March 7, 2018
The decision of the Court of Appeals for the Second Circuit (the “Court”) in In re Momentive Performance Materials Silicones, L.L.C.1 gives corporate trust professionals guidance in the following four areas: (1) the meaning of the commonly defined term “Senior Debt” with respect to subordinated notes, (2) the appropriate interest rate for replacement notes given in exchange for existing notes under a chapter 11 plan of reorganization, (3) when bankruptcy triggers a make-whole premium and (4) when substantial consummation of a plan moots an appeal. A copy of the decision can be accessed here.
The Momentive Performance Materials Silicones chapter 11 bankruptcy restructured first lien, second lien and subordinated notes. The first lien notes received replacement notes in the face amount of their original notes plus accrued interest. The second lien notes received a partial recovery while the subordinated notes received no recovery. The first lien notes and subordinated notes appealed confirmation of the plan of reorganization (“Plan”).
· The subordinated noteholders appealed on the ground that their notes were not actually subordinate to the second lien notes because such second lien notes did not fall within the definition of “Senior Debt” in the subordinated note indenture. The Court rejected this ground of their appeal.
· The senior lien noteholders appealed on the ground that their note claims should have included the make-whole premium provided for in the indenture for the purported occurrence of an “optional redemption” prior to maturity. The Court rejected this ground of their appeal.
· The senior lien noteholders also appealed on the ground that the replacement notes they received were not equivalent in value to their allowed note claims because the interest rate was below market. The Court held that the fully secured group of senior lien noteholders were entitled to a hearing to determine the market rate of interest and that substantial consummation of the Plan did not moot this ground of their appeal.
The following discusses each of these grounds for appeals and the Court’s holdings in more detail.
Meaning of “Senior Debt” For Purposes of Subordination
With respect to the subordination issue, the Court affirmed the rulings of the courts below, but on significantly different grounds. The lower courts had held that the second lien notes were unambiguously “Senior Debt” within the base definition of the subordinated note indenture because, despite their lien being junior to the lien of the first lien notes, the second lien notes were not expressly subordinated in right of payment to any other debt according to the terms of the subordinated note indenture.
The Court rejected this reading of the subordinated note indenture. Instead, it found that the second lien notes, because their lien was subordinated to the first lien notes, might conceivably fall within a proviso to the definition of “Senior Debt” excluding from the definition of “Senior Debt” any debt “that by its terms is subordinate or junior in any respect to any other indebtedness…” (Emphasis supplied). The Court found that the definition of “Senior Debt” in the subordinated note indenture did not unambiguously incorporate the common distinction between “lien subordination” and “payment subordination.” The Court, instead, found that the proviso would be superfluous if the words “in any respect” were deemed to mean junior or subordinate only “in right of payment”. Finding the correct application of the definition to be ambiguous as a matter of law, the Court considered the extrinsic evidence contained in the record to determine whether the second lien notes actually had been intended to be senior debt with respect to the subordinated notes.
Looking at the extrinsic evidence, the Court concluded that the parties had intended the second lien notes to be senior debt despite being secured by a junior lien. The extrinsic evidence included repeated statements by the debtors in their filings under the securities acts that the second lien notes were “senior debt” to which the subordinated notes were subordinated in right of payment. In addition, all of the other secured senior debt, including the first lien notes, were indisputably senior despite containing provisions subordinating their liens to pre-existing liens on particular assets. Finally, the Court noted that the second lien notes had been issued as senior unsecured debt with a provision for its second lien to spring into effect on future events. It found no reason why unsecured debt that had been issued as senior debt would have become subordinated debt merely because of the occurrence of events that had caused that debt to acquire the additional protection of a subordinated lien.
Since the second lien debt was senior debt with respect to the subordinated notes and did not receive a full recovery under the Plan, the subordinated notes were not entitled to any recovery.
Senior Lien Notes’ Claim To a Make-Whole Premium
Under the Plan, the senior lien notes were to be paid in full. However, one major dispute concerned the amount of the senior lien note claims. The senior lien noteholders insisted they were entitled to a “make-whole” premium. Because of that dispute, the classes of senior lien notes were given the option of waiving their claims by class vote and receiving payment in full in cash or rejecting the Plan and receiving through the cramdown provisions of the Bankruptcy Code replacement notes in the amount of the allowed claims as ultimately determined. The senior lien note classes rejected the Plan. The bankruptcy court at confirmation then held that the senior lien note claims did not include a “make-whole” premium and confirmed the cramdown Plan at the lower allowed claim amount.
The senior lien noteholders appealed the confirmation order on two grounds. One ground concerned the disallowance of the “make-whole” payment. The other ground was that the bankruptcy court had erred in fixing the interest rate on the replacement notes by using the “formula” method applied by the Supreme Court to a chapter 13 plan in Till v. SCS Credit Corp., 541 U.S. 465 (2004).
With respect to the “make-whole” premium, the Court applied and reaffirmed its prior decision in In re AMR Corp., 730 F.3d 88 (2d Cir. 2013). It found that the automatic acceleration for bankruptcy in the indenture was not an “optional redemption” exercised in the debtors’ discretion within the meaning of the indenture, which would have triggered the right to a premium. It also found that the automatic acceleration defeated any claim that the distribution on the senior lien notes was a redemption or prepayment at or prior to maturity. According to the Court, the effect of the automatic acceleration was to move the maturity date of the senior lien notes up to the date the bankruptcy cases commenced and, thus, the distribution or redemption under the Plan occurred after the maturity date. It also rejected the argument that the senior lien noteholders should have been allowed to rescind the acceleration after the automatic stay went into effect in order to defeat the bargain they had made by the terms of the optional redemption clause.
Cramdown Interest Rate on Replacement Notes
The senior lien noteholders did improve their Plan treatment in one respect—they got the chance to increase the interest rate on their replacement notes on remand.
The interest rates on the replacement notes were set by the bankruptcy court at 4.1% and 4.85%, using the “formula” or “prime plus risk factor” method upheld by a plurality of the Justices in Till, supra. The senior lien noteholders, however, had presented evidence at confirmation that the debtors had priced a cash-out facility from third-party lenders to be used in the event the senior lien noteholders accepted the Plan. The interest rate for that facility would have been 5% to 6+%. The evidence also showed that the replacement notes were trading at 93% of face amount, indicating that the interest rate was set below market.
The Court found this evidence to be a persuasive indication that there was both a determinable market rate of interest for the replacement notes and that the rate on the replacement notes was below market. Therefore, according to the Court, the distribution that the senior lien noteholders were getting was substantially less than the full value of their allowed claims. In reaching this conclusion, the Court analyzed the Till decision and found that this conclusion was consistent with application of a market rate of interest in a chapter 11 cramdown situation where such a rate could be determined from an efficient market. The Court also found that its conclusion was consistent with other Court of Appeals decisions that encouraged use of reliable market value data, as opposed to the formula approach, when available. In taking this approach, it followed the Sixth Circuit’s decision in In re American HomePatient, Inc., 420 F.3d 559, 568 (6th Cir. 2005). Thus, the Court remanded the case to the bankruptcy court to determine whether an efficient market rate of interest could be determined and, if so, to apply that rate to give the senior lien noteholders the present value of their allowed claim.
In remanding the interest rate issue to the bankruptcy court, the Court rejected the debtors’ argument that senior lien noteholders appeals were equitably mooted because the Plan was already substantially consummated. The Court applied the factors set out in In re Chateaugay Corp., 988 F.2d 322 (2d Cir. 1993), and found that such factors weighed in favor of the senior lien noteholders. According to the Court, the most important factor was whether the appellants had sought a stay pending appeal. Here the appellants had unsuccessfully sought a stay at the bankruptcy, district and circuit court levels. In view of that diligence, the Court found that the additional interest payments which might be required after remand, amounting to $32 million a year for seven years, did not pose a sufficient risk of unraveling the Plan to warrant mooting the appeal.
1874 F.3d 787 (2d Cir. 2017).