Monday, September 15, 2014

Momentous Decision in Momentive Performance Materials Part IV: Make-Wholes and Third Party Releases

Make-whole provisions have come up in bankruptcy court again, this time before Judge Drain in the Momentive Performance Materials case.  Per Weil's Bankruptcy Blog:

This is the last entry in our four-part series analyzing Judge Drain’s widely read bench ruling issued on August 26, 2014 in connection with the confirmation hearing of Momentive Performance Materials and its affiliated debtors. In Parts I and II, we discussed Judge Drain’s conclusions regarding the appropriate calculation of cramdown interest rates for secured creditors. In Part III, we turned to his analysis of certain subordination provisions found in the indentures governing the Debtors’ senior subordinated notes. Today, in Part IV, we discuss Judge Drain’s rulings regarding the parties’ make-whole and third party release disputes.
What You Need to Know: Make-Wholes
Make-wholes have been a “trending” topic of late in the restructuring community. This is partly because it is difficult to find a consistent approach to the issue within the reported decisions. Therefore, even for those of us who have been closely following recent make-whole developments, a brief refresher on make-wholes is always helpful.
What are make-wholes? Make-wholes are contractual provisions found in indentures that typically permit a borrower to redeem or repay notes before maturity but require the borrower to pay a lump sum amount derived from a formula based on the net present value of future coupon payments that will not be paid as a result of early redemption or repayment. Make-wholes are usually available only during a “no-call” period, or a period of time specified in the indenture during which the borrower is prohibited from repaying the debt before maturity.
What is the purpose of make-wholes? The purpose of make-wholes is to determine the rights of the borrower and the creditor in the event repaying a debt before it matures becomes economically efficient for the borrower. From the creditor’s perspective, a make-whole provides yield protection. When debt is redeemed before maturity or repaid upon default, a make-whole or prepayment provision requires the borrower to pay an amount above the principal and interest due on the debt to compensate the lender for economic loss suffered as a result of the redemption or repayment. From the borrower’s perspective, a make-whole provides freedom to repay debt before maturity. Many jurisdictions, including New York, have adopted the “perfect tender in time” rule, which prohibits a borrower from repaying a loan before maturity in the absence of a specific contractual provision permitting early repayment.
When are make-wholes payable in a bankruptcy case? Outside of bankruptcy, whether a creditor is entitled to a make-whole is determined purely by looking to the underlying contract that governs the debt. In other words, the analysis is rooted in state law. Once a borrower is in bankruptcy, however, the Bankruptcy Code adds a layer of complexity that has, at times, led to contradictory decisions on a constellation of bankruptcy-related issues.
While different courts have taken different approaches, a general framework for determining whether a make-whole provision is allowable in bankruptcy has emerged. Bankruptcy courts have generally engaged in two layers of analysis. The first layer of analysis requires analyzing the debt document under state law to determine whether the (i) make-whole has been triggered and (ii) if so, whether the entire claim is enforceable under state law. The second layer of analysis requires considering whether enforceable state law claims are allowable under federal bankruptcy law. The following are typical questions that a bankruptcy court might address in such an analysis:
  • Does the debt document explicitly provide for a make-whole? If so, when exactly is the make-whole triggered?
  • Does a bankruptcy filing automatically accelerate the debt under the debt documents?
  • Does automatic acceleration upon a bankruptcy event of default cause the debt to mature on the petition date under the debt documents?
  • Does a repayment or refinancing in bankruptcy qualify as a voluntary prepayment or redemption under the terms of the debt documents?
  • Does the debt document include a no-call provision prohibiting early repayment of the debt?
  • Can the creditor decelerate the debt postpetition?
  • Would the claim for make-whole be disallowed as a claim for unmatured interest undersection 502(b)(2) of the Bankruptcy Code?
  • Would the claim for make-whole or prepayment premium be allowed as a secured claim under section 506(b) of the Bankruptcy Code?
As we will explore in greater detail below, Judge Drain’s ruling in Momentive touches upon many of these questions.
The Make-Whole Dispute in Momentive
The indenture trustees for the holders of approximately $1.1 billion of First Lien Notes and $250 million of 1.5 Lien Notes (each discussed in greater detail in Parts I and II of this series) asserted that they were entitled to make-whole amounts under the terms of their respective indentures as a result of the repayment (in the form of the issuance of replacement notes) of the First Lien Notes and 1.5 Lien Notes before the original maturity date under the terms of the Debtors’ plan. The trustees also argued that, barring such claim, they could assert a common law claim for damages as a result of the debtors’ breach of the underlying debt documents or the “perfect tender” rule. Both indentures contained identical language with respect to the relevant provisions. As drafted, Momentive’s chapter 11 plan did not contemplate a distribution on account of the make-whole claims asserted. Thus, if the bankruptcy court allowed the make-whole claim, the amount of replacement notes to be issued under the plan to the holders of the First Lien Notes and 1.5 Lien Notes would increase, giving them a larger distribution (approximately $200 million more) under the plan.
The court disagreed with the indenture trustees and ultimately held that they were not entitled to their make-whole claims, that the debtors did not owe damages for breach of a no-call provision or the perfect tender rule, and, lastly, that the indenture trustees were not permitted postpetition to decelerate the already accelerated debt....

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