Second Circuit Affirms Lower Court Decisions Denying Make-Whole Premium and Endorses Market Interest Rate in Chapter 11 Cramdown Plans – BOKF, NA v. Momentive Performance Materials Inc. (In re MPM Silicones, L.L.C.), 874 F.3d 787 (2d Cir. 2017)
The United States Court of Appeals for the Second Circuit has issued a decision containing both favorable and unfavorable rulings for creditors of distressed companies:
- In Momentive, the Second Circuit affirmed lower court decisions that denied a claim for a make-whole premium under New York law when the indenture does not specifically provide for such claim upon an automatic acceleration caused by the debtor’s bankruptcy filing. This ruling makes it more difficult for creditors to pursue make-whole claims in chapter 11 cases where the financing agreement does not provide for a make-whole claim upon the acceleration of the debt. It also conflicts with a 2016 decision by the Third Circuit Court of Appeals in the Energy Futures Holdings chapter 11 cases, thereby creating a circuit split for potential review by the Supreme Court.
- The Second Circuit’s Momentive decision also reversed a lower court decision that permitted the debtors to “cram down” a chapter 11 plan on dissenting secured noteholders by issuing replacement notes bearing interest at a “formula” rate that was calculated using adjustments to a risk-free rate. Instead, the Second Circuit instructed the bankruptcy court to determine if an efficient market rate existed and to apply that market rate to the replacement notes. This ruling reduces the risk that secured creditors could be forced to take new debt instruments with a below-market interest rate in chapter 11 cases.
Momentive Performance Materials and certain of its affiliates (collectively, “MPM”) filed for chapter 11 protection in April 2014 to address significant liabilities, including approximately $1.35 billion of first-lien and 1.5-lien notes (together, the “Senior Lien Notes”). In September 2014, the bankruptcy court confirmed a chapter 11 plan of reorganization proposed by MPM over the objection of the holders of Senior Lien Notes. The chapter 11 plan provided for the issuance of new replacement notes for the Senior Lien Notes who, as a class, had voted to reject the plan. The bankruptcy court determined that (a) the principal amount of the replacement notes did not have to include a make-whole premium, because that premium was due only in the case of an “optional redemption” and not in the case of an acceleration caused by a bankruptcy filing, and (b) the interest rate on the replacement notes proposed by MPM, which was well below a “market” rate, satisfied the Bankruptcy Code’s cramdown provision. The holders of the Senior Lien Notes appealed these rulings to the district court and then to the Second Circuit.
In its decision, the Second Circuit affirmed the bankruptcy court’s ruling that that the noteholders were not entitled to replacement notes for the amount of the make-whole premium. The court noted that the indenture required payment of a make-whole premium only when MPM redeemed the notes “at its option” before maturity. According to the noteholders, MPM had satisfied this requirement by filing for chapter 11 protection and issuing replacement notes under its plan. The Second Circuit disagreed and held that the automatic acceleration of the Senior Lien Notes upon MPM’s bankruptcy filing changed their maturity date and, as a result, they were not “redeemed” early under MPM’s plan – they were paid post-maturity. Additionally, the Second Circuit held that, even if MPM had redeemed the Senior Lien Notes by issuing replacement notes, MPM had not done so “at its option” due again to the automatic acceleration of the Senior Lien Notes under the indenture. Therefore, the Second Circuit determined that the noteholders were not entitled to replacement notes under MPM’s plan on account of the make-whole premium.
While rejecting the noteholders’ appeal of the make-whole ruling, the Second Circuit agreed with the noteholders on their appeal of the interest rate ruling. The bankruptcy court had concluded that the Bankruptcy Code’s cramdown provision, which permits confirmation of a plan over the rejection of secured creditors if such creditors receive deferred cash payments equal to the present value of their collateral, was satisfied by the plan’s issuance of replacement notes with an interest rate calculated by using the national prime rate and adding a small risk adjustment to that rate. This conclusion was based on the Supreme Court’s endorsement of a “formula” rate in a chapter 13 case and an observation that, in that case, there was no market of willing cramdown lenders. The bankruptcy court also explicitly rejected taking market factors into account, even though it was undisputed that the interest rate selected by the bankruptcy court was well below a “market” rate. Importantly, the noteholders presented evidence that MPM had sought exit financing from lenders who had quoted rates well above the interest rate of the replacement notes and argued on appeal that the replacement notes issued under the plan did not trade at par. The Second Circuit observed that the Supreme Court decision relied upon by the bankruptcy court had suggested that its “formula” rate may not apply in chapter 11 cases where an efficient market rate exists and held that the bankruptcy court incorrectly rejected the use of a market rate of interest. Therefore, the Second Circuit reversed the bankruptcy court’s approval of the “formula” interest rate for the replacement notes and remanded the case to the bankruptcy court with instructions for the court to determine whether an efficient market rate exists and, if so, to apply that market rate to the replacement notes.