On October 20, in Matter of M.P.M. Silicones, L.L.C. (“M.P.M. Silicones”), the United States Court of Appeals for the Second Circuit held that secured noteholders were not entitled to an approximately $200 million make-whole premium when their notes were exchanged for new notes as part of a Chapter 11 plan. __ F.3d __, 2017 WL 4772248 (2d Cir. Oct. 20, 2017). Under the relevant indenture, a make-whole premium was due only in the event of an optional redemption of the notes; once the bankruptcy filing accelerated the notes’ maturity, repayment was neither optional nor a redemption. The Second Circuit also held that restructured secured debt may be entitled to an “efficient market” rate rather than the typically lower “formula” or “prime-plus” rate used in Chapter 13 cases.

M.P.M. Silicones involved the bankruptcy of Momentive Performance Materials (“Momentive”) and its affiliates, which restructured in excess of $1 billion in senior secured notes (the “Notes”) with pre-bankruptcy interest rates between 8 percent and 10 percent. Momentive’s plan of reorganization provided for replacing the Notes with new notes (the “Restructured Notes”) that would repay in full, over time, the principal and accrued interest of the Notes at rates between 4 percent and 5 percent. The senior secured noteholders (the “Noteholders”) objected to the plan and, as a class, rejected the plan. The Noteholders contended that the principal of the Restructured Notes should include not only the principal and accrued interest of the Notes, but also a “make-whole” premium of roughly $200 million, reflecting the lost future interest on the Notes. The Noteholders also contended that the interest rate on the Restructured Notes should be based upon the rate an efficient market would produce for a loan equivalent to the Restructured Notes, not the prime-plus rate used in the plan; this would produce approximately $30 million in additional interest payments to the Noteholders. At the plan confirmation hearing, the Noteholders’ objections were overruled, and the plan was confirmed over their dissenting votes (a “cramdown”). In re M.P.M. Silicones, LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014). The Noteholders appealed the decision of the bankruptcy court to the district court, which affirmed; they then appealed to the Second Circuit, which affirmed in part and reversed in part.

The Cramdown Standard. When a class of secured creditors votes to reject a plan, the plan may still be confirmed under the cramdown procedures of Section 1129(b) of the Bankruptcy Code if, among other things, the plan is “fair and equitable” and provides for “deferred cash payments” at least equal to the value of the creditor’s lien.

The Make-Whole Premium. The Second Circuit decided, affirming the lower courts, that the Noteholders were not entitled to include the make-whole premium in the principal of the Restructured Notes, because the Notes were not paid off prior to maturity. By the terms of the indenture, the make-whole payment was due in the event of a “redemption” at Momentive’s “option,” and a bankruptcy filing automatically accelerated the maturity date of the Notes, making the Notes immediately due and payable. The Second Circuit held that because the maturity date of the Notes had been accelerated, repayment was neither optional (it was already due) nor a redemption (a redemption occurs at or prior to maturity, not afterward). The automatic stay in bankruptcy prevented the Noteholders from rescinding the acceleration of the Notes to make the make-whole payment come due, as that would amount to an “end-run around their bargain,” in the Second Circuit’s opinion.

Notably, this decision may create a split with the Third Circuit, which required the debtor to pay a make-whole premium under a New York law indenture with similar language. In re Energy Future Holdings Corp., 842 F.3d 247, 255 (3d Cir. 2016) (finding that “redemption” includes post-maturity repayments of debt under New York law; redemption was “optional” where bankruptcy was voluntary and the debtor could have reinstated the original maturity).

The Interest Rate. In Till v. SCS Credit Corp., the plurality opinion of the United States Supreme Court held that the fair and equitable rate in a Chapter 13 personal bankruptcy was a formula or prime-plus rate that starts with a risk-free rate and modifies it to reflect the risks of inflation and nonpayment (but not transaction costs or profit margins for the lending institution). 541 U.S. 465 (2004). The lower courts in M.P.M. Silicones applied the Till rate to a Chapter 11 case. However, the Second Circuit, following the Sixth Circuit’s decision in In re American HomePatient, Inc., distinguished Till and held that in a Chapter 11 case, if an efficient market for loans to the debtor exists, the interest rate from the efficient market should govern. 420 F.3d 559, 568 (6th Cir. 2005). The Second Circuit remanded the matter back to the bankruptcy court to determine whether there was an efficient market in this case and the appropriate loan rate.

Conclusion. M.P.M. Silicones will give secured lenders additional leverage to seek a higher interest rate than they would receive under the Till paradigm, although it may require significant work to show an efficient market exists. The decision will also likely create an incentive for debtors facing significant make-whole premiums to file for bankruptcy in New York rather than other states, such as Delaware. Since debtors often have a choice of bankruptcy forums, lenders and investors should be wary of whether a make-whole premium is due following an automatic acceleration.