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3rd Circuit Upholds "Make-Whole" in Energy Future

December 1, 2016 - The recent 3rd Circuit ruling on the enforceability of “make-whole” provisions, while surprising to some, reinforces the importance of clear and precise drafting of loan and loan documents and indentures.  Indeed, even if one prevails, fuzzy drafting can cost millions of dollars. We discuss below.

Make-whole provisions, common in bond indentures, are intended to compensate lenders for interest lost when borrowers repay notes prior to a specific date.  As reported in the WSJ, the Court in In re Energy Future Holdings Inc. reversed a decision by the Delaware bankruptcy court (and criticized an important decision by the bankruptcy court in the southern district of New York in Momentive), concluding that the make-whole language in the indentures in question were enforceable in bankruptcy notwithstanding the fact that the borrower’s bankruptcy filing accelerated the maturity of the bonds.

In this case, EFIH issued notes that contained a make-whole provision providing that, prior to a specific date, EFIH could redeem the notes at a redemption price equal to the principal amount of the notes redeemed plus a make-whole premium. Each indenture also contained a separate acceleration provision that made the notes immediately due and payable if EFIH filed for bankruptcy.  In April 2014 EFIH filed for bankruptcy and sought to refinance the notes without paying the make-whole premiums, which the bankruptcy court allowed, rejecting the noteholders’ challenge.  The bankruptcy court reasoned that since the indentures’ acceleration provisions made no mention of the make whole-provisions, they were not enforceable. The district court affirmed.

The 3rd Circuit disagreed, holding that the refinancings were “optional redemptions” that triggered the make-whole premiums.  It rejected the notion that the make-whole did not apply once the debt was accelerated simply because the indentures’ acceleration provisions did not make specific reference to themInstead, the Court viewed the optional redemption provision as separate and apart from the acceleration provision and read the provisions as operating together.  Finally, distinguishing “redemption” premiums from “prepayment” premiums, the Court ruled that the acceleration of the notes’ maturity did not impact the viability of the make-whole premiums, so the acceleration of the debt, which occurred upon the bankruptcy filing, did not impact the analysis of whether a make-whole premium would be due.

Although the bondholders ultimately prevailed (at least pending a possible appeal to the Supreme Court), this case reinforces the need to carefully draft make-whole provisions. As King & Spaulding note in their recent memo, make-whole provisions “should be drafted to clearly define what triggers make-whole payments, and acceleration provisions should be drafted to clearly and unambiguously provide that any make-whole premiums will be applicable notwithstanding an automatic acceleration of the indebtedness”.

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