Presenting a live 90-minute webinar with interactive Q&A Enforceability of Make-Whole Provisions in Bankruptcy: Maximizing Lender and Noteholder Rights to Prepayment Premiums TUESDAY, SEPTEMBER 23, 2014 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Cindy Chen Delano, Vice President, Associate General Counsel, AIG Investments , New York Melinda Franek, Vice President and Senior Counsel, CNH Partners , Greenwich, Conn. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Disclosures The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of AQR Capital Management, CNH Partners, AIG Investments, or their respective affiliates and employees. 4
General Considerations
Premise of Make-Whole / Yield-Maintenance Provisions • Make-whole (MW) provisions are also referred to as “prepayment penalties,” “prepayment premiums,” prepayment fees,” or “optional redemption” clauses. • Lender Protection : Rather than prohibiting repayment, MW provisions are designed to merely discourage borrowers from repaying debt as soon as credit markets move in their favor . • Historically, more prevalent in bond markets and on other long term debt where investors seek long term deployment of capital at fixed rates. Now, becoming more common in loan market. • Examples: – Fixed Percentage: expressed as a certain dollar amount or, more typically, a percentage of the principal amount to be repaid. – Net Present Value: formula-based MW premium that measures the difference between the lender’s expected return and a hypothetical, alternative investment stream (formula could include a minimum rate of return to ensure MW premium is not zero or a negative value). 6
Other Protections Designed to Protect Lender Against Early Repayment • “Hard” call – a specific date after which the company can call the bonds. • “Soft” call – does not prevent the bonds from being called but pays the investor a premium to the face value. • Change of control or fundamental change premiums. • OID (original interest discount): difference between the face amount of the debt issued and the money received by the debt issuer. – This amount amortizes over the term of the debt and thus resembles interest accrual. – Often treated as interest in bankruptcy. Not a make-whole per se, but raises related issues. 7
Considerations for Drafting • Time period within which MW premium to apply? • Amount: what is the amount and how is it calculated? • Triggers for MW payment, e.g., does a repayment or refinancing in bankruptcy qualify as a voluntary prepayment or redemption under the terms of the debt documents? • Market convention plays a role. – Currently, not seeing any push from the buy-side for explicit language in normal-way HY deals. – Occasionally we see tailored language in distressed situations where the buy-side has engaged counsel (separate from underwriter) and there is actual negotiation about the terms of the indenture. 8
Bankruptcy Considerations for Make- Whole Premiums 9
Bankruptcy Considerations for Make-Wholes Acceleration Analysis • In bankruptcy, debt is automatically accelerated to the date the company filed for bankruptcy. In addition, contracts typically provide for automatic acceleration of debt following a bankruptcy filing. • If the debt is accelerated, is there still a valid claim for payment of a MW premium under the agreement (which protected a lender’s expectation of future income streams)? – Example: “Acceleration. If an Event of Default . . . occurs and is continuing, the Trustee by notice to the Company . . . may . . . declare the principal of, premium, if any, and accrued and unpaid interest, if any, on all the Securities be due and payable. Upon such a declaration, such principal, premium and accrued and unpaid interest shall . . . be immediately due and payable” 10
Bankruptcy Considerations for Make-Wholes • Interest Analysis : Is the MW premium merely a proxy for a claim for unmatured interest? • RULE : A claim for “unmatured interest” is disallowed under the Bankruptcy Code. See 11 U.S.C. § 502(b)(2). • “Unmatured interest” is defined as interest that has not yet accrued as of the date a debtor filed for bankruptcy. • Notwithstanding the general rule disallowing claims for unmatured interest, a claim for a MW premium may still be enforced depending on whether the creditor is “ over- secured ,” “ under-secured ,” or “unsecured.” • A lender is “ over-secured ” if the debt owed to such lender is less than the value of the collateral securing that debt. Likewise, a lender is under-secured if the debt owed to such lender exceeds the value of the collateral securing that date. A lender is unsecured if the debt owed to such lender is not secured by any collateral. • In the case of an over-secured lender, 1. the claim is not considered interest, but a reasonable fee or charge on the underlying principal; or 2. the borrower is solvent . 11
Leading Cases: Southern District of New York 12
In re Calpine Corp. (Calpine I) 365 B.R. 392 (Bankr. SDNY 2007) • Debtors were current on payments pre- and post-petition. • Indenture provided that bankruptcy (BK) filing was event of default (EoD) resulting in acceleration; therefore, debt had accelerated and matured by virtue of the Debtors’ filing. • Secured claim unavailable due to lack of explicit language providing for MW damages. • However, court allowed unsecured claim for breach of contract/expectation damages. 13
In re Solutia Inc. 379 B.R. 473 (Bankr. SDNY 2007) • Filing of BK was EoD resulting in automatic acceleration. • Cash collateral order provided for interest payments to noteholders. • Noteholders sent notice of rescission of acceleration and waiver of default, but indenture only allowed deceleration after “notice of acceleration” as opposed to automatic acceleration. In addition, the notice was void because it violated the automatic stay (noteholders did not move to lift stay). • Court rejected bondholders’ general unsecured claims for damages resulting from, among other things, the triggering of a MW provision contained in the indentures for certain secured notes. • The indentures provided for automatic acceleration, the bondholders had explicitly opted to give up their future income in return for an immediate right to collect. • Bondholders failed to include any additional language requiring the payment of such prepayment premiums in the event of automatic acceleration. 14
In re Calpine Corp. (Calpine II) 2010 U.S. Dist. LEXIS 96792 (SDNY 2010) • No-call provisions became unenforceable once the Debtor filed for BK (i.e., under the BK code, you cannot prevent a Debtor from reorganizing and paying its creditors). • Accordingly, there can be no “damages” that result from an unenforceable provision. In addition, payment did not result before maturity because accelerated debts are mature. • No explicit provision in indenture providing for MW after acceleration. • BK Court improperly awarded the noteholders unsecured damages in lieu of the stream of payments they expected to receive over the life of the loans. 15
In re Chemtura Corp. 439 B.R. 561 (Bankr. SDNY 2010) • Indentures did not contain MW provision that provided for prepayment premium on BK filing and automatic acceleration of debt. • One indenture contained different definitions for “Maturity” and “Maturity Date” – MW payable if payment before “Maturity Date.” • Court persuaded by argument that BK automatic acceleration only accelerated “Maturity.” • The Chemtura court believed that the Calpine II analysis was flawed. • Expressed concern about whether full MW would be penalty (but did not have to reach this issue). • MW settlement amount was within the range of reasonableness under B.R. 9019. 16
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