On 20 October 2017, the Second Circuit split with the Third Circuit Court of Appeals (which hears appeals from Delaware, New Jersey and Pennsylvania) regarding the entitlement of a noteholder to a "make-whole" premium in the case of a voluntary bankruptcy filing. A make-whole premium—often included in an indenture— is used to compensate noteholders for the loss of future interest payments in situations where the borrower voluntarily prepays its debt obligations.
Here, the Second Circuit held that noteholders were not entitled to payment of a "make-whole" premium following a voluntary bankruptcy filing. By contrast, the Third Circuit has held that certain noteholders are so entitled.
Between 2006 and 2012, MPM Silicones, LLC and its affiliates (collectively, "Momentive") incurred substantial debt obligations pursuant to various note indentures. One took the form of two classes of senior secured notes. The governing indentures called for the recovery of a make-whole premium if Momentive redeemed the notes prior to their maturity date, which was a fixed date stated in the indenture. The indentures also contained provisions for the automatic acceleration of the principal, premium, if any, and interest on the notes upon a default triggered by a bankruptcy filing. Although most events of default would give the senior lien noteholders the option of accelerating payment, the indentures provided that a default brought about by Momentive's voluntary bankruptcy petition would cause an automatic acceleration under the indentures.
In April 2014, Momentive filed for bankruptcy. Under its proposed plan of reorganization, Momentive issued replacement notes to the senior lien noteholders that did not account for the make-whole premium. Momentive sought a judicial determination that the noteholders were not entitled to payment of the make-whole premium. The bankruptcy court, siding with Momentive, confirmed the plan over the dissent of the noteholders and held, among other things, that the senior lien noteholders were not entitled to the make-whole premium because the indentures were not sufficiently explicit. The bankruptcy court further noted that the Second Circuit has made clear that a contractual automatic acceleration is not voluntary on the issuer's part. Finally, the bankruptcy court, relying in part on a Second Circuit case, In re AMR Corp. (AMR), concluded that the automatic stay of claims against the debtor's estate applied to de-acceleration of the senior lien notes, and that relief from the automatic stay was not warranted, because it would harm the debtors' estates by increasing the noteholders' claims by hundreds of millions of dollars.
The senior lien noteholders (among others) appealed, and the District Court for the Southern District of New York affirmed the decision. The Second Circuit affirmed the decisions of the lower courts as to the make-whole premium. The court rejected the senior noteholders' argument—that when Momentive issued the replacement notes under the Plan, it redeemed the notes prior to their maturity—for the same reason that argument was rejected in AMR. The bankruptcy filing triggered a default, which in turn automatically accelerated the debt, and that acceleration changed the maturity of the debt from a point in the future to the date of the bankruptcy filing. Therefore, the Second Circuit noted, even assuming that the issuance of replacement notes constituted a redemption, any subsequent redemption post-acceleration could not be considered voluntary or optional in nature; instead, the obligation to issue the replacement notes arose by operation of the automatic acceleration clauses in the indentures. A payment made mandatory by operation of an automatic acceleration clause, the court reasoned, is not one made at Momentive's option. The Second Circuit also held that the automatic stay barred the senior noteholders from rescinding the acceleration of the notes. The Second Circuit again cited AMR in concluding that a creditor's post-bankruptcy invocation of a contractual right to rescind an acceleration triggered automatically by a bankruptcy filing is barred because it would be an attempt to modify contractualrights, and therefore is subject to the automatic stay. As a result, the Second Circuit found that the make-whole premium was not owed to the senior lien noteholders.
The Second Circuit's decision creates a circuit split on the issue of entitlement to a make-whole premium under facts similar to those present here. The Third Circuit recently issued a decision that was critical of the decision at the bankruptcy court level, and held that certain noteholders were entitled to payment of make-whole claims. Notably, the indentures at issue involved acceleration provisions similar to those in the indentures here. It will be up to the Supreme Court to resolve the split between the circuits (if it chooses to do so).
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