Paying That Debt Off Early May be Costly

January 13, 2011

Treatment of Debt Prepayment Limitations in Solvent Debtor Chapter 11 Cases

I. Introduction

Bond indentures and credit agreements often restrict a borrower’s ability to voluntarily prepay its debt. The restrictions seek to protect the lender’s bargained-for stream of interest payments at a specified rate over a specified period of time. Some debt instruments contain “no-call” provisions that prohibit prepayment, others have “make-whole” provisions requiring payment of a premium to offset interest lost to the lender from prepayment, while others contain a hybrid of these two – – prohibiting payment for a number of years and then allowing it in later years subject to a make-whole. This article discusses four decisions, including two just recently issued, concerning the enforcement and treatment of debt prepayment limitations in the chapter 11 context, where such restrictions bump up against the reorganization purposes of the Bankruptcy Code. In all four decisions the debtors were solvent – an uncommon occurrence in chapter 11 cases, and while the decisions all agree that a chapter 11 debtor cannot be forced to honor a no-call provision, they split 2-2 on whether a damages remedy is available to the lender if, notwithstanding the no-call or make-whole provision, a solvent debtor decides to pay off the debt prior to the original contractual maturity date.

II. The Decisions

A. Calpine I

In In re Calpine Corp., 365 B.R. 392 (Bankr. S.D.N.Y. 2007) (“Calpine I”), the chapter 11 debtors sought (outside a chapter 11 plan) to obtain new DIP loans to refinance three tranches of pre-bankruptcy secured debt (the “CalGen Note Debt”). Each tranche barred prepayment at that time: the first and second-lien tranches contained no-call provisions barring prepayment before certain dates, after which prepayment with a make-whole was permitted, while the third-lien tranche had a flat prepayment bar. None of the note tranches called for a premium in the event of repayment pursuant to an acceleration of the outstanding debt, which, as is typically the case, had occurred automatically upon the filing of the Calpine bankruptcy cases.

The noteholders asked the bankruptcy court to enforce the no-calls, or alternatively, to award them secured or unsecured damages claims for breach of the no-calls. In its rulings, the bankruptcy court first determined that specific performance of the no-call provisions was unavailable, because in bankruptcy cases it is essential that a debtor be permitted to restructure its debt. Next, the court turned to the noteholders’ argument that they should be awarded damages as part of their secured claims in the amount of the make-wholes under section 506(b) of the Bankruptcy Code, which allows payment to oversecured creditors for post-petition interest and other charges to the extent provided for in the applicable agreement. The court disagreed, however, determining that section 506(b) was unavailable, because the bankruptcy filings had accelerated the CalGen Note Debt, and the acceleration provisions did not provide for the make-whole premiums (as contrasted with the prepayment provisions). However, the bankruptcy court held that the noteholders were not without a remedy for the breach of the no-calls, and awarded them unsecured claims because their “expectation of an uninterrupted payment stream ha[d] been dashed giving rise to damages”.1 The court then used the make-whole formulas as a proxy for the damages suffered by the three tranches of CalGen Note Debt. Calpine I was appealed.

B. Solutia

While Calpine I was on appeal, a different bankruptcy judge from the same court ruled on similar issues in In re Solutia, Inc., 379 B.R. 473 (Bankr. S.D.N.Y. 2007) (“Solutia”). There, secured noteholders, relying on Calpine I, sought to add to their previously-filed claims “expectation damages” for breach of an “implied” no-call provision by a solvent debtor. While the debt documents did not contain no-call provisions, the court recognized the “perfect tender in time” rule under New York law (which governed the indenture) which provides that absent a prepayment clause a borrower does not have a right to prepay debt. However, parsing the language of the debt documents, the Solutia court determined that the automatic acceleration of the notes upon the bankruptcy filing effected a change in the maturity date of the notes to the bankruptcy filing date. Under this construction, there was no prepayment, but instead only a post-maturity repayment. Noting that the debt documents did not provide for a premium or liquidated damages in the accelerated maturity context, the Solutia court denied the damages claims and squarely confronted the holding in Calpine I:

This Court respectfully disagrees with Calpine because it reads into agreements between sophisticated parties provisions that are not there [i.e., damages in an acceleration context]. Perhaps the parties negotiated on the subject but were unable to reach an agreement. It may simply, although less probably, be that this subject was overlooked. In either case, the court cannot supply what is absent . . . . Nothing in the Bankruptcy Code requires this court to provide the 2009 Noteholders with more than the Original Indenture provides. Put yet another way, they have no dashed expectations for which compensation is due.

379 B.R. at 485 n. 7 (emphasis in original)

C. Premier Entertainment

On September 3, 2010, the Bankruptcy Court for the Southern District of Mississippi held in Premier Entm’t Biloxi, LLC v. U.S. Bank N.A. (In re Premier Entm’t Biloxi LLC), 2010 Bankr. LEXIS 2994 (Bankr. S.D. Miss. Sept. 3, 2010) (“Premier”), that breach of no-call provisions entitled the holders to unsecured damages claims. Premier thoroughly analyzed Calpine I and Solutia, agreeing with their specific performance and section 506(b) analyses; however, like Calpine I, the Premier court determined that the noteholders were not without a remedy, which could be provided in the form of an unsecured damages claim measured by the difference between the market interest rate and the contract rate at the time of the repayment. The court also noted the long-standing bankruptcy policy that in a solvent debtor case – where the equity holders retain an interest – courts should look to enforce the creditor’s contractual rights, so that debtors do not escape the bargained for results of their acts.

D. Calpine II

Just 11 days after Premier, the District Court for the Southern District of New York issued its decision on appeal in  2010 U.S. Dist. LEXIS 96792 (S.D.N.Y. Sept. 14, 2010) (“Calpine II”).2 The district court agreed with Calpine I insofar as the unavailability of either specific performance or a secured claim, but disagreed that the noteholders were entitled to unsecured damages claims, reasoning that damages cannot be awarded where the creditor had no claim because the prepayment provisions did not apply to automatically accelerated debt.3

Like Solutia, the Calpine II court stated that “the notes could have provided for the payment of premiums in the event of payment pursuant to acceleration . . . [and] [w]ithout such a provision . . . no damages are recoverable after acceleration.”4 Finally, to further buttress the decision, the court held that any claims for expectation damages are invalid as unmatured interest, which the Bankruptcy Code prohibits.5

Calpine II has been appealed to the United States Court of Appeals for the Second Circuit.6 A decision can be expected sometime next year.7

III. Analysis

It is a well-settled principle of bankruptcy law that in those rare instances of a solvent chapter 11 debtor, “it is the role of the Bankruptcy Court to enforce the creditors’ contractual rights of the parties, and the role that equitable principles play in the allocation of competing interests is significantly reduced.”8 This different treatment occasioned in the case of a solvent debtor has been discussed and found to be determinative in cases dealing with the application of default interest, compound interest and penalties owed to secured creditors.9 These cases have determined that in a solvent debtor case, the creditors should receive the higher interest rate and other payments provided in their contracts and that a contrary decision would benefit equity holders who stand junior to the creditors under the Bankruptcy Code’s “absolute priority rule”. Moreover, the legislative history of chapter 11 of the Bankruptcy Code has cited with approval the prior case law on this point, stating: “Courts have held that where an estate is solvent, in order for a plan to be fair and equitable, unsecured creditors’ claims must be paid in full, including postpetition interest, before equity holders may participate in any recovery.”10

Calpine I and Premier seem guided by and find solid support in this fundamental policy, whereas Solutia and Calpine II seem to have lost sight of it, letting themselves become bogged down in the thicket of contract language intersecting with certain Bankruptcy Code provisions. Or, perhaps, they turned to an overly technical construction out of a misplaced desire to “equitably” reallocate value because of the bankruptcy setting. However, in the solvent debtor context, their deviation from the intent of the agreements leads inexorably to a windfall for equity holders – – inverting the priority pyramid contrary to both Congressional intent and sound bankruptcy policy.

Finally, it should be noted that a solvent debtor in chapter 11 does have an alternative to payment of the damages claim awarded by the Calpine I and Premier courts. Pursuant to section 1124 of the Bankruptcy Code, the debtor may deaccelerate the debt, cure any defaults and reinstate the original maturity dates in the debt instrument. General Growth Properties, Inc. successfully pursued this reinstatement strategy in its recently confirmed chapter 11 plan for approximately $1.6 billion in unsecured debt.11 Depending upon the interest rates and the time to maturity, this may be a less expensive option than the payment of any damages and, in any event, stretches out the additional cost over a number of years.

Mr. Ashmead and Mr. Cohen are partners in the Bankruptcy Department of the firm of Seward & Kissel LLP. They would like to thank Evan Preponis, an associate in the Department, for his assistance in the preparation of this article.

Reprinted with permission from the December 13, 2010 issue of the New York Law Journal. © 2010 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.


1 Calpine I, 365 B.R. at 399.

2 Calpine II goes through a fairly detailed analysis of the existing case law, yet does not mention Premier. It is likely that the District Court was not aware of Premier at the time it issued its decision.

3 Calpine II, 2010 U.S. Dist. LEXIS 96792, at *12.

4 Id., at *14.

5 Section 502(b)(2) of the Bankruptcy Code disallows claims to the extent they are for unmatured interest (i.e., interest that at the time of the bankruptcy filing had not yet been earned/accrued). This provision is most often applied in the context of debt instruments issued at a discount. Its applicability to prepayment damages in the form of a make-whole is questionable, and in a solvent debtor case is doubtful given the case law discussed in the next section of this Article.

6 Calpine II, appeal docketed, No. 10-4302 (2nd Cir. Oct. 20, 2010).

7 After Calpine II, the bankruptcy court in In re Chemtura Corp., No. 09-11233 (REG) (Bankr. S.D.N.Y. Oct. 21, 2010), issued its decision on confirmation of Chemtura’s chapter 11 plan, which integrated a settlement of the no-call and make whole issues. The debtors, the official committee of unsecured creditors and an ad hoc committee of bondholders had agreed to the settlement of make-wholes and no-calls as part of the plan negotiation process. The plan provided for a payment but at a substantially reduced amount. The official committee of equity security holders had objected to the plan, including its no-call/make-whole settlement aspect. The bankruptcy court was not called to decide the merits of no-calls and make-wholes in bankruptcy, but whether a settlement of these open legal issues was reasonable. The Chemtura bankruptcy court analyzed the different positions and case law, taking the time to discuss the strengths and weaknesses in the different positions. Ultimately, the court found the settlement reasonable and confirmed the plan.

8 In re Dow Corning Corp., 456 F.3d 668, 679 (6th Cir. 2006); see also In re 139-141 Owners Corp., 306 B.R. 763, 772-73 (6th Cir. 2006), cert. denied, 1217 S. Ct. 1874 (2007); accord, Gencarelli v. UPS Capital Bus. Credit, 501 F.3d 1, 7 (1st cir. 2007).

9 In re Dow Corning Corp., 456 F.3d 668; Ruskin v. Griffiths, 269 F.2d 827 (2d Cir. 1959); In re 139-141 Owners Corp., 313 B.R. 364, 369 (S.D.N.Y. 2004); see Debentureholdes Protective Comm. Of Cont’l Corp. v. Cont’l Inv. Corp., 679 F.2d 264, 269 (1st Cir. 1982); see also Gencarelli, 501 F.3d at 7 (holding that in a solvent debtor case, “unreasonable” prepayment penalties under section 506(b) that are enforceable under governing state law should be allowed as a valid unsecured claim).

10 Dow Corning, 456 F.3d at 678 citing 140 CONG. REC. H10, 752-01, H10, 768 (1994) (statement of Rep. Brooks, Chairman of the Committee on the Judiciary and co-author of the Bankruptcy Reform Act of 1994).

11 In re General Growth Properties, Inc., No. 09-11977 (ALG) (Bankr. S.D.N.Y. Oct. 18, 2010).


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