On September 12, 2013, the US Court of Appeals for the Second Circuit in US Bank Trust National Ass'n v. American Airlines, Inc. (In re AMR Corp.) affirmed the US Bankruptcy Court for the Southern District of New York's decision approving American Airlines' (Debtors) motion to enter into a postpetition secured financing transaction and use the proceeds to repay $1.3 billion in prepetition debt without paying a make-whole premium (see Legal Update, US Bank Trust National Ass'n v. American Airlines: Bankruptcy Court Relies on Language of Indentures to Reject Make-whole Claim). Make-whole premiums compensate the lender for the early repayment and consequent loss of future debt service payments. The Court interpreted the indentures according to their plain meaning, which were explicit and unambiguous that no make-whole premium would be due on repayment of the debt after automatic acceleration caused by a voluntary bankruptcy filing.

This decision serves as a reminder of the importance of careful drafting for parties seeking to ensure the payment of a make-whole premium upon the repayment of accelerated debt.

Before filing for bankruptcy, the Debtors entered into various loans which were secured by aircraft that were entitled to certain protections under section 1110 of the Bankruptcy Code. On November 29, 2011, the Debtors entered bankruptcy, which constituted a default under the indentures governing this prepetition financing (Indentures). During the bankruptcy, the Debtors elected to make debt service payments to US Bank National Association (Loan Trustee) under section 1110(a) to maintain use of the aircraft. On October 9, 2012, the Debtors brought a motion for approval to:

Several sections of the Indentures deal with payment of a make-whole amount, including:

Despite these provisions in the Indentures, the Loan Trustee raised several arguments before the Bankruptcy Court in an attempt to apply the make-whole premium to the Debtors' repayment of the loans, including:

The Bankruptcy Court rejected these arguments and concluded that, under the Indentures, the Debtors' bankruptcy filing was an event of default that accelerated the debt and that the Debtors owed no make-whole amount. The Loan Trustee appealed directly to the Second Circuit.

The Second Circuit, relying heavily on the plain meaning of the Indentures, agreed with the Bankruptcy Court in rejecting the Loan Trustee's arguments and its request for payment of the make-whole amount.

First, the Second Circuit disagreed that the lender must elect acceleration under New York law. The Court noted that, while in rare circumstances equitable principles may prevent the operation of an acceleration clause under New York law, the vast majority of provisions directing what will happen in the event of default are valid and enforceable. Because the acceleration clause in these Indentures was intended to protect both parties (to accelerate unpaid interest and principal for the lender and to preclude payment of the make-whole premium for the borrower), enforcement of the Indentures as drafted would not result in inequity and therefore required the bargained-for acceleration without the make-whole premium.

Second, the Second Circuit rejected the argument that the Loan Trustee should be allowed to waive the event of default and decelerate the debt payments. Upon entering bankruptcy, the automatic stay takes effect to protect the bankruptcy estate, which includes a debtor's contract rights. The Debtors' ability to repay the accelerated debt without a make-whole amount is a contract right and is therefore protected by the automatic stay.

Third, the Second Circuit ruled that the Debtors' payment on the prepetition debt could not be treated as a voluntary prepayment because it is not a prepayment but is instead a post-maturity date repayment. As a result of the bankruptcy filing, the debt was accelerated and the new maturity date became the date of default. Because the Debtors' payment occurred after this new maturity date no make-whole payment was required. Even if the payment was a voluntary redemption, this is not relevant under the Indentures if the payment occurred after acceleration and maturity.

Fourth, in response to the Loan Trustee's allegation that section 4.02(a)(i) is an unenforceable ipso facto clause, the Second Circuit followed binding precedents which have held that ipso facto clauses "are not per se invalid except where contained in an executory contract or unexpired lease." Since both the Debtors and the Loan Trustee conceded that the Indentures are neither, the Court held that section 4.02(a)(i) was not an invalid ipso facto clause.

Next, the Second Circuit disagreed with the Loan Trustee's section 1110 argument that regular payments of principal and interest under section 1110 decelerated the notes. It explained that making regularly scheduled payments under section 1110 simply allows an airline debtor to take advantage of the benefits of the automatic stay. The resulting interim arrangement does not modify the parties' contractual relationship and therefore does not alter the Debtors' ability to repay the accelerated debt pursuant to the terms of the Indentures.

Finally, the Second Circuit rejected the Loan Trustee's contention that, if the debt was accelerated and was not decelerated by the Debtors' section 1110(a) elections, then by failing to pay the full accelerated debt, the Debtors failed to cure a default that was required to be cured under section 1110(a)(2) of the Bankruptcy Code. The Loan Trustee argued that the Debtors' failure to cure this default deprived them of the protections of the automatic stay. However, the Court explained that section 1110(a)(2)(A) of the Bankruptcy Code does not require the cure of bankruptcy defaults specified in section 365(b)(2), which includes defaults relating to the commencement of a bankruptcy proceeding. Therefore, the Debtors did not lose the benefit of the automatic stay by failing to cure this default because the accelerated debt was due only as a result of the Debtors' bankruptcy filing. Moreover, the Court noted that because section 1110 does not negate these defaults but merely postpones their consequences, the Debtors were not obligated to pay off the accelerated portion of the debt for the period in which they sought the protection of the automatic stay.

This decision serves to enforce the applicability of make-whole provisions under New York law while highlighting the importance of careful drafting. Since courts are guided by contracts, parties who wish to provide for the payment of a make-whole premium on acceleration must ensure that their agreements clearly and specifically provide for this. To ensure that there is no ambiguity regarding the application of a make-whole provision, financing agreements should:

However, the question as to whether make-whole premiums are generally enforceable in bankruptcy has not been answered in this case because the Second Circuit'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, 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.