Indentures often contain make-whole premiums payable upon early
redemption of the debt, and term B loan agreements often include
"soft call" protection in the form of prepayment premiums
during the early life of the loan. If the debt issuer becomes
subject to a chapter 11 proceeding after the debt issuance, the
question then arises as to how this payment obligation is to be
treated: Does the make-whole or prepayment premium constitute
unmatured interest due as a result of the debt acceleration, which
would be disallowed, or is it liquidated damages? Often, the
make-whole premium in the bond market is computed as interest that
would have been received through the life of the debt had
prepayment not occurred early; therefore, treating the premium as
unmatured interest can be enticing.
Last month, LSP Energy LP, an electricity provider, filed a
lawsuit seeking declaratory judgment in the latest chapter 11 case
to examine make-whole premiums in the context of debt accelerated
upon a chapter 11 filing. The indenture trustee has argued that it
is owed $80 million as a "make-whole premium" because LSP
is planning to repay the debt on a date prior to the stated
maturity date. However, LSP has argued it does not owe such amount
because the indenture provides that the make-whole premium is due
only upon a redemption of the bonds prior to maturity, and the
bankruptcy filing accelerated the maturity to the petition date as
specifically provided in the indenture. As a result, according to
LSP, the automatic acceleration of the debt renders any redemption
of the bonds made after the petition date to be after (and not
prior to) the maturity date, and thus the make-whole premium is not
due. LSP also has argued that the claim for the make-whole premium
must be disallowed as a claim for unmatured interest as a result of
the acceleration of debt upon the chapter 11 filing.
Previous Decisions
Earlier court proceedings that have examined the dispute over
the nature and enforceability of make-whole premiums after the
issuer has become subject to a chapter 11 proceeding are summarized
below.
In re Calpine Corp.1 On
December 20, 2005, Calpine Corporation and its affiliates filed a
Chapter 11 bankruptcy petition and an emergency motion for up to $2
billion in debtor-in-possession financing, which was granted by the
bankruptcy court in January 2006. In January 2007, Calpine filed a
motion to refinance the debtor-in-possession facility and repay
approximately $2.5 billion in outstanding secured debt of Calpine
Generating Company, LLC. The debt consisted of three levels of
priority notes, all but one of which included no-call provisions
for prepayment, but none of which included prepayment premiums in
the event of repayment pursuant to acceleration.
The bankruptcy court granted the refinancing prepayment motion in
March 2007, determining that the bankruptcy filing rendered the
notes mature and payable. Further, since no make-whole claims were
explicitly required in the loan documents in the case of
acceleration of the debt due to the bankruptcy filing, the court
determined that the lenders were not entitled to secured claims as
a result of such damages. However, the court held that the lenders
were entitled to unsecured claims for expectation damages due to
the amount of interest payments the lenders had expected to receive
over the life of the notes as contained as prepayment premiums in
the notes. The court considered these claims to be "reasonable
proxies for measures of damages to be awarded."
Calpine ultimately settled by giving first-lien noteholders a $50.4
million secured claim plus a $33.4 million unsecured claim for a
$97.2 million make-whole premium. Additionally, Calpine Generating
Company, LLC gave its first lienholders $20.1 million in make-whole
premium and damage claims. In December 2007, the bankruptcy court
approved the plan with these claims.
HSBC Bank USA, Nat'l Ass'n v. Calpine
Corp.2 On September 15, 2010, the
indenture trustee and Calpine both filed appeals for the amount the
bankruptcy court granted to the lenders in unsecured damages in
March 2007 on grounds, among others, that the make-whole premium
constituted unmatured interest that could not be claimed after
acceleration caused by the chapter 11 filing. Judge Daniels in the
Southern District of New York reversed the award of unsecured
claims for expectation damages arising from the early repayment of
the notes, as 11 U.S.C. § 502(b)(2) prohibits claims for
unmatured interest as a result of the acceleration of debt upon the
bankruptcy filing. Additionally, Judge Daniels affirmed the
bankruptcy court's decision that Calpine's bankruptcy
filing rendered the no-call provisions in the notes unenforceable,
so Calpine could not incur any liability for early repayment.
However, Judge Daniels mentioned that the notes "could have
provided for the payment of premiums in the event of payment
pursuant to acceleration."
In re Premier Entertainment Biloxi
LLC.3 The debtors filed a plan of
reorganization in December 2006. The lenders filed suit to obtain
secured claims for make-whole damages under an indenture provision
that provided that if an event of default was caused by a
"willful action" of the debtor, a prepayment premium was
due. The bankruptcy court for the Southern District of Mississippi
ruled that the lenders were not entitled to a secured claim for
make-whole damages because maturity of the loans was automatically
accelerated as a consequence of the debtor's bankruptcy filing,
which did not constitute a willful action. In addition, the
indenture at issue required prepayment penalties only if the debtor
repaid the loan prior to maturity. As a result of acceleration, the
repayment could not be construed as occurring prior to the maturity
date.
In re Trico Marine Services, Inc. The
debtors sought a determination that the make-whole premium was not
an allowable claim because it was merely unmatured interest subject
to disallowance under 11 U.S.C. § 502(b)(2) or, alternatively,
that it was at best a general unsecured claim. The court agreed
with the latter. In so holding, the court noted that in following a
"substantial majority of courts, a make-whole premium is in
the nature of liquidated damages, not interest."
Conclusion
LSP's challenge to the demand for a make-whole premium upon prepayment of debt in a chapter 11 context serves as an important reminder to bondholders and loan market participants that this kind of investor protection may be construed in a bankruptcy proceeding as either unmatured interest and disallowed or, more likely, as liquidated damages.
Footnotes
1. In re Calpine Corp., 365 B.R. 392 (Bankr.
S.D.N.Y. 2007)
2. HSBC Bank USA, Nat'l Ass'n v. Calpine
Corp., No. 07-civ-3088 (GBD), 2010 WL 3835200 (S.D.N.Y. Sept.
15, 2010)
3. In re Premier Entertainment Biloxi LLC, 2010 WL 3504105
(Bankr. S.D. Miss. Sept. 3, 2010)
4. In re Trico Marine Services, Inc., 450 B.R. 474 (Bankr.
D. Del. 2011)
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.