Australia: Bankruptcy court rejects payment of make-whole in connection with the prepayment of aircraft finance transactions

Summary of bankruptcy court's decision

On January 17, 2013, the United States Bankruptcy Court for the Southern District of New York ruled in U.S. Bank Trust National Assoc. v. Am. Airlines, Inc. (In re AMR Corp.), Nos. 12-01932(SHL), 12-01946(SHL), 2013 Bankr. LEXIS 239 (Bankr. S.D.N.Y. Jan. 17, 2013), that American Airlines, Inc. ("American") was not required to pay a "make-whole" premium when prepaying secured debt owed under certain aircraft financing transactions. Loan agreements often require that a borrower pay a "makewhole" premium to a lender if the loan is voluntarily redeemed or prepaid before maturity. The purpose is to compensate the lender for the loss of future interest payments in a fixed-rate transaction.

The Bankruptcy Court held that the plain language in the loan documents, however, did not require any "make-whole" payment where the debt had been automatically accelerated by virtue of American's Chapter 11 filing. This decision reinforces the point that non-debtor parties' rights in bankruptcy cases are heavily dependent on the plain language in their operative agreements. The lenders have appealed the Bankruptcy Court's decision. The parties are requesting that the appeal be heard on an expedited basis by the United States Circuit Court of Appeals for the Second Circuit, thereby skipping the intermediate level of appeal in the United States District Court.

Background facts

American financed a pool of aircraft pursuant to three prepetition financing transactions (the "Prepetition Financings"), two of which involved enhanced equipment trust certificates (EETCs). American filed Chapter 11 on November 29, 2011.

Within the first 60 days of American's bankruptcy filing, American agreed to cure defaults and fully perform its contractual obligations under the financings in accordance with and pursuant to section 1110(a) of the Bankruptcy Code. By making this "section 1110(a) agreement," American was allowed to continue in possession of the relevant aircraft so long as it continued to make all scheduled loan payments.

On October 9, 2012, American filed a motion for authority to enter into a new $1.5 billion financing at lower interest rates in order to prepay the Prepetition Financings. The new financing took advantage of lower market interest rates available during the bankruptcy case and American estimated the reduced interest rate would save the estates in excess of $200 million. To effectuate such savings, American sought to avoid paying "makewhole" amounts to the existing lenders.

The indentures for the Prepetition Financings provided that the "make-whole" amount is payable upon a voluntary redemption of the debt by American. On the other hand, the indentures also provided that upon an event of default due to American's bankruptcy filing, "the unpaid principal amount of the Equipment Notes then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder (but for avoidance of doubt, without Make-Whole Amount), shall be immediately and without further act become due and payable . . . ." In re AMR Corp., 2013 Bankr. LEXIS 239, at *7-8 (emphasis added). A default and acceleration make prepayment of the debt mandatory and not voluntary.

U.S. Bank, as loan and security agent under the Prepetition Financings, objected to American's motion and requested payment of the "make-whole" amount. Among other things, U.S. Bank argued that the prepayment was a voluntary redemption under the indentures and not a mandatory prepayment that was triggered by a default.

Bankruptcy court decision

The Bankruptcy Court agreed with American and approved the new financing without requiring payment of the "make-whole" amount to the existing lenders.

The Bankruptcy Court relied heavily on the plain language in sections 4.02(a)(1) and 3.03 of the indentures and held that the indentures expressly provided that a "make-whole" amount was not payable in connection with the repayment of the debt following acceleration.1 The Bankruptcy Court held that the indentures provided that (a) the filing of a voluntary bankruptcy petition by American constituted an event of default, (b) this bankruptcy default by the terms of the indentures resulted in the automatic acceleration of the debt without the need for any notice or action by the lenders, and (c) the "make-whole" amount was not required to be paid by American after such a default and acceleration of the debt.

The lenders made several arguments, each of which were rejected by the Bankruptcy Court. First, the lenders argued that the indenture provisions relied upon by American (and the Bankruptcy Court) applied only where the payment by American was made "as a consequence of or in connection with an Event of Default or acceleration," as set forth in section 3.03 of the indentures. Id. at *48. The lenders argued that American was voluntarily repaying the debt to take advantage of low interest rates. This was not a forced repayment as a result of a default. The Bankruptcy Court, however, held that "in connection with" a default or acceleration should be read broadly to include any payment after a default or acceleration.

Second, the Bankruptcy Court rejected the lenders' argument that a lender must affirmatively choose to accelerate a debt as a remedy under New York law, regardless of the contractual provisions. The Bankruptcy Court distinguished two New York State Supreme Court cases, Wurzler v. Clifford, 36 N.Y.S.2d 516, 517 (Sup. Ct. 1942), and Tymon v. Wolizter, 240 N.Y.S.2d 888, 895 (Sup. Ct. 1963), on the grounds that the acceleration provisions were not selfoperative in those cases. In an ironic twist, the Bankruptcy Court noted that the courts in those cases "expressed concern that holding a bare bones acceleration clause to be self-operative would permit a borrower to intentionally default when market conditions render the loan unfavorable, thereby requiring a lender to accept immediate repayment." In re AMR, Corp., 2013 Bankr. LEXIS 239, at *28. However, the Bankruptcy Court seemed content in distinguishing the facts on the basis that the provisions in the present case were not "bare bones" acceleration provisions, but rather specifically carved-out exceptions.

Third, the lenders argued that the indenture provisions providing for automatic acceleration upon American's bankruptcy were unenforceable ipso facto clauses under section 365(e) of the Bankruptcy Code.2 The Bankruptcy Court rejected this argument by holding that ipso facto clauses are only unenforceable where they are incorporated into an "executory contract" or "unexpired lease" that is governed by section 365 of the Bankruptcy Code. Here, the parties conceded that the indentures were not executory contracts or unexpired leases and thus the Bankruptcy Court held that section 365 was inapplicable. Moreover, the Bankruptcy Court noted that the anti-ipso facto clause provision of section 365(e) of the Bankruptcy Code was designed to protect the debtor's interest in a contract or lease. Here, the estates would be harmed by application of section 365(e) to the indentures.

Finally, the Bankruptcy Court dismissed the lenders' argument that since American exercised its rights under section 1110 it could not now claim that the prepayment was anything other than a voluntary redemption. The lenders argued that by making the "section 1110(a) agreement" and continuing to perform and make scheduled loan payments under the indentures, American had effectively taken the position that an acceleration had not occurred. The Bankruptcy Court, however, noted that section 1110(a) does not require the cure of a bankruptcy default. Thus, the "section 1110(a) agreement" and compliance with section 1110(a) could not and did not negate the bankruptcy default and resulting automatic acceleration. Further, the Bankruptcy Court explained that section 1110 provides protections to lenders, but does not serve as a "permanent commitment" by the debtor to bind itself to the aircraft financing. Id. at *72. Accordingly, section 1110 only provides how a debtor can ensure that the automatic stay remains in place, but does not prevent future rejection of the relevant aircraft lease or abandonment of aircraft that is subject to financing.


With many large Chapter 11 cases being filed in the Southern District of New York, this decision will have a significant impact. Given the importance of the issue, the story will not end here. Specifically, U.S. Bank has filed a notice of appeal; the parties are also requesting that the appeal go directly to the Second Circuit Court of Appeals, rather than the United States District Court, which would be the normal course.

If left standing, the decision reinforces the notion that non-debtor parties live and die by the words in their contracts, which may at times be interpreted in ways that favor the reorganizing debtor. Here, had the indentures provided that the "make-whole" amount was payable in all circumstances, including postacceleration, then the Bankruptcy Court likely would not have been able to deny payment, at least based on the terms of the indentures. Thus, lenders should make sure their loan documents are drafted such that the "makewhole" payment is clearly required no matter the context of the early repayment. In addition, lenders may reconsider the utility of automatic acceleration of the debt upon a bankruptcy filing. In AMR, the Bankruptcy Court might have held that the refinancing was a voluntary redemption if the debt had not been accelerated by the terms of the indentures.

These types of drafting changes may not be a complete solution since a court could still resort to other theories in striking down the "make-whole" amount, such as treating the "make-whole" payment as an unenforceable penalty. A lender nonetheless should draft the loan documents such that they clearly do not exclude the payment of the "makewhole" due to a bankruptcy event of default. This increases the chances of lenders succeeding in obtaining payment of the "make-whole" amount if the debtor seeks to refinance during a Chapter 11 case.


1Section 4.02(a)(i) of the indentures provided that upon an event of default due to a bankruptcy filing by American "the unpaid principal amount of the Notes then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder (but for avoidance of doubt, without Make-Whole Amount), shall be immediately and without further act become due and payable . . . ." In re AMR, Corp., 2013 Bankr. LEXIS 239, at *19. Section 3.03 of the indentures further provided that such "make-whole" amount was not payable "as a consequence of or in connection with an Event of Default or acceleration . . . ." Id. at *21.

2Section 365(e) of the Bankruptcy Code provides that "an executory contract or unexpired lease of the debtor may not be terminated or modified . . . at any time after the commencement of the case solely because of a provision in such contract or lease that is conditioned on – . . . (B) the commencement of a case under this title [11]." 11 U.S.C. § 365(e).

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.

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