Latest Trends in the Enforceability of Make-Whole Premiums

A lender’s entitlement to a make-whole premium, that is, a prepayment penalty designed to compensate the lender for the loss of interest payments it would have received had the borrower continued to service the debt through the maturity date of the loan, depends principally on the plain language of the bond indenture or credit agreement.  See, e.g., HSBC Bank USA, N.A. v. Calpine Corp. (In re Calpine Corp.), No. 07 Civ 3088 (GBD), 2010 WL 3835200, at *4 (S.D.N.Y. Sept. 15, 2010) (after reviewing the debt instruments, the district court agreed with the bankruptcy court insofar as it held that the lenders were not entitled to make-whole premiums because the plain language of the debt instruments did not provide for the payment of premiums in the event of payment pursuant to acceleration); In re Solutia, Inc., 379 B.R. 473, 485 n.7 (Bankr. S.D.N.Y. 2007) (where the indenture provided for automatic acceleration upon the filing of a chapter 11 petition but was silent as to whether any make-whole amount would or would not be payable in connection with such an acceleration, the court refused to “read into agreements between sophisticated parties provisions that are not there,” and held that no make-whole amount was due); Premier Entm’t Biloxi, LLC v. U.S. Bank N.A. (In re Premier Entm’t Biloxi LLC), 445 B.R. 582, 625-27 (Bankr. S.D. Miss. 2010) (trust indenture that provided for automatic acceleration of notes upon default arising from debtors’ bankruptcy filing rendered the notes mature at time of their repayment as part of consummation of debtors’ confirmed chapter 11 plan, such that noteholders had no contractual right to prepayment premium).

Consistent with those cases, on January 17, 2013, the United States Bankruptcy Court for the Southern District of New York ruled that American Airlines (“American”) was not obligated to pay make-whole premiums at the time American refinanced a series of loans.  See U.S. Bank Trust National Association v. American Airlines Inc. (In re AMR Corp.), Bankr. No. 11-15463 (SHL), Adv. Nos. 12-01932 (SHL), 12-01946 (SHL), 2013 WL 209643 (Bankr. S.D.N.Y. Jan. 17, 2013).

Facts

Prior to its bankruptcy filing, American entered into three separate financing transactions.  One transaction involved the issuance of notes secured by certain aircrafts (the “Secured Notes Financing”).  The remaining two transactions were structured as enhanced equipment trust certificate (“EETC”) financings, which involved the issuance of equipment notes secured by certain aircrafts (the “EETC Financing” and, together with the Secured Notes Financing, referred to collectively as the “Prepetition Financing”).  During its bankruptcy case, American sought approval to enter into a new $1.5 billion EETC facility (at a lower interest rate than the Prepetition Financing) to refinance the Prepetition Financing.  As part of the request, American sought to avoid paying the make-whole premiums contained in the Prepetition Financing loan documents.

American’s bankruptcy filing constituted an event of default under each of the indentures.  The indentures provided that a bankruptcy filing automatically accelerated the Prepetition Financing without any further action by U.S. Bank Trust National Association, as the loan trustee and security agent (“U.S. Bank”).  Under those circumstances, the indentures expressly provided that the Prepetition Financing was payable in full without having to pay the make-whole premium that was due in other cases of repayment of the Prepetition Financing.  Specifically, the indentures provided that upon an event of default due to American’s bankruptcy filing: “the unpaid principal amount of the [Prepetition Financing] then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder (but for the avoidance of doubt, without Make-Whole Amount), shall immediately and without further act become due and payable…” (emphasis added).

The Court’s Holding and Rationale

Relying on this express contractual provision, the court held that a make-whole premium was not due upon American’s repayment of the Prepetition Financing after the automatic acceleration that occurred as a result of its bankruptcy filing.  In so ruling, the court rejected several arguments advanced by U.S. Bank.  First, U.S. Bank argued that the automatic acceleration clause was not enforceable under New York law because the lenders did not choose to invoke that clause.  The court found that the indentures provided U.S. Bank the option to pursue remedies following certain events of default.  Where a default was premised upon a bankruptcy filing, however, the indentures explicitly state that all amounts due, other than the “Make-Whole Amount,” were immediately due and payable.  In addition, U.S. Bank unsuccessfully argued that the automatic acceleration clause constituted an invalid ipso facto clause under the Bankruptcy Code.  Because the parties conceded the indentures were not executory contracts, the court relied on the cases that hold that ipso facto clauses are not per se invalid except where contained in executory contracts.  U.S. Bank further argued that it could decelerate the Prepetition Financing, either by contractual right or the lifting of the automatic stay in American’s bankruptcy.  The court held that the automatic stay prohibited U.S. Bank from decelerating the Prepetition Financing.

Finally, U.S. Bank contended, to no avail, that American’s attempt to refinance the Prepetition Financing without satisfying the make-whole provision was inconsistent with American’s previous exercise of its rights under section 1110 of the Bankruptcy Code.  Section 1110 of the Bankruptcy Code provides certain special rights to parties involved in aircraft financing.  More specifically, the provision allows a party with a security interest in aircraft and related equipment to take possession of its collateral pursuant to the terms of the contract, notwithstanding the automatic stay normally imposed by Section 362 upon the filing of the bankruptcy, unless the debtor meets certain conditions.  These conditions include that, within the first 60 days of the case, the debtor must agree to perform its contractual obligations as they become due and that the debtor must also cure certain contractual defaults, other than a default of a kind specified in section 365(b)(2) of the Bankruptcy Code.  The kinds specified in section 365(b)(2) include a default that is a breach of a provision relating to– (A) the insolvency or financial condition of the debtor at any time before the closing of the case; (B) the commencement of a case under this title; (C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement; or (D) the satisfaction of any penalty rate or penalty provision relating to a default arising from any failure by the debtor to perform nonmonetary obligations under the executory contract or unexpired lease.

The court held that section 1110(a) requires only that a debtor continue performing its contractual obligations and cure any non-bankruptcy defaults.  The court held that section 1110(a), however, does not require the curing of a bankruptcy default.  Because it was the commencement of the case that triggered a bankruptcy default, acceleration and the language that provides for no payment of a make-whole premium, American was not required to cure the bankruptcy default and pay the make-whole premium.

In conclusion, the plain meaning of the relevant indenture terms prevailed.  Notwithstanding all of U.S. Bank’s reasonable arguments, the court held no make-whole premium would be due upon repayment by American of the Prepetition Financing after the automatic acceleration that occurred as a result of American’s bankruptcy filing.

U.S. Bank will presumably appeal the decision.  If an appeal is filed, a key issue at the District Court level likely will be whether Judge Lane’s interpretation of section 1110(a) of the Bankruptcy Code was accurate.