March 16, 2017

Third Circuit Departs from Momentive and Enforces Make-Whole Provisions in EFH

Curtis S. Miller and Matthew O. Talmo – March 16, 2017

On November 17, 2016, the Third Circuit Court of Appeals held in Delaware Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.) (EFH), 842 F.3d 247 (3d Cir. 2016), that the debtors, Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (collectively, EFIH), were obligated to pay make-whole premiums despite the acceleration of the underlying debts caused by the debtors’ filing for Chapter 11 bankruptcy. The Third Circuit’s decision is contrary to recent decisions by the bankruptcy and the district courts for the Southern District of New York, which held that make-whole premiums were not due after acceleration unless explicitly provided for in the loan agreement. In re MPM Silicones, LLC (Momentive), 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). The Second Circuit Court of Appeals presently has the same legal issue under advisement, and it remains to be seen whether the Third Circuit’s decision in EFH will affect the Second Circuit’s decision.


In 2010, EFIH issued notes, due in 2020, totaling about $4 billion at a 10 percent interest rate secured by a first-priority lien on its assets. In 2011 and 2012, EFIH issued two more sets of notes secured by a second-priority lien on its assets. The indentures governing all of the notes each contained a redemption provision that provided for the payment of the principal amount of the notes plus an applicable make-whole premium if the notes were redeemed prior to specific dates.

The notes also contained acceleration provisions with different language. The acceleration provision in the first-lien notes made “all outstanding Notes . . . due and payable immediately” if EFIH filed a bankruptcy petition. The second-lien notes’ acceleration provision, however, provided that “all principal of and premium, if any, interest . . . [,] and any other monetary obligations on the outstanding [second-lien notes] shall be due and payable immediately.” EFH, 842 F.3d at 251 (emphasis added). The acceleration provisions allowed the noteholders to rescind the acceleration of the notes.

EFIH considered refinancing the notes when market interest rates decreased. Believing that bankruptcy would allow it to avoid paying the make-whole premiums if it refinanced, EFIH filed an 8-K form with the Securities and Exchange Commission (SEC) in 2013, disclosing its proposal to file for bankruptcy and refinance the notes without paying any make-whole amount. On April 29, 2014, EFIH filed for Chapter 11 bankruptcy.

The Bankruptcy and District Courts Side with EFIH

In response, the trustee for the first-lien noteholders filed an adversary proceeding seeking a declaration that refinancing the first-lien notes would trigger the make-whole premium. In addition, the trustee sought a declaration that it could rescind the first-lien notes’ acceleration without violating the automatic stay. Without acting on the adversary proceeding, the bankruptcy court granted a motion by EFIH to pay out the first-lien notes and refinance the debt at a lower interest rate of 4.25 percent, saving an estimated $13 million in interest per month. Further, EFIH did not pay the make-whole premium, which would have been about $431 million.

Shortly after filing for bankruptcy, EFIH filed another 8-K with the SEC stating that it reserved the right to redeem the second-lien notes. The second-lien noteholders subsequently filed their own adversary proceeding seeking a declaration that EFIH would have to pay the make-whole premium if it refinanced the second-lien notes and requesting relief from the automatic stay. With the bankruptcy court’s permission, EFIH refinanced a portion of the second-lien notes without paying the make-whole premium.

The bankruptcy court ruled that EFIH was not obligated to pay the first-lien noteholders the make-whole premium because it was not specifically mentioned in the acceleration provision contained in the first-lien notes’ indentures. In re Energy Future Holdings Corp., 527 B.R. 178, 194 (Bankr. D. Del. Mar. 26, 2015). Further, it ruled that the automatic stay prevented the noteholders from rescinding the acceleration of the notes and refused to lift the stay. Id.; In re Energy Future Holdings Corp., 533 B.R. 106, 125 (Bankr. D. Del. July 8, 2015). Later, despite differences in the language of the indentures, the bankruptcy court adopted these findings and conclusions to deny the second-lien noteholders payment of the make-whole premium as well. In re Energy Future Holdings Corp., 539 B.R. 723, 732 (Bankr. D. Del. Oct. 29, 2015). The district court affirmed both decisions, and the trustees brought appeals, which were consolidated by the Third Circuit. In re Energy Future Holdings Corp., 2016 WL 627343 (D. Del. 2016); In re Energy Future Holdings Corp., 2016 WL 1451045 (D. Del. 2016).

The Delaware bankruptcy and district court decisions were grounded in the Momentive decision. In Momentive, the district court for the Southern District of New York affirmed the bankruptcy court’s ruling denying noteholders the payment of a make-whole premium under similar facts and circumstances. There, the district court held that a prepayment premium is not due following acceleration unless the acceleration clause “clearly and unambiguously calls” for it. Momentive, 531 B.R. at 336. The court stated that the language used in the acceleration clause—“premium, if any”—was “not sufficient to create an unambiguous right to a make-whole payment.” Id. Consequently, the debtors were not obligated to pay it.

The Third Circuit’s Reversal and Requirement to Pay the Make-Whole Premiums

Departing from the decision in Momentive,the Third Circuit concluded that (a) acceleration provisions do not insulate debtors from obligations to pay make-whole provisions stemming from redemptions; and (b) redemption premiums and prepayment premiums are different, and a make-whole premium is payable depending on which is included in the loan agreement.

Acceleration did not affect the make-whole premium. The Third Circuit first concluded that EFIH’s redemption of the notes was optional. In reaching this conclusion, the Third Circuit considered three questions: “was there a redemption; was it optional; and if yes to both, did it occur before [the specified date]?” EFH, 842 F.3d at 254. Relying on New York and federal case law holding that “redemptions” include pre- and post-maturity payments of debt, the Third Circuit first rejected EFIH’s argument that its post-maturity refinancing of the notes was not a “redemption.” Second, the Third Circuit determined that “[l]ogic leaves no doubt this redemption of the Notes was ‘[o]ptional’” under the make-whole provision because (1) EFIH voluntarily filed for bankruptcy, (2) declined to reinstate the accelerated notes’ original maturity date under section 1124(2) of the Bankruptcy Code, (3) previously announced plans to redeem the notes before their maturity date, and (4) redeemed the notes over the noteholders’ objections. Id. at 255. Finally, the Third Circuit noted that all this occurred before the notes’ original maturity dates.

The Third Circuit then found that EFIH was required to pay the first-lien noteholders the make-whole premium despite the automatic acceleration of the notes. Rejecting EFIH’s argument that the make-whole and acceleration provisions were “different pathways” to choose between, the Third Circuit explained that “together they form the map to guide the parties through a post-acceleration redemption.” Id. at 256. Although the first-lien notes’ acceleration provision did not mention the make-whole premium, the Third Circuit looked to the New York Court of Appeals’ decision NML Capital v. Republic of Argentina,that acceleration does not automatically render other provisions of a contract unenforceable. 952 N.E.2d 482, 492 (N.Y. 2011). Interpreting the language of the acceleration provision in the second-lien notes separately, the Third Circuit determined that the additional language “premium, if any” made an explicit link between the make-whole and acceleration provisions. Thus, “there were optional redemptions before a date certain, thereby triggering the make-whole premiums.” EFH, 842 F.3d at 257. In so holding, the Third Circuit explicitly rejected the Momentive holding that the phrase “premium, if any” was not specific enough to incorporate the make-whole premiums. According to the Third Circuit, “the result in Momentive conflicts with that indenture’s text and fails to honor the parties’ bargain.” Id.

There is a difference between “redemptions” and “prepayments.” The crux of the Third Circuit’s decision was the distinction between “redemptions” and “prepayments.” The Third Circuit acknowledged the logic that a prepayment is payment before maturity and that a party cannot exercise its right to prepay if an acceleration clause advances the maturity date. Thus, acceleration would insulate a debtor from paying prepayment premiums in the absence of language in the loan agreement to the contrary. Here, however, the notes’ indentures used the term “redemption.” A redemption, according to the Third Circuit, can occur “at or before maturity”; thus, unlike a prepayment premium, a premium tied to “‘redemption’ would be unaffected by acceleration of a debt’s maturity.” Id. at 259.

The Third Circuit relied on a statement by the New York Court of Appeals in NML Capital that “in New York the consequences of acceleration of the debt depend on the language chosen by the parties in the pertinent loan agreement.” 952 N.E.2d at 492. The Third Circuit rejected EFIH’s reliance on Northwestern Mutual Life Insurance Co. v. Uniondale Realty Associates (Northwestern), 816 N.Y.S.2d 831, 836 (N.Y. Sup. Ct. 2006), a New York trial court decision holdingthat a “prepayment premium will not be enforced under default circumstances in the absence of a clause which so states.” The Third Circuit explained that the “Northwestern rule” is simply that “[i]f parties want to mandate a ‘prepayment’ premium following acceleration, they must clearly state it in their agreement.” EFH, 842 F.3d at 259.According to the Third Circuit, the Momentive court “stretched Northwestern beyond its language” when it stated that New York law provides that “a make-whole, like a prepayment premium, will only be due on a default and acceleration ‘when a clear and unambiguous clause’” calls for it. Id. at 260 (quoting Momentive,2014 WL 4436335, at *13). By using the word “redemption,” the Third Circuit explained, the parties “decided that the make-whole would apply without regard to the Notes’ maturity.” Id.

Takeaways from EFH

Perhaps the most significant takeaway from EFH is the importance of careful drafting in contractual agreements. The Third Circuit relied on the distinction between “prepayment” and “redemption” in determining whether a particular make-whole provision is enforceable. Unless there is specific language in the loan document providing otherwise, a redemption premium will be unaffected by the acceleration of the underlying debt while a prepayment premium will be rendered unenforceable under facts similar to those in EFH. Lenders will need to insist on clear and unambiguous language in their loan documents to ensure they are able to realize upon the payment of make-whole premiums.

A second takeaway from EFH is that there is a split between courts in two popular bankruptcy circuits in the country regarding make-whole provisions: the Second and Third Circuits. It is worth noting that the Fifth Circuit has also considered the issue, but the facts in that case did not present the same questions raised in EFH. In In re Denver Merchandise Mart, Inc., 740 F.3d 1052 (5th Cir. 2014), the Fifth Circuit affirmed bankruptcy and district court rulings disallowing the payment of a prepayment premium after acceleration because express language providing otherwise was absent from the loan document. It is important to note that the facts of Denver Merchandise Mart contained two key differences from those of Momentive and EFH: (1)The make-whole provision at issue specifically discussed “prepayment”; and (2) the event necessary to trigger the premium did not occur. Nonetheless, as more circuits consider the issue, the split between the Second and Third Circuits could grow.

Keywords: bankruptcy and insolvency litigation, prepayment, redemption, make-whole, acceleration, premium, Energy Future Holdings, notes

Curtis S. Miller and Matthew O. Talmo – March 16, 2017