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Momentive Ruling - Make Whole Litigation Controversy Continues

V&E Restructuring & Reorganization Update E-communication, November 8, 2017

The Second Circuit issued its long-awaited decision in the MPM Silicones LLC (“Momentive”) bankruptcy case, concluding, among other things, that (1) where an efficient market exists, the interest rate in a chapter 11 case should be determined using a market-based approach, and (2) the Debtors were not obligated to pay the “make-whole” premium required under the bond indenture based on the express language of the indenture.

The Momentive chapter 11 plan gave the senior-lien noteholders the option to (1) accept the plan and immediately receive a cash payment of the outstanding principal and interest due on their notes (excluding the make-whole premium), or (2) reject the plan and receive replacement notes equal to the allowed amount of their claim — leaving entitlement to the make-whole premium an issue to be litigated. The senior-lien noteholders voted to reject the plan. Litigation ensued regarding the interest rate applicable to the replacement notes and whether the noteholders were entitled to the make-whole premium under the bond indenture. The bankruptcy and district courts held that the Till, formula-based calculation of interest rate applied to the replacement notes, and that the debtors had no obligation to pay the make-whole premium. The noteholders appealed.

Chapter 11 Interest Rate

The Second Circuit reversed the courts below on how to calculate the interest rate for secured creditors being “crammed-up” pursuant to section 1129(b)(A)(i) of the Bankruptcy Code. The lower courts concluded that they were bound by the Supreme Court’s decision in Till v. SCS Credit Corp., 541 U.S. 465 (2004), to calculate the interest rate by starting at the national prime rate and adding a risk adjustment of between 1-3%. The lower courts rejected the reasoning of the Sixth Circuit in In re American HomePatient Inc., 420 F.3d 559 (6th Cir. 2005), in which it applied a market-based interest rate to a chapter 11 case. The Sixth Circuit relied on Till’s footnote 14 which suggests that a market-based interest rate may be appropriate in a chapter 11 case.

The Second Circuit similarly relied on Till’s footnote 14 and affirmatively adopted American HomePatient’s two-step analysis to calculate the interest rate in a chapter 11 case: if an efficient market exists, a market-based rate should be applied in a chapter 11 case; where no such market exists, the “risk free-plus” approach endorsed by the Till plurality is appropriate. The court remanded the case to the bankruptcy court to determine whether an efficient market exists, and if so, to calculate an interest rate accordingly.

It remains to be seen what evidence bankruptcy courts rely on to determine whether an efficient market exists. The Second Circuit noted that the debtor in Momentive engaged in a process to obtain exit financing as a contingency in the event the noteholders voted to accept the plan. That process produced interest rates between 5-6+%. Under those rates, the noteholders would receive $150 million more than they would under the 4.1% and 4.85% rates provided by the Till notes. The court did not express a view as to whether interest rates for exit financings were reflective of an efficient market rate.

Make-Whole Premiums

Make-whole premiums are designed to give lenders the value of their expected interest rate for the original term of the loan in the event they are paid before the original maturity date. The treatment of this method of yield-protection in chapter 11 cases has divided courts.

In Momentive, the Second Circuit affirmed the lower courts’ findings that the Debtors had no obligation to pay the make-whole premium under the bond indenture. The court addressed three primary arguments raised by the noteholders: (1) that they are entitled to the make-whole premium under the bond indenture’s optional redemption clause, (2) that they are entitled to the make-whole premium under the bond indenture’s acceleration clause, and (3) even if the bond indenture did not allow for the premium upon acceleration, the noteholders should not have been barred from exercising their contractual right to rescind acceleration postpetition.

The noteholders first argued that the Debtors issuance of replacement notes constituted “redemption” of the original notes at the Debtors’ “option,” entitling the noteholders to the make-whole premium. The court rejected the premise that the Debtors redeemed the notes at all. The court found that to “redeem” means to repay a debt security at or beforematurity, and dismissed the noteholders’ argument that “prepayment” — the term used in the AMR case on the same issue — was distinct from “redemption.” Further, per the terms of the bond indenture, the filing of the bankruptcy petition shifted the maturity date of the loan from a future date to the bankruptcy petition date, thus the replacement notes were issued after the new maturity date and no pre-maturity redemption occurred. Moreover, the court found that even if the issuance of replacement notes constituted redemption, it was not at the Debtors’ option because the obligation to issue replacement notes was mandatory under the bond indenture.  

The noteholders next argued that the bond indenture’s acceleration clause included the amount of the make-whole premium. The clause provided that in the event of default “the principal of, premium, if any, and interest on all the Notes shall ipso facto become and be immediately due and payable without any declaration or other act on the part of the Trustee or any Holders.” The court responded in the same way it did to the noteholder’s first argument, concluding that no make-whole premium was owed at the time the petition was filed, so the reference to “premium, if any” in the acceleration clause was inapplicable. In other words, nothing in the bond indenture generated a make-whole premium prior to filing the petition, and thus there was no premium for the acceleration clause to capture.

Finally, the noteholders argued that they should be entitled to their contractual right to rescind acceleration and reinstate the original maturity date. The theory being that if the maturity date was reinstated the optional redemption clause would remain in effect. The court concluded that such a rescission would modify the contractual rights of the debtor and therefore run afoul of the automatic stay.

Momentive represents a departure from the Third Circuit’s 2016 decision in Energy Future Intermediate Holdings (“EFIH”) on nearly identical facts. For example, the Third Circuit concluded that redemption can occur post-maturity and that the debtor in that case exercised redemption at its option.

The noteholders raised this conflict in a recent motion to the Second Circuit asking the court to reconsider Momentive. The noteholders argue that Momentive is in irreconcilable conflict with EFIH and the panel’s decision to follow the court’s precedent in AMR justifies en banc review. As it stands, the two Circuits that handle the majority of chapter 11 cases are split on an important, recurring issue of bankruptcy law.

Summary of Key Takeaways:

  • The Second Circuit has now joined the Sixth Circuit in interpreting Till to allow for the calculation of a market-based interest rate in chapter 11 cases where feasible.  
  • Analyzing nearly identical language, the Second and Third Circuits are split on whether the obligation to pay make-whole premiums is terminated by virtue of filing a bankruptcy petition and issuing replacement debt securities. Specifically, whether redemption can occur post-maturity, and whether it occurs at the debtor’s option.
  • Careful drafting is crucial. In particular, the outcome in Momentive might have been different had the acceleration clause unequivocally included the make-whole premium or the optional redemption clause established maturity as a date certain and specified that issuance of replacement notes in bankruptcy constituted optional redemption. 
  • Borrowers and issuers may consider the impact of this ruling in connection with future amendments, issuances and potential restructurings.
  • The In re Ultra Petroleum Corp., 2017 WL 4221098 (Bankr. S.D. Tex. Sept. 21, 2017), decision on appeal to the Fifth Circuit is one to watch for to see whether a make-whole premium is owed by a solvent debtor where the creditor is unimpaired under the plan.

This update presents a high-level summary of several key takeaways from the Second Circuit’s ruling in In re MPM Silicones, LLC, 2017 WL 4772248 (2d. Cir. Oct. 20, 2017).

Visit our website to learn more about V&E’s Restructuring & Reorganization practice. For more information, please contact V&E Partner/Restructuring and Reorganization Practice Group Leader Bill Wallander (Dallas) or David Meyer (New York).

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This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.