As they say, what one hand giveth, the other hand taketh. In its recent decision in In re MPM Silicones, LLC, the U.S. Court of Appeals for the Second Circuit addressed make-whole premiums and cramdown rates of interest (among other issues not addressed here), issuing rulings that will impact creditors and debtors alike. Not only will the Second Circuit’s decision have an immediate impact on proceedings in bankruptcy courts in the near term, the decision may affect debt issuance in the long term.
Momentive Performance Materials, Inc. (“MPM”), a producer of silicones used to manufacture household and industrial products, filed its chapter 11 bankruptcy petition in April 2014. At filing, MPM’s debt included the 2012 issuances of first lien and 1.5-lien senior secured notes, due in 2020. The indentures underlying these notes each contained a make-whole provision, pursuant to which noteholders (together, the “Senior Lien Noteholders”) would receive a make-whole premium in the event that MPM, at its option, redeemed the senior secured notes before October 15, 2015. The indentures also each included an acceleration clause that provided that if MPM filed a bankruptcy petition, the principal, interest and “premium, if any” would ipso facto become immediately and automatically due and payable, as of the petition date.
When MPM proposed its plan of reorganization, it gave the Senior Lien Noteholders the option to accept the proposed plan and receive a cash payment in the amount of the outstanding principal and interest immediately (without any make-whole premiums), or to reject the plan and receive replacement notes with a present value equal to the Senior Lien Noteholders’ allowed claim which could, if the Senior Lien Noteholders were successful in their arguments, include the make-whole premium. The Senior Lien Noteholders rejected the plan, arguing that they were entitled to the make-whole premium and that the rate of interest on the proposed replacement notes was below ascertainable market rates and therefore did not comply with the cramdown requirements under Section 1129(b) of the Bankruptcy Code.
The bankruptcy court confirmed the proposed plan over the Senior Lien Noteholders’ objections, finding that the plan met the fair and equitable standards for cramdown under Section 1129(b). In particular, the court concluded that the plan was fair to the Senior Lien Noteholders because the indentures did not require payment of the make-whole premium and because the interest rate on the proposed replacement notes, though below the market rate, had been calculated using a formula that complied with Supreme Court’s decision in Till v. SCS Credit Corp., 541 U.S. 465 (2004), and Second Circuit precedent. The Senior Lien Noteholders appealed plan confirmation, and the district court affirmed. The district court found that neither the indentures nor the notes themselves clearly and unambiguously provided for a make-whole premium in the event of an acceleration caused by a voluntary bankruptcy filing. The district court also agreed that the “formula approach” to calculating the cramdown interest rate was appropriate.
The Senior Lien Noteholders appealed to the Second Circuit. On October 20, 2017, the Second Circuit issued its ruling in which it affirmed the lower courts’ conclusions that the Senior Lien Noteholders were not entitled to the make-whole premium, but reversed the bankruptcy court’s use of the formula approach to calculating the cramdown interest rate.
With respect to the make-whole premium, the Second Circuit rejected the Senior Lien Noteholders’ argument that the issuance of the replacement notes under the plan constituted a redemption of the notes at the MPM’s option. The Second Circuit found that the bankruptcy petition had accelerated the maturity date, and therefore any payments made (or the issuance of the replacement notes) after the petition date was not an early redemption of the notes since the payments or issuances occurred after the maturity date. Furthermore, such payments were not at MPM’s option, as required by the indentures, but were instead mandated by operation of the automatic acceleration clause. As such, the acceleration clause’s reference to a “premium, if any” being payable did not apply because the clause that grants the make-whole premium—early redemption at MPM’s option—had not been triggered in the first place.
The Second Circuit also rejected the Senior Lien Noteholders’ argument that they should, under the terms of the indentures, be able to rescind acceleration and reinstate the original maturity date, thereby entitling them to the make-whole premium. The Second Circuit agreed with the lower courts that such rescission would violate the automatic stay, and would be “an end-run around their bargain” as an attempt to modify contract rights.
With respect to the rate of interest applied by the bankruptcy court, the Second Circuit found that the formula approach endorsed by the Supreme Court plurality in Till is not necessarily required in chapter 11 cases, and that the lower courts had erred in dismissing out of hand the probative value of market rates. Till concerned the cramdown of an individual debtor’s chapter 13 plan; the Supreme Court’s plurality opinion concluded that the appropriate cramdown rate of interest would be the prevailing national prime rate adjusted upward to account for the risk of nonpayment by the individual borrower in bankruptcy. In footnote 14 of the decision, however, the Supreme Court indicated that the formula approach may not be well-suited to chapter 11. The Supreme Court distinguished chapter 13, in which “value can be elusive” because the borrower is usually unsophisticated and there is no free market of willing cram down lenders. By contrast, in a chapter 11, there can be several lenders willing to finance debtors in possession, from which a market rate of interest can be ascertained. The Second Circuit cited Till’s footnote 14 and adopted the two-step approach to cramdown interest rate calculation adopted by the Sixth Circuit Court of Appeals in In re American HomePatient, Inc., 420 F.3d 559 (6th Cir. 2005). Under the two-step approach, the court determines first whether an efficient market exists, and then determines the proper approach based on the existence on an efficient market. An efficient market exists when loans of term, size and collateral comparable to the loan contemplated under the plan are available.
The Second Circuit found that when there is an efficient market that generates an interest rate acceptable to sophisticated parties dealing at arms-length, the market rate of interest is preferable to the prime-plus formula rate. The two-step approach is not precluded by Till and, consistent with Section 1129, Till and other precedent, better ensures that secured creditors receive the full present value of their claims. Implicitly, the Second Circuit’s decision rejects the bankruptcy court’s conclusion that the two-step approach misinterprets Till and the purpose of Section 1129. The Second Circuit remanded the case back to the bankruptcy court to determine whether the efficient market rate is better suited to the case at hand.
With one hand, the Second Circuit has given secured creditors higher payouts, in the form of higher interest rates. Certainly, the two-step approach to cramdown interest rates could result in expensive litigation over whether an efficient market exists, thereby diminishing the net effect of any resulting cramdown interest rate. However, debtors seeking to minimize such litigation costs may be induced to offer higher rates to secured creditors, or to seek exit financing at a competitive interest rate in order to pay secured creditors up front. Either scenario would likely result in a better outcome for secured creditors than payment of a formula-based prime-plus interest rate. On the other hand, and at odds with the Third Circuit’s decision in In re Energy Future Holdings Corp., 842 F.3d 247 (3d Cir. 2016), the Second Circuit has limited the availability of make-whole premiums, squarely putting the onus on lenders who will now need to ensure that their indentures contain language that requires the payment of a make-whole premium upon a bankruptcy filing. Furthermore, it may be that lenders are only able to obtain such terms when lending to distressed borrowers who are more likely to file a case in the short-term. Such a result would tend to defeat the purpose of the make-whole premium in the first place.