United States: Recent Developments In The Enforceability Of Make-Whole Premiums In The Second Circuit

In March 2019, Judge Stuart M. Bernstein of the U.S. Bankruptcy Court for the Southern District of New York ruled that lenders using clear and unambiguous language in their loan agreements may be entitled to prepayment premiums that they would have otherwise forfeited in a borrower’s bankruptcy. In In re 1141 Realty Owner LLC, Judge Bernstein acknowledged the general rule set forth in the U.S. Court of Appeals for the Second Circuit’s decisions in In re AMR Corp. and In re MPM Silicones, L.L.C. (Momentive) that when a lender accelerates a loan following a debtor’s default, the lender forfeits the right to a prepayment premium because the acceleration advances the maturity date, and therefore the debt cannot be prepaid. However, the court enforced the mortgage lender’s claim for a prepayment premium despite its pre-petition acceleration of the loan, ruling that parties can, and in this case did, contract around this general rule by requiring payment of the make-whole premium in connection with any post-default payment.

The 1141 Realty decision provides guidance for debtors and lenders on the enforceability of prepayment premiums if the borrower files for bankruptcy protection in the Second Circuit.

Make-Whole Premiums and the Legal Landscape in the Second Circuit

Debt instruments often include provisions providing for prepayment premiums, also known as make-whole premiums, yield-maintenance premiums or redemption premiums. These types of provisions are designed to compensate the lender for its anticipated interest-rate yield if the borrower elects to repay its debt in advance of the maturity date. Put simply, the provisions protect the lender’s expected return on its investment. Although prepayment premiums are generally enforceable outside bankruptcy, courts have reached conflicting decisions on their enforceability in Chapter 11.

In 2013, in AMR, the Second Circuit relied on the express language of the indentures in holding that the debtor’s voluntary bankruptcy filing triggered a default which automatically accelerated the notes but did not require payment of the make-whole amount. Following the bankruptcy filing, the debtors sought to repay certain pre-petition notes excluding the make-whole amount. The indentures defined a voluntary bankruptcy filing as an event of default and, in such event, provided for the automatic acceleration of the unpaid principal amount of the notes, including interest and other amounts due, but excluding the make-whole amount. In an attempt to refute the plain language of the indentures, the noteholders argued that (1) the trustee never elected to accelerate the debt, (2) even if acceleration took place, the lender could rescind acceleration, which would require payment of the make-whole amount in connection with the debtor’s proposed refinancing, and (3) regardless of whether the debt was accelerated upon the bankruptcy filing, the debtor’s proposed refinancing was a voluntary redemption requiring payment of the make-whole amount.

The Second Circuit rejected each of the lender’s arguments, holding that payment of the make-whole was not required because the indentures provided for the automatic acceleration of the notes excluding the make-whole amount upon the debtor’s voluntary bankruptcy filing. Importantly, the Second Circuit found that the automatic acceleration of AMR’s debt changed the maturity date from some point in the future to the date of the debtor’s default (i.e., the date of the bankruptcy filing). Therefore, AMR’s attempt to repay the debt following the bankruptcy filing was not a voluntary prepayment but rather a post-maturity payment that did not trigger the make-whole amount.

The Second Circuit revisited the enforceability of make-whole premiums in its 2017 decision in Momentive. The indentures governing Momentive’s senior-lien notes contained optional redemption clauses providing for the payment of a make-whole premium if Momentive were to redeem the notes at its option prior to October 15, 2015, which was five years prior to the maturity date. When Momentive issued replacement notes under its Chapter 11 plan in October 2014, the senior-lien noteholders argued that they were entitled to payment of the make-whole premium because Momentive had redeemed the notes at its option prior to October 15, 2015. Similar to AMR, the indentures in Momentive provided for the automatic acceleration of the notes upon a bankruptcy filing. Relying on its prior holding in AMR, the Second Circuit held that any payment on the accelerated notes following the bankruptcy filing was a post-maturity payment, not a redemption. The Second Circuit also noted that, even assuming Momentive’s issuance of the replacement notes was a redemption, the make-whole was only payable upon optional prepayment of the debt and would not have been at Momentive’s option as required to trigger the make-whole premium, because the repayment obligation arose automatically from the acceleration provisions in the indenture.1 Nevertheless, the court left open whether a properly drafted make-whole provision would be enforceable in bankruptcy.

1141 Realty Decision

1141 Realty Owner LLC owns the Flatiron Hotel in New York City. In 2015, 1141 Realty borrowed $25 million secured by a mortgage on the hotel property. In 2017, 1141 Realty defaulted under the loan by failing to maintain a valid liquor license. The lender declared a default and elected to accelerate the debt pre-petition. 1141 Realty subsequently filed for bankruptcy, and the lender filed a claim for approximately $32 million, including approximately $3.1 million allocated to a yield-maintenance premium, i.e., a make-whole premium. Relying on the Second Circuit’s decisions in AMR and Momentive, 1141 Realty argued that the yield-maintenance premium was unenforceable as a matter of New York law because the lender had accelerated the debt.

The loan agreement in 1141 Realty provided that any payment made after an event of default “shall be deemed a voluntary prepayment” that violated the loan agreement’s prohibition against prepayments, triggering payment of the yield-maintenance premium. The yield-maintenance provision did not mention acceleration of the debt.

Judge Bernstein acknowledged the general rule in the Second Circuit that a lender that accelerates a loan following a default forfeits the right to a prepayment premium because the acceleration advances the maturity date, and therefore, the loan cannot be prepaid. However, Judge Bernstein noted that there are two exceptions to this general rule. First, if a clear and unambiguous provision requires payment of the prepayment premium even after the default and acceleration, the provision will be analyzed as a liquidated damages provision. Second, if the borrower intentionally defaults in order to accelerate the debt and evade payment of the prepayment premium, the prepayment premium will be enforced.

Judge Bernstein found that the parties in 1141 Realty had contracted around the general rule by providing that any payment following an event of default would trigger payment of the yield-maintenance premium. Judge Bernstein distinguished the Second Circuit’s decisions in AMR and Momentive based on differences in the relevant loan agreements in those cases: (1) in AMR, the relevant provision explicitly stated that no make-whole premium was due in the event of an automatic acceleration, and (2) in Momentive, the relevant provision required payment of the make-whole premium in the event of an optional redemption, which the Second Circuit concluded had not occurred because the acceleration of the debt upon the bankruptcy filing made payment mandatory and not optional.

Judge Bernstein distinguished the Second Circuit’s decisions in AMR and Momentive based on differences in the relevant loan agreements in those cases. 

Notably, Judge Bernstein rejected the debtors’ arguments that (1) a lender forfeits a prepayment premium as a matter of law by accelerating the debt, and (2) a make-whole provision must expressly require payment of the premium after acceleration. Rather, Judge Bernstein found that the “parties can provide for their rights with any language that plainly conveys their intent.”

Takeaways

The 1141 Realty decision provides guidance on the enforceability of make-whole premiums in the Second Circuit. Under Judge Bernstein’s ruling, a make-whole provision is more likely to be enforced if the underlying debt documents explicitly provide that the premium is payable even after acceleration or, alternatively, render acceleration irrelevant, and as the parties did in 1141 Realty, require payment of the premium in connection with any post-default payment.

However, there are important distinctions between AMR and Momentive, on the one hand, and 1141 Realty, on the other, which may limit the reach of Judge Bernstein’s decision. First, the lender in 1141 Realty had accelerated the debt pre-petition, whereas in AMR and Momentive the debt was automatically accelerated upon the debtor’s bankruptcy filing. Second, in 1141 Realty, the make-whole provision was payable in connection with any post-default payment, therefore rendering acceleration irrelevant. In contrast, in AMR and Momentive, the automatic acceleration of the debt upon the debtor’s bankruptcy filing was key to the analysis of the make-whole provision.

Footnote

1 By contrast, in In re Energy Future Holdings Corp., the U.S. Court of Appeals for the Third Circuit held that the debtor’s noteholders were entitled to an optional redemption premium, i.e., a make-whole, when the debtor chose to refinance its notes in bankruptcy, notwithstanding the automatic acceleration of the notes upon the debtor’s bankruptcy filing.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions