Prepayment premiums (also referred to as make-whole premiums) are a common feature in loan documents, allowing lenders to recover a lump-sum amount if a borrower pays off loan obligations prior to maturity, effectively compensating lenders for yield that they would have otherwise received absent prepayment. As a result of the widespread use of such provisions, three circuit courts of appeal – the U.S. Court of Appeal for the Second, Third and Fifth Circuit – have recently had to address the enforceability of prepayment provisions in bankruptcy. A quick review of these cases reveals a central theme: the enforceability of such a premium will likely turn on contract-specific language, and, in particular, whether the governing agreements specifically address payment following bankruptcy, including the effects of acceleration caused by bankruptcy.
Cases Disallowing Prepayment Premiums
The Second Circuit has, on two different occasions, disallowed prepayment claims in bankruptcy after the automatic acceleration of the underlying debt. First, in 2013, the Second Circuit held in In re AMR Corp.[1] that, where loan documents automatically accelerate upon bankruptcy, the filing date becomes the maturity date and thus payment on or after that date is not a pre-payment, triggering the premium. Instead, it is a “timely” payment, made on or after maturity.
In 2017, the Second Circuit held in In re MPM Silicones, L.L.C. (“Momentive”)[2] that noteholders were not entitled to a premium because such payment was only required under an optional redemption clause in the relevant indenture. The court concluded that payment following automatic bankruptcy acceleration was not an “optional” redemption. Specifically, the court noted that “payment on the accelerated notes following a bankruptcy filing would not be “one made at [the debtor]’s option” but would instead be a “payment made mandatory by operation of an automatic acceleration clause.”[3]
More recently, the Fifth Circuit in In re Ultra Petroleum Corp.[4] indicated (without ruling) that it might characterize prepayment premiums as disallowed unmatured interest under section 502(b)(2) of the U.S. Bankruptcy Code. Ultra presented a fairly unusual set of facts, because the debtor ended up being solvent (i.e., had sufficient funds to pay all creditors in full) but the applicable loan agreement was unsecured. This brought into question whether the lenders are entitled to post-petition interest under the “solvent debtor” exception and also whether the portion of the lenders’ claim for the prepayment premium should be disallowed under Section 502(b)(2).
Cases Allowing Prepayment Premiums
In 2016, the Third Circuit in Energy Future Holdings[5] enforced a prepayment premium triggered in connection with an optional redemption clause (similar to the Momentive clause) on the basis that the debtor had voluntarily triggered the clause with its bankruptcy filing thus rendering payments as part of that filing “optional” redemptions. Relying on the specific language of the indenture, the court also found that acceleration had no bearing on whether and when the premium was due, noting that if the debtor “wanted its duty to pay the make-whole on optional redemption to terminate on acceleration of its debt, it needed to make clear” in the indenture that such acceleration trumped the requirements of the optional redemption clause.[6] Energy Future thus is at odds with Momentive and AMR, creating a circuit split and potentially setting the stage for the Supreme Court to address this issue at some point if presented with the right cert petition.
However, even within the Second Circuit, one court has recently allowed a prepayment premium, relying on the specific contract language. Earlier this year, the Bankruptcy Court for the Southern District of New York in In re 1141 Realty Owner, LLC[7] allowed a prepayment premium on the basis that the loan agreement at issue required payment of the premium with any payment made post-default, not just a prepayment.[8] The court acknowledged the Momentive court’s views regarding the prohibition on “optional” prepayment premiums following acceleration, but found that the parties had “contract[ed] around the general rule and [lender]’s rights [should] depend on the terms” of the underlying loan agreement at issue.[9]
Observations
Lenders should be aware of the differing treatment of prepayment premiums in various jurisdictions and of the importance of the specific contract language around optional and mandatory prepayments or redemptions. Since loan documents often have varying language as to whether or not a prepayment premium is payable upon acceleration, this issue could potentially lead to forum shopping. Regardless, enforceability of a prepayment provision may largely depend on whether loan documents clearly and unambiguously require payment following acceleration and on a post-default basis.
[1] In re AMR Corp., 730 F.3d 88 (2d Cir. 2013).
[2] In re MPM Silicones, L.L.C. (“Momentive”), 874 F.3d 787 (2d Cir. 2017).
[3] Id. at 802-03 (emphasis added).
[4] In re Ultra Petroleum Corp., __ F.3d ___, 2019 WL 6318074 (5th Cir. 2019).As will be discussed in a subsequent post, the Ultra Petroleum decision ultimately may lead to a decision addressing whether, and in what circumstances, a claim for a make-whole premium must be disallowed as “unmatured interest” when a debtor is solvent.
[5] In re Energy Future Holdings Corp., 842 F.3d 247 (3d Cir. 2016).
[6] Id. at 260.
[7] 598 B.R. 534 (Bankr. S.D.N.Y. 2019).
[8] Id. at 541.
[9] Id.