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A Momentous Decision: Second Circuit Affirms Momentive Plan, Rejects Application of Till in Major Chapter 11s, and Splits with Third Circuit on Make-Whole Payments

On October 20, 2017, the United States Court of Appeals for the Second Circuit issued its long-awaited opinion in Momentive Performance Materials Inc. v. BOKF, NA (In re MPM Silicones, LLC), Case No. 15-1682 (2d Cir. Oct. 20, 2017) [D.I. 256] (available here). A unanimous panel affirmed the district court’s affirmance of the bankruptcy court’s confirmation of the chapter 11 plan (“Plan”) of Momentive Performance Materials, Inc. and its affiliated debtors (“MPM”). In so doing, the Second Circuit embraced a two-part test incorporating the “efficient market” approach over the Till approach to calculate the proper interest rates under the “cramdown” provisions of the Bankruptcy Code[1]; created a circuit split over the enforceability of “make-whole” provisions for early repayment when the triggering event of default and subsequent acceleration is the filing of a bankruptcy petition; rejected the argument that the claims of certain Subordinated Note holders were subordinate to the claims of certain Second Lien Notes holders; and refused to dismiss the appeals as equitably moot.

Prior to the Second Circuit’s ruling, courts generally followed the test adopted by the Supreme Court in Till v. SCS Credit Corp., 541 U.S. 465, 478-79, 124 S.Ct. 1951, 1961, 157 L.Ed.2d 787 (2004) to determine proper “cramdown” interest rates. The Till formula approach requires a two-step analysis to determine the “prime plus” rate. First, the court must identify the national prime rate that reflects the financial market’s estimate of the amount a commercial bank should charge to compensate for the opportunity costs of a loan, the risk of inflation, and the default risk. Second, the court must adjust the prime rate upwards, generally by 1 to 3 basis points, for the risk posed by lending to a bankruptcy debtor. After Momentive, courts in the Second Circuit are no longer required to employ the Till approach in the context of chapter 11 cases and instead may look to market rates in determining an appropriate interest rate. To that end, the Second Circuit remanded the case to the bankruptcy court solely to determine the proper “cramdown” interest rate under its newly articulated test after holding that the bankruptcy court had erred “in categorically dismissing the probative value of market rates of interest.”

Background

MPM, a leading silicone producer, had issued substantial debt obligations before filing its chapter 11, including: (i) $500 million in subordinated unsecured notes, issued in 2006 (the “Subordinated Notes”); (ii) $1 billion in “springing” second lien unsecured notes issued in 2010 (the "Second Lien Notes”), secured by second-priority liens junior to pre-existing liens upon the redemption of $118 million in 2009 second lien notes[2] in November 2012; and (iii) $1.1 billion in first-lien secured notes and $250 million in “1.5-lien” secured notes in 2012 (together, the “Senior Lien Notes”).[3]

The Senior Lien Notes indentures required a “make-whole” premium in the event they were redeemed prior to October 15, 2015. The indentures also contained an acceleration provision, triggered upon an “Event of Default” such as filing a voluntary bankruptcy, which required the payment of the principal, “premium, if any,” and interest on the Senior Lien Notes. MPM’s Plan presented the Senior Lien Notes holders with a proverbial “death trap” scenario: accept the Plan and get cash immediately in exchange for waiving any make-whole claims, or reject the Plan and receive replacement notes with below-market interest rates (but preserve the make-whole premium argument). The Senior Lien Notes holders chose the latter option and objected to confirmation of the Plan, asserting that MPM owed the make-whole premiums and that the forced acceptance of a below-market interest rate on their replacement notes violated the Bankruptcy Code’s requirement that plans be “fair and equitable.”[4]

The primary issues before the Second Circuit were (i) whether the Senior-Lien Notes holders were entitled to the make-whole’ premium; and (ii) the appropriate interest rate for Senior Lien Notes holders’ replacement notes if issued pursuant to the Plan. The Second Circuit also determined that the Second Lien Notes had priority over the Subordinated Notes and that the appeals were not equitably moot.

Analysis

The first of the two most significant aspects of the Second Circuit’s opinion is the court’s adoption of the Sixth Circuit’s two-step “efficient market” approach for determining cramdown interest rates in a chapter 11, notwithstanding the Supreme Court’s guidance in Till,[5] a consumer bankruptcy. In their confirmation objection, the holders of the Senior Lien Notes asserted that the interest rates on their replacement notes under the Plan failed to meet the “cramdown” standard of Bankruptcy Code section 1129(b)(2)(A)(i)(II), pursuant to which debtors may make “deferred cash payments” to secured creditors so long as the interest rates ensure that secured creditors will receive the full present value of their claims.

The bankruptcy court had utilized the Till formula in determining the appropriate interest rates on the Senior Lien Notes to be 4.1% and 4.85%. In reaching its decision, the bankruptcy court declined to consider evidence offered by the Senior Lien Notes holders that the market rates would actually be in the 5 to 6% range or higher. The evidence supporting these market rates was clear since the Debtors had previously solicited bids on an exit facility in case the Senior Lien Notes holders chose the cash-out option offered under the Plan. The Second Circuit held that failure by the bankruptcy court to consider evidence of market rates was error and adopted a two-step test, which provides that the “market rate” should be utilized in chapter 11 cases in which an “efficient market” exists,[6] but where no such market exists, a court should revert to the Till formula.[7] In its view, this approach appropriately compensates secured creditors for the inherent risks in post-petition/plan-related financing.

The second noteworthy aspect of the opinion – the holdings on make-whole premiums – created a split between the Second and Third Circuits. In Momentive, the optional redemption clauses in the indenture controlling the Senior Lien Notes (which were governed by New York law) provided for a “make-whole” payment in the event that the Senior Lien Notes holders opted to redeem before October 15, 2015. The Second Circuit agreed with both lower courts and held that an acceleration resulting from the filing of a bankruptcy petition was not an “optional redemption” and therefore, the holders were not entitled to the “make-whole” payment.

Relying on its decision in In re AMR Corp., 730 F.3d 88 (2d Cir. 2013), the Second Circuit held that the automatic acceleration of the Senior Lien Notes changed their maturity dates to the petition date and that “redemption” is limited to the repayment of debt prior to the maturity date. As a result, the post-petition date/post-maturity date issuance of replacement notes under the Plan did not qualify as a “redemption.” The Court also dispensed with the argument that the Senior Lien Notes holders could rescind the acceleration, holding that doing so would violate the automatic stay and would be an “end-run around their bargain by rescission.”

This holding is directly at odds with the Third Circuit’s recent decision in In re Energy Future Holdings Corp., 842 F.3d 247 (3d Cir. 2016)[8] that certain noteholders (whose indentures were also governed by New York law) were entitled to a “make-whole” premium upon the debtor’s post-petition payment of notes accelerated by the filing of the bankruptcy. The Third Circuit found that “New York and federal courts deem ‘redemption’ to include both pre- and post-maturity repayments of debt,” and therefore redemption is possible after the automatic acceleration caused by the filing of a bankruptcy petition. Based on the facts of that case, the Third Circuit found that the debtor’s ability to repay the accelerated debt in full “demonstrate[d] that the redemption was very much at [the debtor’s] option, and thus the repayment of the notes was sufficiently voluntary to render the make-whole payment due.

Lessons

The Second Circuit’s decision regarding the appropriate rate of “cramdown” interest is a step towards recognition of the practical realities of the market: it would be rare to find a lender willing to provide exit financing at interest rates computed pursuant to Till. However, it is important to note the limitations of the decision. It provides protection to secured creditors only in cases in which a “efficient market’ exists for loans similar to the type proposed by the plan. And, in most chapter 11 cases, no “efficient market’ will exist for the loans forced upon secured creditors in a cram-down plan. That is because most such cram-down loans are made at a 100% loan to value ratio and the market for such loans for most borrowers is thin to non-existent.

Further, in addition to creating an issue for potential review by the Supreme Court, the circuit split sets the stage for potential forum shopping, as the Second Circuit is (for now) a more suitable venue than the Third for chapter 11 cases in which a debtor may have liability under a less-than-clear make-whole provision.

For More Information

If you have any question regarding this Client Alert, please contact Jason D. Angelo at 302.425.3311 or the Stevens & Lee attorney with whom you normally consult.

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[1] 11 U.S.C. §§ 101 et seq.

[2] In 2009, MPM issued secured second-lien notes and gave the Subordinated Notes holders the option of exchanging their notes for the new second-lien notes. $118 million of the $500 million in Subordinated Notes exercised this option.

[3] In re MPM Silicones, LLC, 531 B.R. 321, 326 (S.D.N.Y. 2015).

[4] 11 U.S.C. § 1129(b).

[5] Till, supra, 541 U.S. at 478-79, 124 S.Ct. at 1961 (adopting the ‘formula’ approach to calculating cramdown interest rates)). Till was a chapter 13 case, and the Supreme Court’s plurality opinion acknowledged that the formula approach may not be appropriate in a chapter 11 case given the possible availability of willing lenders. Id. at 476 n.14. The plurality opined that “it might make sense to ask what rate an efficient market would produce” in such situations. Id.

[6] An “efficient market” is one in which a loan, comparable in size, term, and collateral to the contemplated cramdown loan, is available. See In re Texas Grand Prairie Hotel Realty, L.L.C., 710 F.3d 324, 337 (5th Cir. 2013).

[7] In re American HomePatient, Inc., 420 F.3d 559,568 (6th Cir. 2005).

[8] Energy Future is the governing precedent in the Third Circuit following the withdrawal of the Debtors’ motion for rehearing en banc.