United States: Momentive: Case Update

As an update to our prior blog post, on May 4, 2015, Vincent Briccetti, United States District Court Judge for the Southern District of New York, issued a decision affirming the Bankruptcy Court's order confirming Momentive's cramdown chapter 11 plan. The decision was long awaited with the parties having completed briefing in December 2014.

Judge Briccetti followed the reasoning of the Bankruptcy Court and affirmed the use of the "formula" approach to determine the cramdown interest rate. Under the formula approach, the cramdown interest rate is equal to the sum of a "risk free" base rate (such as the prime rate) plus a risk margin of 1-3%. Judge Briccetti rejected the "efficient market" approach advocated by the first and 1.5 lien noteholders, affirming the view that rates should not include any profit to secured creditors. Under the efficient market approach, the cramdown interest rate is based on the interest rate the market would pay on such a loan.

Although the Supreme Court in Till and the Second Circuit in Valenti previously adopted the formula approach, those cases were decided in the context of chapter 13 debtors. Citing to Till and Valenti, Judge Briccetti observed that "Congress intended bankruptcy judges and trustees to follow essentially the same approach when choosing an appropriate interest rate" and that "the Bankruptcy Code does not intend to put creditors in the same position they would have been in had they arranged a new loan." According to Judge Briccetti, the first and 1.5 lien noteholders provided "no good reason" why the cramdown interest rate calculation should differentiate between chapter 11 and 13 debtors.

In addition, Judge Briccetti affirmed the Bankruptcy Court's determination that Momentive was not obligated to pay a make-whole premium upon the repayment of the first and 1.5 lien debt. Based on the language of the first and 1.5 lien note indentures, Judge Briccetti held that Momentive's bankruptcy triggered an automatic acceleration of the debt and that under New York law (which governed the indentures), "a lender forfeits the right to a prepayment consideration by accelerating the balance of the loan. The rationale most commonly cited for this rule is that acceleration of the debt advances the maturity date of the loan, and any subsequent payment by definition cannot be a prepayment." Although the noteholders could have contracted around this general rule, Judge Briccetti found that the indentures did not "clearly and unambiguously call for the payment of the make-whole premium upon acceleration of debt."

Judge Briccetti also affirmed the Bankruptcy Court's holding that the language of the indenture governing the senior subordinated notes subordinated the claims of senior secured noteholders to the deficiency claims of second lien noteholders. Thus, the plan—which provided no distributions to senior subordinated noteholders—was "fair and equitable" under section 1129(b) of the Bankruptcy Code.

Because Judge Briccetti affirmed the Bankruptcy Court's order confirming Momentive's plan, he did not address the merits of Momentive's motion to dismiss the noteholders' appeals on equitable mootness grounds.

As noted in our prior blog post, we expect that Judge Briccetti's decision will be appealed to the Second Circuit and possibly beyond. If these issues are put before the Second Circuit, the court will have an opportunity to clarify the scope of its holding in Valenti and possibly take-up another make-whole premium dispute after ruling on the subject in 2013 in the AMR chapter 11 bankruptcy.

Please see the original post from February 25, 2015, below.

Momentive: Where does it stand?

On September 9, 2014, following a hotly contested four-day confirmation hearing, Robert Drain, U.S. Bankruptcy Judge for the Southern District of New York, issued a bench ruling approving Momentive's chapter 11 plan. See In re MPM Silicones, LLC, No. 14-22503-rdd, 2014 Bankr. LEXIS 3926 (Bankr. S.D.N.Y. Sept. 9, 2014).Momentive's plan provided for the company's first and 1.5 lien noteholders to receive new notes with extended maturities at a reduced interest rate, while fully equitizing the second lien noteholders. Holders of senior subordinated notes did not receive any recovery. At the heart of the plan was a $600 million rights offering backstopped by the second lien noteholders.

In approving the plan, Judge Drain overruled objections filed by trustees for the first and 1.5 lien noteholders who argued that the plan was not "fair and equitable" because the proposed cramdown interest rate for each of the new notes was below the applicable market rate. The first and 1.5 lien noteholders also asserted that a make-whole premium would have been due upon a repayment of the debt pursuant to language in the first and 1.5 lien note indentures. The trustee representing holders of senior subordinated notes also objected to the plan on the grounds that it impermissibly subordinated the claims of senior subordinated noteholders to the deficiency claims of second lien noteholders, which resulted in the senior subordinated noteholders not receiving any recovery. The trustee for the senior subordinated notes also argued that the plan violated the absolute priority rule because Momentive and its debtor-subsidiaries retained intercompany interests even though the senior subordinated notes were not paid in full.

Although Judge Drain's bench decision touched on several important confirmation topics, the ruling was controversial because it explicitly rejected a market-based approach to calculating the cramdown interest rate and endorsed the "formula approach" espoused in the chapter 13 cases Till v. SCS Credit Corp., 541 U.S. 465 (2004) and In re Valenti, 105 F.3d 55 (2d Cir. 1997). Under the formula approach, the debtor must, in a cram-down scenario, provide a secured creditor with new notes bearing interest equal to a "risk free" base rate (such as the prime rate) plus a risk adjustment of 1-3%. Importantly, he found while market pricing includes an element of profit, the Bankruptcy Code has no such requirement and thus the risk adjustment should be just that – an adjustment that reflects the ultimate risk of nonpayment, and not a mechanism to recover opportunity costs. Judge Drain's decision conflicts with decisions issued by the U.S. Court of Appeals for the Fifth and Sixth Circuits as well as some lower court opinions. In economic terms, Momentive's oversecured first and 1.5 lien noteholders lost nearly $100 million in trading value for their existing notes because the cramdown interest rate was calculated using the formula approach versus a market rate.

Following his confirmation decision, Judge Drain denied the creditors' immediate request for a stay of consummation of the plan pending appeal. Whether a stay pending appeal is granted is committed to the discretion of the judge after considering the following factors: (i) whether the movant will suffer irreparable injury absent a stay, (ii) whether a party will suffer substantial injury if a stay is issued, (iii) whether the movant has demonstrated a substantial possibility of success on appeal, and (iv) the public interest that may be affected. On September 11, 2014, Judge Drain formally entered an order confirming Momentive's plan, prompting the trustees for the first and 1.5 lien noteholders as well as the trustee for the senior subordinated noteholders to file an appeal with the district court and once again seek a stay pending appeal.

Proceedings before District Court and Second Circuit

On September 22, 2014, Vincent Briccetti, U.S. District Court Judge for the Southern District of New York, issued a bench ruling where he also declined to issue a stay pending the appeal. Judge Briccetti held that a stay should not be imposed primarily because the creditors did not demonstrate a "substantial possibility of success on appeal" and that they would suffer irreparable harm absent a stay.

As to the creditor's possibility of success on appeal, Judge Briccetti stated that Judge Drain's decision regarding the appropriate cramdown interest rate was "based on a sensible reading of both Till and Valenti." He also found, solely for purposes of whether a stay should be granted, that Judge Drain was likely correct with respect to his rulings on the make-whole premium and interpretation of the subordination clause in the senior subordinated notes indenture. Judge Briccetti was careful to note that he was not "making any conclusions on the merits of the underlying disputes," but that the appellants did not demonstrate a "substantial possibility" that Judge Drain ruled incorrectly.

In addition, Judge Briccetti found that the appellants failed to demonstrate that they would be irreparable injured absent the stay. He acknowledged that although an appeal is presumed equitably moot where a debtor's plan is substantially consummated (e.g., when a plan becomes effective), he believed that "the risk of equitable mootness" was "not very great" because, among other things, it is possible to "recalibrate" consideration provided to the second lien noteholders. While the creditors failed to demonstrate irreparable injury, Judge Briccetti believed that the opposite was true for the debtors. Specifically, he observed that a stay could cause Momentive to lose $600 million in proceeds from the rights offering and accrue incremental costs during the pendency of the stay such as interest, professional fees and other expenses.

At the same hearing, the first and 1.5 lien noteholders further sought to certify a direct appeal of the merits of Judge Drain's confirmation ruling to the U.S Court of Appeals for the Second Circuit. Judge Briccetti denied the request because, among other things, the questions presented on appeal presented a mixed question of fact and law and there was no immediate need for appellate review. As a last resort, the creditors sought a stay from the Second Circuit and their request was also denied in brief written orders.

What's Next?

In the absence of a stay, Momentive's plan became effective on October 24, 2014, resulting in, among other things, the consummation of a rights offering, the issuance of new equity in the reorganized company and the distribution of new notes to the first and 1.5 lien noteholders. But that is not the end of Momentive's journey through bankruptcy. All of Momentive's objecting creditors have continued to press their appeal with the district court arguing that Judge Drain's confirmation ruling was incorrectly decided on the merits. Also pending before Judge Briccetti is a motion filed by Momentive to dismiss the appeals on equitable mootness grounds (notwithstanding Judge Briccetti prior finding that equitable mootness was unlikely). These issues have been fully briefed and a decision could be entered by Judge Briccetti without oral argument.

Although Judge Briccetti's basis for denying a stay pending appeal strongly suggests that he agrees with Judge Drain's interpretation of the underlying issues on appeal, it is important to remember that the standard for review on appeal differs greatly from the standard for deciding a stay pending appeal. Specifically, on appeal, a bankruptcy court's legal conclusions are subject to a de novo standard of review, meaning that no deference is given to the bankruptcy court's determinations in that regard. Thus, there is no certainty that Judge Drain's decisions will be affirmed. Moreover, given the significant economic impact of this decision on the appellants, it is possible that this issue may be appealed to the Second Circuit and beyond.

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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