter, the adversary complaint and the stay-applicability motion. Each side argued that, under New York law, the Indenture was clear and unambiguous.

Outcome

The Court rejected the Trustee's argument that the Noteholders were entitled to the make-whole premiums, holding that:

The plain language of the Indenture did not require payment of the make-whole premium.
The Debtors' bankruptcy filing was not an intentional default under the Indenture.

However, the Court also held that the Trustee had a qualified right under the Indenture to rescind the acceleration of the Notes that took place on the Debtors' bankruptcy filing.

Plain Language of the Indenture Did Not Require Payment of Make-whole Premium

First, the Court held that the plain language of the Indenture did not require payment of the make-whole premium.

Relying on the US Bankruptcy Court for the Southern District of New York's recent ruling in In re MPM Silicones, LLC ("Momentive") (see No. 14-22503, (Bankr. S.D.N.Y. Sept. 9, 2014) and Legal Update, In re MPM Silicones: SDNY Bankruptcy Court Denies Make-whole Claim and Approves Cramdown of Secured Creditors with Below-market Replacement Notes) and other New York case law, the Court noted that "an indenture must contain express language requiring payment of a prepayment premium upon acceleration; otherwise, it is not owed." It found that, in this case, the acceleration clause in the Indenture did not include clear and unambiguous language that a make-whole premium was due on the repayment of the Notes following a bankruptcy acceleration. Rather, the make-whole premium was not owed because the Indenture did not specify that the make-whole premium was owed after automatic acceleration.

The Court noted that the parties could have bargained for this provision. To support its conclusion, the Court compared the relevant language in the Indenture with substantially similar language from other cases, including Calpine, Premier, Momentive and Solutia, all cases in which courts found no make-whole obligation was created.

The Court then rejected the Trustee's argument that the "Optional Redemption" provision was a "wholesale bar" to any repayment before December 1, 2015 because the Indenture expressly distinguished between "optional redemption," and "automatic acceleration." The Court noted that under the Indenture, Optional Redemption contemplated a voluntary action requiring advanced written notice, while under New York law, "a borrower's repayment after acceleration is not considered voluntary" because "[a]cceleration moves the maturity date from the original maturity date to the acceleration date and that date becomes the new maturity date."

The Court therefore concluded that the plain language of the Indenture did not require payment of the make-whole premium in June 2014 when the Debtors repaid the Notes following the automatic acceleration caused by the bankruptcy filing.

Debtors' Bankruptcy Filing Was Not an Intentional Default under the Indenture

Next, the Court held that the bankruptcy filing was not an intentional default under the Indenture, noting that:

The Indenture did not contain a provision stating that a premium would be owed if the Debtors intentionally caused an event of default to avoid paying the make-whole premium.
The Trustee failed to meet its burden of supplying "sufficient evidence (not mere allegations)" for a reasonable factfinder to conclude that the Debtors intentionally defaulted. The Trustee could not counter the overwhelming evidence that the Debtors filed bankruptcy because they were facing a severe liquidity crisis, even though the Debtors planned prepetition and followed through after filing bankruptcy, to use the default created by that filing to refinance the Notes without paying the make-whole premium.

The Trustee Had a Qualified Right to Rescind Acceleration

However, the Court also held that the Trustee had a qualified right under the Indenture to rescind the acceleration of the Notes that took place on the Debtors' bankruptcy filing. This qualified right raised a number of issues.

First, the Court held that the Trustee's right to rescission was not barred by Section 6.02 of the Indenture as a result of the automatic stay. Section 6.02 provided that the Trustee may not rescind acceleration of the Notes if doing so would "conflict with any judgment of a court of competent jurisdiction." However, the Court explained that the automatic stay is not a "judgment of a court of competent jurisdiction" because it is prescribed by statute and applies in every bankruptcy case automatically, without a court order.

Next, the Court held that the automatic stay barred the Trustee's June 4, 2014 rescission notice. Relying on Momentive, AMR Corp. and Solutia, the Court held that the rescission notice was an act to "collect, assess or recover" on a claim, and therefore violated the automatic stay.

Finally, the Court explained that if the Court were to lift the automatic stay retroactively to a date on or before the repayment of the Notes on June 19, 2014 to allow the Trustee to waive the default and decelerate the Notes, the Debtors' refinancing would be an Optional Redemption and the make-whole premium would be due and owing to the non-settling Noteholders. The Court rejected the Trustee's arguments that:

A debtor's solvency is, as a matter of law, cause to lift the automatic stay, explaining that while it is a relevant consideration, it is not the sole factor to be considered.
Lifting the automatic stay would not prejudice either the bankruptcy estate or the Debtors because doing so would simply hold the Debtors to their bargain and there can be no harm to a solvent estate.

However, the Court held that while the Trustee could not meet its burden that cause exists to lift the stay, it also rejected the Debtors' argument that cause does not exist as a matter of law. Therefore, the Court held that there was a genuine issue of material fact as to whether cause exists to lift the automatic stay.

Practical Implications

This decision extends into Delaware the rationale regarding make-whole premiums recently adopted by the SDNY Bankruptcy Court in Momentive (see and Legal Update, In re MPM Silicones: SDNY Bankruptcy Court Denies Make-whole Claim and Approves Cramdown of Secured Creditors with Below-market Replacement Notes). Delaware now follows New York in requiring that a make-whole claim must be supported by clear and express language in the applicable documents.

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) and 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.
Include language that the make-whole premium will be owed if the issuer intentionally causes an event of default.

Junior creditors looking to dispute payment of the make-whole premium should review the senior lenders' loan documents to check whether they provide for these provisions. Conversely, investors should also carefully scrutinize these documents, especially the default and acceleration provisions, to evaluate the enforceability of the make-whole premium if the borrower files for bankruptcy.

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.

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.

In re Energy Future Holdings Corp: Delaware Bankruptcy Court Extends SDNY's Momentive Ruling in Denying Make-whole Claims | Practical Law