United States: Effect Of Acceleration Upon A Chapter 11 Filing On Enforceability Of Make-Whole Or Prepayment Premiums

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)

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