Restructuring

Contributed by Dana Hall and Conray C. Tseng

Part I of III In An Examination of Recent Decisions Analyzing the Enforceability of Make-Whole Provisions in Bankruptcy

 
This is the first in a series of three blog posts discussing recent decisions related to “no-call” provisions and prepayment premiums or “make-whole” provisions: In re Premier Entm’t. Biloxi LLC; In re Calpine Corp.; and In re Chemtura Corp.  The underlying issues are whether a debtor may repay debt prior to its maturity where the debt instrument contains a provision prohibiting such repayment (i.e., a “no-call” provision) and whether such repayment entitles the lenders to a claim in the debtor’s chapter 11 cases over and above principal and accrued interest (e.g., prepayment premiums, make-wholes, or damage claims).  A related issue with respect to secured debt instruments is whether a prepayment premium is a secured or unsecured claim.
As discussed in more detail in each post, much of the analysis turns on the specific language in the debt instrument, and, as such, much of the uncertainty related to no-call provisions and prepayment penalties may be eliminated through more precise drafting of the debt instrument.  Careful review by lenders and borrowers of these provisions prior to issuing debt may avoid uncertainty and costly litigation of the issues in a subsequent bankruptcy filing.
In Premier Entm’t., the United States Bankruptcy Court for the Southern District of Mississippi held that, in the case of a solvent debtor, a debtor’s early repayment breached the indenture’s “no-call” provision and entitled the secured noteholders to general unsecured claims for expectation damages.  The court also held the lenders would receive postpetition interest upon their unsecured claims at the federal judgment rate as a condition to equity retaining its interests.
The Biloxi Hard Rock Hotel and Casino
In 2004, the Premier Entm’t. debtors issued secured notes due February 1, 2010 to raise capital to construct a Hard Rock Hotel and Casino in Biloxi, Mississippi.  The indenture governing the notes prohibited the debtors from refinancing and repaying the notes prior to February 1, 2008 (i.e., a no-call provision).  The indenture also provided that if the debtors caused an event of default to occur with the intention of avoiding the no-call provision, such default would trigger a prepayment premium.  Applicable events of default included the commencement of a chapter 11 case and the early repayment of the debt.
In 2005, Hurricane Katrina destroyed the hotel days before its scheduled opening.  As a result, the debtors received $181 million in insurance proceeds, which were deposited with the indenture trustee for the senior notes.  The debtors attempted to access the funds to rebuild the casino, but the indenture trustee refused to provide access.  In 2006, the debtors filed for chapter 11 protection to, among other things, access the insurance proceeds.
The debtors’ chapter 11 plan provided for payment to the noteholders of the par value of the notes plus accrued unpaid interest through the effective date of the plan.  The noteholders opposed the repayment of the notes and asserted that, in addition to payment in full under the plan, they were entitled to a secured claim for the prepayment premium or, in the alternative, an unsecured claim for breach of contract damages as a result of the debtors’ breach of the no-call provision.
The two primary issues before the court were whether the debtors caused an event of default in order to avoid the no-call provision, thereby entitling the noteholders to a prepayment premium, and whether the debtors breached the no-call provision, thereby entitling the noteholders to a general unsecured claim.
The Prepayment Premium
Sections 502(b) and 506(b) of the Bankruptcy Code permit an oversecured creditor to include as part of its secured claim “charges” under the agreement under which the claim arose (such as prepayment premiums) if such charges are enforceable under applicable state law.  In Premier Entm’t, the court did not decide the enforceability of the prepayment premium under state law because the court held the debtors did not trigger the prepayment premium under the indenture.
Under the terms of the indenture, in order to trigger the prepayment premium, the debtors must have caused an event of default to occur with the intention of avoiding the no-call provision.  The noteholders cited to two events of default:  the commencement of the debtors’ chapter 11 cases and the repayment of the debt under the plan.  The court found, however, that the debtors had entered bankruptcy in order to, among other things, access the insurance proceeds to fund reconstruction.  Because this was a legitimate alternative reason for the debtors to file for bankruptcy protection, the court found that the debtors had not filed for the specific purpose of avoiding the no-call provision, and, therefore, the filing did not trigger an event of default.  As to repayment of the debt under the plan, the court found that the indenture automatically accelerated the debt upon the commencement of the debtors’ chapter 11 cases, which made the debt immediately due and payable.  Accordingly, the court found that repayment of the secured notes was not an event of default triggering the repayment premium.
Interestingly, more precise drafting of the prepayment provision in the indenture could have avoided the ensuing confusion as to when the prepayment premium was triggered.  Had the noteholders intended for the prepayment premium to be triggered, they could have ensured so with some minor word-smithing.  In a later blog post, we will discuss possible alternative language seen in more recent indentures.
Breach of Damages Claim
In the alternative, the noteholders asserted a general unsecured claim for breach of the no-call provision.  The debtors, on the other hand, argued that no-call provisions are per se unenforceable in bankruptcy, and that a contractual or liquidated damages provision in the indenture is necessary to assert damages.
Although specific performance of a no-call provisions is not enforceable in bankruptcy, the court held that unenforceability does not deprive the noteholders of a breach of contract claim.  The court also found that a contractual or liquidated damages provision is not necessary to assert a breach of contract claim.  In so finding, the court distinguished its holding from the recent decision in In re Solutia, Inc., 379 B.R 473, 484 n. 7 (Bankr. S.D.N.Y. 2007), by noting the language of the indenture in Premier Entm’t provided that “all remedies are cumulative to the extent permitted by law” and, in turn, finding that the explicit remedies provided in the indenture are not limiting.  In this case, smart drafting may have preserved the noteholders’ rights.  The court qualified its decision by noting that the Premier Entm’t debtors were solvent and suggested that, in the case of an insolvent debtor, damages for breach of a no-call provision may not be awarded.
Damage Calculation and Interest
In concluding its somewhat lengthy opinion, the court went on to consider the appropriate method by which to calculate the noteholders’ damages.  The Debtors proposed three methods:  (1) the cost of defeasance under the indenture, (2) actual loss calculated by reinvesting in similar debt issued by similar companies, and (3) the prepayment premium for the earliest possible redemption.  The court found the actual loss approach was the best approximation of damages.
The court considered four potential rates of interest that could apply to the damage claims: the contract non-default rate of 10.75%, the contract default rate of 11.75%, the state law judgment rate of 9%, and (d) the federal judgment rate of approximately 0.25%.  The court found that the federal judgment rate was appropriate, in part, because a significant amount of delay was caused by the noteholders.