Restructuring

Contributed by Brian Wells
Today we write on relatively recent decision on remand in the Chesapeake Energy Corporation early redemption litigation we previously covered.  In short, the United States District Court for the Southern District of New York held that the payment terms of an indenture prevail over equitable arguments, and if notes were redeemed at a time when a make-whole would be owed under the terms of an indenture, the make-whole was owed – even if the issuer didn’t mean to trigger it. 
Our earlier post chronicled an interesting interpretive back and forth between the district court and Second Circuit leading up to this point.  At issue had been whether Chesapeake would be able to redeem notes in time to make a “special early redemption,” in which case it would be spared from paying a make-whole premium.  Chesapeake had held off on redeeming the notes to wait for a declaratory judgment from the district court either affirming or denying its view that it was able to effectuate an early redemption.  When the district court held that the clear and unambiguous language of the indenture supported Chesapeake’s position, Chesapeake proceeded to redeem the notes at the discounted special early redemption price.  Meanwhile, the trustee appealed to the United States Circuit Court for the Second Circuit, which subsequently issued an opinion agreeing with the district court that special early redemption window was absolutely clear – albeit with the opposite interpretation!  This left Chesapeake in the unenviable position of having inadvertently redeemed the notes at the discounted price at a time when the make-whole was in fact applicable.  As Chesapeake has noted, it would not have redeemed at all if it had known this to be the case.
The decision on remand went to the measure of damages, given that Chesapeake had only paid the discounted early redemption price.  The trustee took a hardline approach based on the contract:  The redemption was made during a period when the make-whole applied, so the holders were entitled to the unpaid value of the make-whole premium.  Chesapeake had a creative theory for a lower recovery, which was rooted in principles of equity:  It did not intend to redeem the notes at the make-whole price, so it should only pay “restitution,” calculated as the present value of payouts that noteholders would have received if they had held the notes to maturity (an amount Chesapeake estimated would be $280 million less than the make-whole price).
Although contractual provisions generally prevail over equitable principles, Chesapeake’s argument was more than just a plea to fairness.  Chesapeake cited cases in which courts provided restitution to parties that were disadvantaged by a lower court ruling (for example, by paying damages) that was later reversed.  Given that Chesapeake clearly relied upon the district court’s holding that its special early redemption was timely when it decided to proceed with redemption, this would appear to be at least a colorable argument.
The district court disagreed.  Chesapeake clearly knew that the decision could be appealed and overturned; indeed, the district court raised this possibility at first-stage hearings, pointing out to Chesapeake on the record that if it were subsequently overruled Chesapeake could be liable for the make-whole.  Unlike cases where a court has compelled someone to pay in a ruling that is later reversed, Chesapeake went ahead with redemption of its own volition.  The district court also opted to apply the indenture’s provisions mechanically rather than apply equitable principles to revise or supplement its clear language.  And this mechanical application was clear – redemption outside the early redemption window required payment of the make-whole.  Following this line of thought, the district court also decided that prejudgment interest should be paid at the contractual rate provided in the indenture, not a lower “equitable” rate proposed by Chesapeake.
Although an interesting conclusion to the Chesapeake saga, the decision does not offer a “bankruptcy” lesson, per se.  It was a contractual dispute applying state and federal law.  That said, the market activity surrounding the decision is a reminder of the behind-the-scenes trading that so frequently drives litigation, including in the context of chapter 11 cases.  (As we mentioned in our prior post, upon remand, a gray market formed for trading in the already-redeemed notes’ rights to any damages.)  The dispute turned on a clear cut question of contractual interpretation, and, although Chesapeake raised some creative arguments in an attempt to mitigate damages, the disputes remained tethered to the indenture.  In addition, the litigation process was linear and predictable – trial, decision, appeal, decision, remand, decision.  Moreover, the final decision (an order to pay the make-whole, or not) was a clear catalyst establishing recoveries on the subject securities.  In this scenario, Chesapeake likely could do little other than litigate with the investors until their investment theses panned out (or didn’t).
Bankruptcy cases present an interesting counterpoint.  They are common vehicles for investment strategies and will present a number of events, such confirmation or a settlement, that crystalize legal rights into a definite value.  But if there are more opportunities, bankruptcies also pose more risks given that value in bankruptcies might not be determined solely by a clear cut, linear litigation as was the case in Chesapeake.  Debtors, for example, have many more levers than Chesapeake had at its disposal to affect an adversary’s value proposition – for better or worse.  So, while Chesapeake doesn’t address what might happen under the Bankruptcy Code, bankruptcy professionals might nonetheless take it as an opportunity to consider the many moving parts in a bankruptcy case and how those may be creatively used to advance a position in non-linear ways.