May 11, 2020
Make-whole premiums are of increasing importance in an environment of decreasing interest rates that may become negative. This client-update discusses the enforceability of “make-wholes” in bankruptcy cases.
Generally, make-wholes are designed to provide a bargained-for approximation of the loan’s present value to the lender, i.e., the discounted present value of future interest payments, plus the amount due on redemption, in excess of the principal amount. Make-whole terms are often intensely negotiated, leading to drafting inconsistencies from one loan or indenture to the next. Contractual interpretation disputes often find their way to court, particularly in chapter 11 cases. We can expect more make-whole disputes in the Covid-19/low-interest-rate era as many companies with funded debt file for chapter 11 protection.
Make-wholes are generally enforceable outside of bankruptcy according to their terms as a form of liquidated damages, but certain Bankruptcy Code provisions disallowing claims for unmatured interest and “penalties” have led to disputes when the borrower seeks bankruptcy relief.
Investment-grade and high-yield bonds often provide that they may not be pre-paid before scheduled maturity without a redemption premium payment and that such premium is also payable if the maturity of the bond is accelerated upon default. In the case of high-yield bonds, there is typically a defined non-call period during which the bond can be redeemed only upon payment of a make-whole premium. Similarly, some term loans contain call premiums if the borrower prepays or defaults, often calculated as a percentage of the remaining outstanding loan principal. Private placement notes frequently contain make-whole provisions. Make-wholes may be payable upon optional redemption or acceleration of the debt, but such terms vary from bond to bond, note to note, and term loan to term loan.
The courts have not applied a uniform approach to the allowance of make-whole claims in bankruptcy cases. In fact, three circuits have issued conflicting decisions on the topic.  In some cases, courts have categorically disallowed make-wholes on the grounds they constitute penalties or unmatured interest. Other courts have held that make-wholes are a form of liquidated damages and thus enforceable so long as they approximate the lender’s reasonable losses from prepayment or acceleration and the provisions evidence agreement that a make-whole is payable under the circumstances of the case.
A 2019 case from the SDNY Bankruptcy Court is instructive regarding the current state of make-whole jurisprudence. In In re 1141 Realty Owner, the creditor sought a make-whole premium in its proof of claim. The debtor objected, alleging that the premium was unenforceable under New York law because the loan trustee accelerated the debt prepetition and the make-whole provision at issue excluded the word “acceleration.” . In response, the bankruptcy court stated as follows:
Generally, a lender that accelerates a loan following a default forfeits the right to a prepayment premium because the acceleration advances the maturity date, and by definition, the loan cannot be prepaid. Courts recognize two exceptions to this general rule. First, if a clear and unambiguous clause requires the payment of the prepayment premium even after default and acceleration, the clause will be analyzed as a liquidated damages clause. Second, if the borrower intentionally defaults to trigger the acceleration and ‘evade’ payment of the prepayment premium, the lender can enforce the prepayment premium.
After concluding that the prepayment language at issue was clear and unambiguous, and that the amount sought by the creditor was not disproportionate to the creditor’s losses, the court in 1141 Realty upheld the premium as a form of liquidated damages. . In particular, the court noted that the loan agreement required the payment of a make-whole premium in connection with “any payment” made after an event of default, “not just a prepayment made after an event of default but before acceleration. Instead, the clause deems the post-default payment, whenever made, to be a ‘voluntary prepayment’ for purposes of the Yield Maintenance Premium” (all italics in original). Moreover, the court noted that parties are free to “contract around” the rule that a lender forfeits a prepayment premium by accelerating the debt. 
The court then added this practice tip to its decision:
[The] parties can provide for their rights with any language that plainly conveys their intent. One way to ensure that a make-whole premium is payable even after acceleration is to say so explicitly. Another way to ensure that the make-whole premium is payable even after acceleration is to render acceleration irrelevant and . . . make the premium contingent on any post-default payment. (citations omitted)
At the opposite ends of the spectrum are provisions that leave no doubt that a make-whole is due after acceleration or default as well as upon a voluntary pre-payment and provisions that limit the make-whole to a voluntary bankruptcy pre-payment. Conversely, between these two extremes, courts will consider the choice of governing law, the method for calculating the premium, the wording that defines what events trigger the make-whole, and the cumulative nature of remedies in deciding the amount of the lender’s claim.
Lenders would be wise to consider amending existing make-whole provisions that fall short of the clarity the courts require, perhaps as consideration for waivers and forbearance agreements requested by borrowers. Borrowers too may want to clarify make-whole terms to ensure they are consistent with the parties’ intent.
Partners in Moses & Singer’s Bankruptcy and Banking & Finance Departments would be pleased to discuss the content of this memorandum in more detail. Please contact Patrick Trostle at (212) firstname.lastname@example.org or Mark Parry at (212) email@example.com with your questions.
 – Compare Ultra Petroleum Corp., 943 F.3d 748 (5th Cir. 2019); Momentive Performance Materials Inc. v. BOKF, N.A. (In re MPM Silicones, L.L.C.), 874 F.3d 787 (2d Cir. 2016); and In re Energy Future Holdings Corp., 842 F.3d 247 (3d Cir. 2016).
 – In re 1141 Realty Owner LLC, 598 B.R. 534 (Bankr. S.D.N.Y. 2019). The debt at issue in the case involved a “Yield Maintenance Default Premium,” defined as the “amount equal to the greater of: (i) three percent (3%) of the principal amount of the Loan being repaid and (ii) the excess, if any, of (a) the present value (determined using a discount rate equal to the Treasury Rate at such time) of all scheduled payments of principal and interest payable in respect of the principal amount of the Loan being repaid provided the Note shall be deemed, for purposes of this definition, to be due and payable on the Free Window Date, over (b) the principal amount of the Loan being repaid.” The court noted that the debtor could not prepay the loan except as provided in the loan agreement, and that “any prepayment following an Event of Default was deemed a ‘voluntary prepayment’ requiring the payment of the Yield Maintenance Default Premium.”
 – Both parties in 1141 Realty submitted that no extrinsic evidence existed to support their respective views of the loan agreement. In ruling that the contract language was not ambiguous, the court negated the need for extrinsic evidence to support the claimant’s position. Whether or not such evidence existed, the court made clear that it could determine the meaning of the contract as a question of law.
 – See Momentive Performance Materials Inc. v. BOKF, N.A. (In re MPM Silicones, L.L.C.), 874 F.3d 787 (2d Cir. 2016).