In re Energy Future Holdings Corp.: Third Circuit Reverses and Requires EFIH to Pay Make-Whole Claims | Practical Law

In re Energy Future Holdings Corp.: Third Circuit Reverses and Requires EFIH to Pay Make-Whole Claims | Practical Law

In Delaware Trust Co. v. Energy Future Intermediate Holding Co., LLC (In re Energy Future Holdings Corp.), the US Court of Appeals for the Third Circuit reversed the holdings of the US District Court for the District of Delaware and the US Bankruptcy Court for the District of Delaware disallowing the noteholders' claims for make-whole premiums, ruling that the relevant indenture provisions support payment of the make-whole amounts.

In re Energy Future Holdings Corp.: Third Circuit Reverses and Requires EFIH to Pay Make-Whole Claims

by Practical Law Bankruptcy & Restructuring
Published on 09 Dec 2016 • USA (National/Federal)
In Delaware Trust Co. v. Energy Future Intermediate Holding Co., LLC (In re Energy Future Holdings Corp.), the US Court of Appeals for the Third Circuit reversed the holdings of the US District Court for the District of Delaware and the US Bankruptcy Court for the District of Delaware disallowing the noteholders' claims for make-whole premiums, ruling that the relevant indenture provisions support payment of the make-whole amounts.
On November 17, 2016, the US Court of Appeals for the Third Circuit, in Delaware Trust Co. v. Energy Future Intermediate Holding Co., LLC (In re Energy Future Holdings Corp.), reversed the holdings of the US District Court for the District of Delaware and the US Bankruptcy Court for the District of Delaware disallowing the noteholders' claims for make-whole premiums, ruling that the relevant indenture provisions support payment of the make-whole amounts ( (3d Cir. Nov. 17, 2016)).

Background

Energy Future Intermediate Holding Company, LLC and EFIH Finance, Inc. (collectively, EFIH) borrowed approximately $4 billion in 2010 at a 10% interest rate by issuing a series of notes due in 2020, secured by a first-priority lien on its assets (First Lien Notes). Section 3.07 of the indenture for the First Lien Notes (First Lien Indenture) provided that "at any time prior to December 1, 2015, [EFIH] may redeem or all a part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium … and accrued and unpaid interest" (emphasis in original). The term "Applicable Premium" refers to the make-whole premium, which was intended to compensate the bondholders for interest lost if the notes were redeemed early. The First Lien Indenture also contained an acceleration provision in section 6.02, providing that all outstanding notes were immediately due and payable if EFIH filed for bankruptcy.
In 2011 and 2012, EFIH borrowed additional funds by issuing two sets of notes secured by a second-priority lien on its assets (Second Lien Notes). The indenture for the Second Lien Notes (Second Lien Indenture) contained a make-whole provision similar to the First Lien Indenture. However, the acceleration provision in section 6.02 of the Second Lien Indenture differed from the First Lien Indenture, containing language that expressly referenced payment of a "premium if any . . . and any other monetary obligations."
Disclosing its intentions in public filings to refinance its First Lien and Second Lien Notes at a lower interest rate without paying the make-whole premiums, EFIH filed Chapter 11 petitions on April 29, 2014 in the US Bankruptcy Court for the District of Delaware. Soon after filing, EFIH sought approval of DIP financing, in part to repay the outstanding First Lien Notes, which the bankruptcy court approved. On March 10, 2015, EFIH also refinanced a portion of the Second Lien Notes with permission of the Bankruptcy Court. While EFIH repaid the holders of the First Lien Notes their principal and accrued interest, and partially repaid the holders of the Second Lien Notes their principal and accrued interest, EFIH did not pay any of the make-whole premiums. The trustees for each of the First Lien Notes and the Second Lien Notes filed adversary proceedings seeking declarations that refinancing the notes would trigger the make-whole premiums and requesting retroactive relief from the automatic stay to rescind the acceleration.
The Bankruptcy Court ruled against the trustees, holding that:
The District Court affirmed both decisions of the Bankruptcy Court. The Third Circuit consolidated the appeals of the trustees for the First Lien Notes and the Second Lien Notes.

Outcome

The Third Circuit reversed the District Court and the Bankruptcy Court decisions and enforced the make-whole claims for the First Lien Notes and the Second Lien Notes. In reversing, the Third Circuit focused on:
  • The make-whole premium contemplated by the First and Second Lien Indentures as being triggered on a "redemption" of the notes.
  • The entirety of both the redemption and acceleration provisions in both the First and Second Lien Indentures, finding that they are not inconsistent.
The Third Circuit held that entitlement to the make-whole premium was a matter of contractual interpretation under New York law, concluding that under New York contract principles EFIH's refinancing was a voluntary "redemption" within the meaning of the indentures, thereby triggering the make-whole provisions.

First Lien Indenture Language

The Third Circuit held that in accordance with the section 3.07 of the First Lien Indenture, the Debtors voluntarily chose to redeem the notes, which required payment of the make-whole premium. The Court also found that the acceleration provision in 6.02 did not supersede the earlier redemption provision and remained applicable after the bankruptcy filing.
In reaching its decision, the Third Circuit analyzed the text of the First Lien Indenture and noted a key distinction between the concepts of "prepayment" and "redemption." The Court determined that:
The Third Circuit also reasoned that:
  • The text of sections 3.07 and 6.02 were not in conflict, and were not mutually exclusive.
  • When EFIH filed for bankruptcy, the maturity date was accelerated to the petition date, and its postpetition payment of the notes was a post-maturity payment governed by section 6.02. The Third Circuit noted that, under NML Capital v. Republic of Argentina, if the parties intend for obligations from acceleration to cease they need to include language to that effect in their agreement (952 N.E.2d 482, 490 (N.Y. 2011)).

Second Lien Indenture Additional Language

As with its analysis of the First Lien Indenture, the Third Circuit ruled that EFIH was also obligated to pay the make-whole premium under the Second Lien Indenture. The Third Circuit determined that the additional language "all of the principal and premium, if any" contained in the acceleration provision of section 6.02 of the Second Lien Indenture, refers to the make-whole premium provided for in section 3.07.
The Third Circuit rejected EFIH's reliance on the decisions of the US District Court and Bankruptcy Court for the Southern District of New York in In re MPM Silicones, LLC, that the indenture's language needs to be more specific and refer to the premiums specifically in section 3.07 of the indenture (, at *13 (Bankr. S.D.N.Y. Sept. 9, 2014), aff'd, 531 B.R. 321 (S.D.N.Y. 2015) (Momentive); see Legal Update, In re MPM Silicones: SDNY Bankruptcy Court Denies Make-whole Claim and Approves Cramdown of Secured Creditors with Below-market Replacement Notes). The Third Circuit noted that it believed the result in Momentive conflicted with that indenture's text and failed to honor the parties' bargain.

The Effect of Acceleration on Make-Whole Provisions

In the last part of the Third Circuit's analysis, the Court rejected EFIH's argument that it should not have to pay the make-whole premium because the accelerated maturity date caused by section 6.02 occurred before EFIH paid off the notes. The Third Circuit relied on NML Capital, which held that under New York law, the consequences of acceleration depend on the language used by the parties in their agreement (NML Capital, 952 N.E.2d at 492).
The Third Circuit determined the following:
  • A prepayment is different from a redemption because a redemption may occur after a debt's maturity (relying on Chesapeake Energy Corp., 773 F.3d at 116). A premium tied to a redemption is therefore unaffected by acceleration of a debt's maturity.
  • Nothing in section 6.02 of the First Lien Indenture or Second Lien Indenture negates the premium required by section 3.07 if EFIH opts to redeem the notes before the stated date.
  • The Bankruptcy Court, by following Momentive and Northwestern, ran afoul of New York law by failing to enforce the contract provision of section 3.07 that was not affected by acceleration (NML Capital, 952 N.E.2d at 492).

Practical Implications

The decision departs from the rationale regarding make-whole premiums that the SDNY Bankruptcy Court set out in Momentive (see 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 will certainly impact future Chapter 11 cases filed in the District of Delaware and other districts in the Third Circuit. It remains to be seen how the Second Circuit will hold in Momentive and whether it will leave a split among the circuits.
The Third Circuit's opinion serves as a reminder of the importance of careful drafting and the need to include explicit language in indentures concerning the parties' intentions to enforce or avoid make-whole premiums after acceleration or upon redemption.
However, the Court's decision was based only on its interpretation of the specific contractual provisions before it. Therefore, the question of whether make-whole premiums will be enforceable in other bankruptcy cases will depend on that court's interpretation of the contractual language in the indenture.
For more information about the lower court rulings, see the following Legal Updates:
For more information on make-whole provisions in bankruptcy, see Practice Note, Treatment of Make-Whole and No-call Provisions in Bankruptcy.