In a decision released on November 17, 2016, the Third Circuit Court of Appeals reversed the holding of the Delaware Bankruptcy Court, affirmed by the District Court, that EFIH is not required to pay make-whole payments. In re Energy Future Holdings Corp., 16-1351, _ F.3d _ (3d Cir. Nov. 17, 2016).
Summary of Facts
In 2010, Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (together “EFIH”) borrowed approximately $4 billion. In return, EFIH issued notes secured by a first priority lien on their assets. The indenture governing the loan (the “First Lien Indenture”) allowed an early redemption prior to December 1, 2015 provided that EFIH paid a “redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium [i.e., the make-whole] . . . and accrued and unpaid interest” (the “Optional Redemption Provision”). The First Lien Indenture also provided for an immediate acceleration of “all outstanding Notes” in the event EFIH filed for bankruptcy (the “Acceleration Provision”). The Acceleration Provision provided the First Lien Noteholders the right to “rescind any acceleration [of] the Notes and its consequences[.]”
In 2011 and 2012, EFIH borrowed additional funds and issued Notes secured by a second priority lien on their assets. The indenture governing the Notes (the “Second Lien Indenture”) contained a redemption provision similar to the one described above. The Second Lien Indenture, however, contained an acceleration provision providing that “all principal of and premium, if any, interest . . . [,] and any other monetary obligations on the outstanding Notes shall be due and payable immediately” if EFIH filed for bankruptcy.
The Bankruptcy and District Court Decisions
On April 29, 2014, EFIH and certain affiliates filed for bankruptcy in the Delaware Bankruptcy Court. EFIH sought, among other things, to refinance the Notes, at a lower interest rate, without incurring the obligation to pay the make-whole. The bankruptcy filings caused the debt to accelerate and, by definition, triggered the right of the Noteholders to rescind the acceleration. The indenture trustees for the First and Second Lien Noteholders, Delaware Trust Company and Computershare Trust Company, N.A. and Computershare Trust Company of Canada respectively, commenced separate adversary proceedings seeking, among other things, a declaration that EFIH’s refinancing of the Notes would entitle the Noteholders to make-whole payments.
In 2015, the Bankruptcy Court, in two separate opinions,held that the Noteholders were not entitled to make-whole payments. In re Energy Future Holdings Corp., 527 B.R. 178 (Bankr. D. Del. 2015), aff’d, No. CV 15-620 RGA, 2016 WL 627343 (D. Del. Feb. 16, 2016); In re Energy Future Holdings Corp., 539 B.R. 723 (Bankr. D. Del. 2015), aff’d, No. CV 15-1011 RGA, 2016 WL 1451045 (D. Del. Apr. 12, 2016). Specifically, the Bankruptcy Court found that when EFIH filed for bankruptcy, the Notes automatically accelerated and became due immediately. Because the Notes became due and payable upon acceleration, EFIH’s refinancing could not constitute an “optional redemption” and, therefore, did not trigger the obligation for make-whole payments under the Indentures. The Bankruptcy Court further held that the automatic stay prevented the Noteholders from rescinding the acceleration of the Notes. The First Lien Noteholders then sought relief from the automatic stay, which the Bankruptcy Court denied.In re Energy Future Holdings Corp., 533 B.R. 106, 116 (Bankr. D. Del. 2015). The District Court affirmed the decisions of the Bankruptcy Court and the indenture trustees each appealed to the Third Circuit and the appeals were subsequently consolidated.
The Third Circuit Decision
The Third Circuit, in analyzing whether a make-whole payment was due, focused on the following questions: (1) was there a redemption, and (2) if so, was the redemption optional?
With respect to the first question, the Court rejected EFIH’s argument that the term “redemption” only entailed “repayments of debt that pre-date the debt’s maturity” as the Bankruptcy Court had concluded. The Third Circuit, relying on rulings of New York and federal courts, concluded that the term encompasses both pre- and post-maturity repayments of debt. The Court further concluded that the redemption was “optional,” because the Debtors voluntarily filed for chapter 11 protection intending to “refinance the Notes without paying any make-whole amount” and had opposed the Noteholders’ attempt to lift the automatic stay and rescind the acceleration of the Notes. Finding that the refinancing of the Notes constituted “optional redemptions” that occurred prior to December 1, 2015; the Court concluded that EFIH was obligated to pay the make-whole payments.
Next, the Court addressed the relationship between the Optional Redemption and the Acceleration Provisions and concluded that both provisions “address different things . . . [that they] provide the map to guide the parties through a post-acceleration redemption.” The Third Circuit specifically rejected EFIH’s reliance on In re AMR Corp.,which held that no make-whole payment was due because the text of AMR’s acceleration provision specifically stated that no make-whole was due upon acceleration. 730 F.3d 88 (2d Cir. 2013). After taking a closer look at the additional language contained in the acceleration provision in the Second Lien Indenture, i.e., “premium, if any,” the Court found that it “leaves no doubt that [the Optional Redemption Provision] and [the Acceleration Provision] work together.” EFIH had further argued, relying on a recent Southern District of New York decision, Momentive, currently on appeal before the Second Circuit, that the language – “premium, if any” – is not specific enough to require a make-whole payment. In re MPM Silicones, LLC, No. 14-22503-RDD, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 (S.D.N.Y. 2015) (“Momentive”). The Third Circuit seized the opportunity to criticize Momentive finding it “unpersuasive” and noting it “conflicts with that indenture’s text and fails to honor the parties’ bargain.”
EFIH further argued that “courts must close their eyes to make-whole provisions once a debt’s maturity has accelerated.” The Third Circuit disagreed and concluded that the Optional Redemption “applies no less following acceleration of the Notes’ maturity than it would to a pre-acceleration redemption.”
Finally, the Court rejected EFIH’s reliance on Northwestern, a New York state court decision, that stands for the proposition that “prepayment premiums” can only arise before a debt’s maturity date. Nw. Mut. Life Ins. Co. v. Uniondale Realty Assocs., 816 N.Y.S.2d 831, 836 (N.Y. Sup. Ct. 2006) (“Northwestern”). Noting that EFIH and the lower courts “stretch Northwestern beyond its language and appl[y] its clear-statement rule to yield-protection payments not styled as prepayment premiums,” the Court observed that the indentures at issue did not use the word “prepayment,” but instead the term “redemption,” which, as the court earlier explained, can occur “at or before maturity.” The Court concluded that when the term redemption is properly understood, the Optional Redemption Provision and the Acceleration Provision have no “linguistic tension to resolve.”
Conclusion and Practice Pointer
The Third Circuit repeatedly emphasized its duty to “give full meaning and effect to all of [the Indenture’s] provisions” and that “adherence to these principles is particularly appropriate in a case like this involving interpretation of documents drafted by sophisticated, counseled parties and involving the loan of substantial sums of money.” In re Energy Future Holdings Corp., 16-1351, _ F.3d _ (3d Cir. Nov. 17, 2016) (quoting NML Capital v. Republic of Argentina, 952 N.E.2d 482, 489-90 (N.Y. 2011)).
Practitioners drafting indenture agreements should insist on clear and unambiguous terms governing make-whole obligations.
The Third Circuit’s decision also reflects a departure from recent make-whole decisions in bankruptcy and federal courts. As discussed, the Third Circuit disagreed with the New York bankruptcy and district courts’ holding in Momentive, finding it inconsistent with the text of the indenture. We await the Second Circuit’s decision in Momentive and whether it will present a split in the circuits. Stay tuned!