Appellate CourtThe Third Circuit Court of Appeals, in an opinion authored by Judge Thomas Ambro, has reversed two district court opinions and refused to allow a company to use a Chapter 11 bankruptcy filing as a means to reduce interest on its debt obligations.  Specifically, the court held that filing for bankruptcy would not excuse a debtor from its obligation for a “make-whole” payment otherwise due to its lenders.

Energy Future Holding Company LLC and EFIH Finance Inc. (collectively, “EFIH”) borrowed over $4 billion at a 10% interest rate by issuing notes secured by first- and second-priority liens on EFIH’s assets. The Indentures governing the loans provided  that EFIH could redeem all or part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed plus the “Applicable Premium” and interest.  This Applicable Premium was understood to be a “make-whole,” a payment designed to compensate the lenders for the interest they would have earned had the Notes not been redeemed early. The Indenture also included an acceleration provision, which provided that all outstanding notes would become due and payable immediately if EFIH were to file bankruptcy.

When market interest rates went down, EFIH sought to refinance the Notes, but refinancing outside of bankruptcy would have required it to pay the make-whole premiums.  In an effort to avoid paying the make-whole and still refinance, EFIH voluntarily filed for Chapter 11 bankruptcy.  Lower court decisions analyzed whether EFIH had to pay the make-whole for either the first- or second-priority lienholders, given that it was in bankruptcy.  Both lower courts held that EFIH did not have to make the make-whole payments, because the acceleration provision, which made no mention of the make-whole, took effect when EFIH entered bankruptcy, and the automatic stay prevented the noteholders from rescinding the Notes’ acceleration.

Following oral argument in September before a three-judge panel comprising Judges Ambro, Smith, and Fisher, the Court of Appeals for the Third Circuit reversed both decisions. The court reasoned that EFIH had voluntarily redeemed the Notes, and therefore EFIH was provisionally bound to pay the make-whole payment. According to the court, the redemption provision remained applicable even in a post-bankruptcy acceleration context. The court found no conflict between the redemption provision and the acceleration provision, holding that the redemption provision, not the acceleration provision, was clearly in play in the debtors’ bankruptcy cases.

This opinion is notable because unlike the Second Circuit, the Third Circuit is interpreting New York law to allow for a post-bankruptcy make-whole payment, emphasizing the importance of giving “effect to the intent of the parties as revealed by the language of their agreement.” Additionally, the opinion makes it clear to borrowers that the burden is on them to make explicit in their agreements whether an acceleration provision is intended to override an optional redemption provision.  It also serves as a warning to borrowers that filling bankruptcy will not necessarily allow avoiding redemption provisions and any make-whole payments that may accompany them.