On November 17, 2016, the United States Court of Appeals for the Third Circuit issued its opinion in In re: Energy Future Holdings Corp. The Third Circuit reversed a ruling by the United States Bankruptcy Court for the District of Delaware that had been affirmed on appeal by the District Court that lenders were not entitled to be paid early redemption premiums when their Chapter 11 borrower refinanced its obligations to the lenders prior to the scheduled maturity date.
Interest accrued on the obligations at issue in Energy Future Holdings at an annual rate of 10%. To preserve the lenders’ expected income streams, one section of the loan documents, which were governed by New York law, provided that if the borrower exercised the option to pay the debt prior to December 1, 2015, specified early redemption premiums were due to the lenders. The loan documents also provided in a different section that the borrower’s obligations would be immediately due and payable if the borrower filed for bankruptcy.
Late in 2013, with prevailing interest rates being well below 10%, the borrower filed with the Securities and Exchange Commission an 8-K form outlining its plan to file for bankruptcy and refinance its obligations to the lenders. In April of 2014, the borrower filed a Chapter 11 bankruptcy case in Delaware. The debtor filed a motion seeking permission to obtain a new loan to refinance its existing obligations at a much lower interest rate of 4.25%. Refinancing at the lower rate would save the borrower $13 million per month if the borrower did not have to pay any early redemption premium to its existing lenders. The borrower asserted that it did not have to pay any early redemption premium because, since the entire debt had become due when it filed for bankruptcy, it was not paying its obligations early and its payment of the pre-bankruptcy obligations were mandatory rather than “optional.”
The lenders responded by requesting relief from the automatic stay to rescind the acceleration of the borrower’s obligations that had resulted from the filing of the borrower’s Chapter 11 petition. The bankruptcy court denied that request, determined that the borrower did not have to pay early redemption premiums, and authorized the borrower to obtain the new loan to satisfy its obligations, excluding early redemption premiums, to the pre-bankruptcy lenders. The bankruptcy court based its ruling largely upon the fact that the section of the loan documents that provided for automatic acceleration of the borrower’s obligations upon a bankruptcy filing did not expressly identify early redemption premiums as being included in the obligations that were accelerated. In so doing, it relied on the opinion of the United States Court of Appeals for the Second Circuit in In re: AMR Corp. and the opinion of the United States Bankruptcy Court for the Southern District of New York in In re MPM Silicones, LLC, commonly referred to as the “Momentive” case. The United States District Court for the District of Delaware affirmed the decision of the Bankruptcy Court on appeal and the lenders then appealed to the Third Circuit.
The Third Circuit began its opinion by noting that, under New York law: (1) “[t]he fundamental, neutral precept of contract interpretation is that agreements are construed in accord with the parties’ intent;” (2) “The best evidence of what parties to a written agreement intend is what they say in their writing;” and (3) “It is the role of the courts to enforce the agreement made by the parties—not to add, excise or distort the meaning of the terms they chose to include, thereby creating a new contract under the guise of construction.” Applying these principles, the Third Circuit noted that the relevant issue under the language of the loan documents was not whether the borrower had paid its obligations “early” or “prior to maturity,” but prior to December 1, 2015, which it unquestionably had.
Turning to the borrower’s argument that its payment before December 1, 2015 was not “optional” because it had no choice but to pay its obligations to the lenders once they became immediately due and payable as a result of the bankruptcy filing, the Third Circuit said “this contention does not match the facts.” The Third Circuit noted that the borrower had laid out its plan to refinance its obligations in its filing with the SEC well before it voluntarily filed for Chapter 11 and caused the obligations to become due. Furthermore, the Third Circuit noted that the lenders had tried to rescind the automatic acceleration of the obligations that had occurred when the Chapter 11 petition was filed, but that the bankruptcy court had barred them from doing so in response to the borrower’s objection. On these facts, the Third Circuit said “Logic leaves no doubt this redemption of the Notes was “[o]ptional” under § 3.07 [of the loan agreements].”
The Third Circuit said that the Second Circuit’s holding in In re: AMR Corp. that no early redemption premium was owed when a debt was automatically accelerated as a result of a bankruptcy filing did not support the borrower’s position in Energy Future Holdings because the language of the loan documents in the two cases was different. While the loan documents in Energy Future Holdings provided that all obligations of the borrower would become immediately due and payable upon a bankruptcy filing, the loan documents in In re: AMR Corp. provided that, upon a bankruptcy filing, “the unpaid principal amount of the Equipment Notes then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder (but for the avoidance of doubt, without Make–Whole Amount), shall immediately and without further act become due and payable.” The Third Circuit said, “AMR is the easy case; just follow the text.”
Unlike AMR Corp., the decision of the United States Bankruptcy Court for the Southern District of New York in Momentive did support the borrower’s position in Energy Future Holdings. In Momentive, The New York Bankruptcy Court had ruled that the lender was not entitled to an early redemption premium because the provision in its loan documents making all principal, interest, and “premium, if any” automatically due upon a bankruptcy filing by the borrower was “not specific enough to require payment of a make-whole.” The Third Circuit declined to follow Momentive, stating “We believe, however, the result in Momentive conflicts with that indenture’s text and fails to honor the parties’ bargain.”
The Third Circuit’s decision in Energy Future Holdings is important for a number of reasons. First, Delaware, where many major Chapter cases are filed, is in the Third Circuit so the decision is binding on the Delaware Bankruptcy Court and will govern those cases. Second, the Southern District of New York is also a jurisdiction in which may large, high profile Chapter cases are filed. Although the Third Circuit’s decision in Energy Future Holdings is not binding on the New York Bankruptcy Court, by rejecting that court’s Momentive decision and reconciling the Energy Future Holdings decision with the decision of the Second Circuit in AMR Corp., which is binding on the New York Bankruptcy Court, the Third Circuit provided a cogent argument against application of Momentive in future New York cases. Finally, because of the prominence of New York in large and sophisticated financing transaction, the documents used in transactions with borrowers throughout the country are often governed by New York law. Consequently, the Third Circuit’s ruling as to when a lender is entitled to an early redemption premium under documents governed by New York law in a Chapter 11 case will be persuasive authority in major cases even in bankruptcy courts outside of the Second and Third Circuits.