United States: Original Issue Discount Claim: Maybe It’s Allowed, And Maybe It’s Not

Last Updated: October 18 2013
Article by Vicki Harding

Official Comm. of Unsecured Creditors v. UMB Bank, N.A. (In re Residential Capital, LLC), 495 B.R. 250 (Bankr. S.D. N.Y. 2013) –

An unsecured creditors committee brought an action against an indenture trustee and collateral agent (a) seeking to recharacterize a facility as a secured financing, (b) requesting a declaratory judgment that liens did not extend to released collateral and loans, and (c) seeking partial disallowance of claims of noteholders on the basis that the claims included original issue discount (OID) that should be disallowed as unmatured interest.  In this decision the bankruptcy court ruled on the trustee's motion to dismiss these claims.

As is often the case, the Chapter 11 debtors agreed to a series of stipulations regarding the validity of pre-petition credit facilities and liens as a condition for obtaining post-petition financing, but with the caveat that the unsecured creditors committee would be given time to investigate and potentially challenge the claims and liens.  After months of investigation, the creditors committee obtained court authorization to pursue a variety of claims on behalf of the debtors.

One area of challenge involved a Master Repurchase Agreement pursuant to which debtors agreed to "sell" mortgage loans to a third party for a "purchase price" of $250 million, and agreed to "repurchase" the loans for an amount equal to the purchase price plus a "price differential" equal to LIBOR plus 4.75%.  As a repurchase agreement, the transaction had the benefit of Sections 555 and 559 of the Bankruptcy Code that provide protection from avoidance actions and excluded closing out the repurchase from the automatic stay.

The committee attempted to recharacterize the facility as a secured financing so that it would not have the benefit of these provisions.  The court rejected the committee's arguments and granted the motion to dismiss this claim – among other things, concluding that it doesn't matter whether a repurchase agreement is a true sale or a financing for purposes of Sections 555 and 559.

With respect to the issue regarding release of collateral, the relevant credit documents granted liens on all assets of certain debtors except for "Excluded Assets."  Certain collateral was initially included in the category of Excluded Assets, but later was released.  However, since the applicable security agreement "does not contain a traditional savings clause through which previously excluded property automatically became subject to a lien once the reason for the exclusion is removed,"  the court decided that it required additional evidence and denied the motion to dismiss this count.  (Once again, tiny technical details can make a big difference.)

The third area considered by the court involved the committee's contention that a portion of the noteholder claims should be disallowed on the basis that it constituted unmatured interest.  As background, Section 502(b)(2) of the Bankruptcy Code provides that a claim will be disallowed to the extent that it is for unmatured interest.

As a corollary, generally unamortized OID (original issue discount) constitutes unmatured interest that should be disallowed.   A Congressional committee report on Section 502(b) gave as an example a bankruptcy claim based on a note with a face value of $1,000 issued the day before bankruptcy that included an original issue discount of 10%, so that only $900 cash was advanced.  The $100 discount was viewed as an interest component of the note that must be amortized, and should be disallowed to the extent it is for interest post-petition (i.e. the entire $100 in the example).

However, this case involved a note exchange, as opposed to issuance of new notes.  The bankruptcy court noted that the Second Circuit has held that a "face value exchange of debt (as opposed to a fair market value exchange) in a consensual out-of-court workout does not result in the generation of disallowable OID."   As described by the Second Circuit, in a fair market value exchange the old note is exchanged for a new note with a reduced principal amount based on the market value at which the old note was trading.  In contrast, a face value exchange substitutes a new note for the old note that involves modification of terms or conditions but does not reduce the principal of the note.

In deciding that a face value exchange does not give rise to new disallowable OID in a bankruptcy (regardless of the treatment for tax purposes), the Second Circuit relied on a "strong bankruptcy policy in favor of the speedy, inexpensive, negotiated resolution of disputes, that is an out-of-court or common law composition."  If exchange debt increased the amount of OID, then creditors would not be inclined to cooperate.  (The bankruptcy court also noted that the Fifth Circuit agreed that a face value exchange does not generate disallowable OID for policy reasons, without expressing an opinion on whether a fair market value exchange creates OID.)

In this case, the debtor offered (1) to exchange old unsecured notes for new secured notes with significantly different terms, and (2) to purchase a limited number of old notes for cash in a modified Dutch auction.  As a result, the debtor exchanged approximately $6 billion of old notes for approximately $4 billion of new notes and $862 million in cash.  As of the petition date, the outstanding face amount of the new notes was $2.2 billion.  The committee contended that at least $377 million was unamortized OID.  The parties agreed that the note exchange was a fair market value exchange.  So the question was whether this generated disallowable OID.

The trustee started by arguing that the basis for OID disallowance was not applicable here:  Disallowance is because a debtor receives less cash than the face amount of the notes.   Here the debtor extinguished $1,000 of old notes by exchanging $800 of new notes.  The trustee also argued the policy reasons favoring out-of-court restructurings.

The committee made several arguments in response, including that the new notes were received in a fair market value exchange, and the holders should have a claim limited to the cash value of the old bonds that were tendered, discounted for OID, because the exchange was the equivalent of a cash purchase.

In the end, the court left resolution of this issue for another day as it denied the motion to dismiss on the basis that the record was insufficient to make a decision as a matter of law.

Although the exchange offer resulted in a reduction of the face amount of the debtor's outstanding notes, in the context of the bankruptcy it appears that the holders of the new notes will likely receive a significantly higher distribution.  According to the committee, holders of old notes who declined the exchange offer have a $1,000 unsecured claim and will recover $360, while note holders who participated in the exchange offer now expect to recover $658 plus potential post-petition interest.  It will be interesting to see what the court does.  Stay tuned.

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.

Vicki Harding
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
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must 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.


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.


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