Chipping Away at the Till Formula: Second Circuit Momentive Decision Confirms Denial of Make Whole But Raises Interest Rate Calculation in the Chapter 11 Context

10.25.17

Hugh M. McDonald

Harris B. Winsberg

Eunjin E. Lee

The Second Circuit’s recent Momentive decision, In re MPM Silicones, LLC, Case Nos. 15-1771, 15-1682 & 15-1824 (2d Cir. Oct. 20, 2017), contained some good news and bad news for bondholder creditors – a market-based approach to setting interest rates in a cram-down scenario while affirming the denial of make-whole payments to bondholders whose claims are being satisfied in full under a plan. The result is a partial reversal of one aspect of the substantially consummated Chapter 11 Plan detailed in In re: MPM Silicones, LLC, et al. 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).

Holders of secured Senior-Lien Notes issued by debtor Momentive Performance Materials, Inc. (“Momentive”), objected to the Plan as it precluded recovery of a “make-whole” premium Momentive was to have paid had it opted to redeem the notes prior to original, October 15, 2020, maturity date. By debtors’ calculations, this premium would have been nearly $200 million. Objecting secured creditors were issued replacement notes (i.e. the “deferred cash payments” allowed under the Bankruptcy Code) which were to amount to the full present value of the secured creditors’ claims by carrying an appropriate rate of interest. Relying on the formula set forth in Till v. SCS Credit Corp., 541 U.S. 465 (2004) which instructs the bankruptcy court to begin with a largely risk-free rate (i.e. the national prime rate) and make plan-specific risk adjustments upwards based on evidence presented by the parties, the Bankruptcy Court set the interest rate at indisputably below-market rates.

The Plan was confirmed over the objections of the Senior noteholders and they appealed to the Second Circuit arguing that the Plan was not “fair and equitable” as required by Section 1129(b) of the Bankruptcy Code because Momentive would have to pay a much higher rate to a contemporaneous, sophisticated, arms-length lender in the open market. Effectively, the Plan would require the Senior-Lien Noteholders to lend to debtors at a rate much lower than any other lender would have received for offering the same loan on the open market. Noting that the appeal was not “equitably moot” because the senior secured creditors took steps to seek a stay pending appeal, the Second Circuit agreed with the senior secured creditors as to the proper standard to determine the cramdown interest rate.

Distinguishing the readily available market of willing cramdown lenders in the Chapter 11 context to the non-existent market in the Chapter 13 context, the Second Circuit concluded that efficient market rates for cramdown loans cannot be ignored in Chapter 11 cases. The Second Circuit adopted the Sixth Circuit Court of Appeals’ two-part process for selecting an interest rate in Chapter 11 cramdowns established inIn re American Homepatient, Inc., 420 F. 3d 559, 568 (6 th Cir. 2005), which first looks to the market rate where there exists an efficient market (i.e. where a loan with a term, size, and collateral comparable to the forced loan contemplated under the cramdown plan exists in the open market), and only looks to the formula approach endorsed by the Till plurality where no efficient market exists. In reversing and remanding the decision to the Bankruptcy Court, the Second Circuit leaves open complex issues including how to determine the existence of an “efficient market” and the boundaries of such a market. Nonetheless, this step away from Till marks a victory for lenders and bondholders in both the Chapter 11 and workout negotiation context as debtors lose their ability to threaten to impose new loans on creditors with below-market rates by filing for bankruptcy protection. Thus, going forward, creditors should prepare with care evidence in support of the existence of, and the terms being offered by, the efficient market when facing a potential Chapter 11 cramdown.

Additionally, the Second Circuit continued to adhere to its decision in In re AMR Corp., 730 F.3d 88 (2d Cir. 2013) and affirmed the decision that Senior-Lien Notes holders are not entitled to the “make-whole” premium because the debtors bankruptcy filing irreversibly accelerated the maturity date to the petition date, thus preventing the ability to trigger the rights to the premium. The subsequent payments could not be voluntary prepayments because prepayment can only occur before the maturity date. This conclusion puts the Second and Third Circuits in opposite camps with regard to the entitlement of make-whole payments after the commencement of a bankruptcy case. See In re Energy Futures Holdings Corp., 842 F.3d 247 (3d Cir. 2016).

Finally, the Second Circuit affirmed the lower court decision and found that secured Second-Lien Notes stand in priority to unsecured Subordinated Notes notwithstanding ambiguity of contract language that left the issue open due to the clear intention of parties to subordinate the Subordinated Notes to the Second-Lien Notes. The fact that the Court found ambiguity when it appeared to be clear that subordinated debt holders should rank behind secured debt holders may give some lenders concern that the clearly stated priority of debt may still lead to interpretation by a Court. Lenders and investors should be careful that there is no ambiguity in debt priority or conflicting provisions in documents that could lead to a court opening the door to determine if in fact one debt holder should rank ahead of another.