In In re Ultra Petroleum Corp., 913 F.3d 533(5th Cir. 2019), the U.S. Court of Appeals for the Fifth Circuit ruled that a "make-whole," or "prepayment," premium owed on unsecured notes issued by a chapter 11 debtor constituted unmatured interest disallowed by section 502(b)(2) of the Bankruptcy Code. The ruling represents a landmark decision on the allowance of such premiums in chapter 11, over which there has been considerable litigation in recent years, including at the circuit court level.
Enforceability of Make-Whole Premiums in Bankruptcy
Restrictions on a borrower’s ability to prepay secured debt are a common feature of bond indentures and credit agreements. Lenders often incorporate "no-call" provisions to prevent borrowers from refinancing or retiring debt prior to maturity. Alternatively, a loan agreement may allow prepayment at the borrower’s option, but only upon payment of a "make-whole premium" (commonly referred to as a "prepayment penalty"). The purpose of these prepayment penalties is to compensate the lender for the loss of the remaining stream of interest payments it would otherwise have received had the borrower paid the debt through maturity.
Most recent court rulings addressing the allowance of claims for make-whole premiums have focused on highly technical legal and contractual issues. For instance, in Del. Tr. Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016), the U.S. Court of Appeals for the Third Circuit ruled that certain noteholders were entitled to payment of a premium upon the redemption of their notes during a chapter 11 case. According to the Third Circuit, the premium was warranted because the optional redemption provision in the note indenture (which required the payment) did not conflict with the indenture’s acceleration provision, which provided that the notes were accelerated upon a bankruptcy filing, thereby potentially no longer making payment of the debt a "prepayment" that would require the payment of a "prepayment premium" under the contract. By contrast, in Momentive Performance Materials Inc. v. BOKF, NA (In re MPM Silicones, L.L.C.), 874 F.3d 787 (2d Cir. 2017), the U.S. Court of Appeals for the Second Circuit held that certain noteholders were not entitled to a prepayment premium because the notes were accelerated upon the bankruptcy filing and, therefore, could no longer be prepaid.
As noted, make-whole or prepayment premiums are typically structured to compensate noteholders for lost future interest resulting from payment of their notes prior to maturity. As a consequence, claims for such premiums have long been challenged (with mixed results) under section 502(b)(2) of the Bankruptcy Code, which disallows claims for "unmatured interest." Compare In re Ridgewood Apartments of DeKalb Cnty., Ltd., 174 B.R. 712, 720 (Bankr. S.D. Ohio 1994) ("Absent actual prepayment by the Debtor, [the lender’s] claim for a prepayment penalty could be no more than a contingent liability. Further, because the contingent claim is for interest which is not yet due at the time the bankruptcy was filed (because prepayment had not occurred), it would not be allowed to an undersecured creditor [under section 502(b)(2)]"), with In re 360 Inns, Ltd., 76 B.R. 573, 576 (Bankr. N.D. Tex. 1987) ("[T]he prepayment penalty was not unmatured interest as contemplated in § 502(b)(2), inasmuch as the prepayment penalty was activated and matured once the plan of reorganization proposed to prepay [the lender’s] debt.").
However, more recent litigation over such premiums has generally sidestepped this issue, focusing instead on the technical provisions of the indentures at issue. The Fifth Circuit’s decision in Ultra Petroleum refocuses the analysis on the legal issue of whether a make-whole premium is unmatured interest that must be disallowed under section 502(b)(2).
Impairment Under a Chapter 11 Plan
Classes of claims or interests may be either "impaired" or "unimpaired" by a chapter 11 plan. The distinction is important because only impaired classes have the ability to reject a plan. Under section 1126(f) of the Bankruptcy Code, unimpaired classes of creditors and shareholders are conclusively presumed to have accepted a plan.
Section 1124 provides that a class of creditors is "impaired" under a plan unless, among other things, the plan: (1) "leaves unaltered the legal, equitable, and contractual rights" to which the claimant is entitled; or (2) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates the claimant for resulting losses.
Section 1124 originally included a third option for rendering a claim unimpaired—by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that a solvent debtor’s chapter 11 plan that paid unsecured claims in full in cash, without postpetition interest, did not impair the claims.
Because of the perceived unfairness of New Valley, Congress removed this option from section 1124 of the Bankruptcy Code in 1994. Since then, most courts considering the issue have held that, if an unsecured claim is paid in full in cash with postpetition interest at an appropriate rate, the claim is unimpaired under section 1124. See, e.g.,In re PPI Enterprises (U.S.), Inc.,324 F.3d 197, 205–07 (3rd. Cir. 2003).
Ultra...
