Effect Of Acceleration Upon A Chapter 11 Filing On Enforceability Of Make-Whole Or Prepayment Premiums

Indentures often contain make-whole premiums payable upon early redemption of the debt, and term B loan agreements often include "soft call" protection in the form of prepayment premiums during the early life of the loan. If the debt issuer becomes subject to a chapter 11 proceeding after the debt issuance, the question then arises as to how this payment obligation is to be treated: Does the make-whole or prepayment premium constitute unmatured interest due as a result of the debt acceleration, which would be disallowed, or is it liquidated damages? Often, the make-whole premium in the bond market is computed as interest that would have been received through the life of the debt had prepayment not occurred early; therefore, treating the premium as unmatured interest can be enticing. Last month, LSP Energy LP, an electricity provider, filed a lawsuit seeking declaratory judgment in the latest chapter 11 case to examine make-whole premiums in the context of debt accelerated upon a chapter 11 filing. The indenture trustee has argued that it is owed $80 million as a "make-whole premium" because LSP is planning to repay the debt on a date prior to the stated maturity date. However, LSP has argued it does not owe such amount because the indenture provides that the make-whole premium is due only upon a redemption of the bonds prior to maturity, and the bankruptcy filing accelerated the maturity to the petition date as specifically provided in the indenture. As a result, according to LSP, the automatic acceleration of the debt renders any redemption of the bonds made after the petition date to be after (and not prior to) the maturity date, and thus the make-whole premium is not due. LSP also has argued that the claim for the make-whole premium must be disallowed as a claim for unmatured interest as a result of the acceleration of debt upon the chapter 11 filing.

Previous Decisions

Earlier court proceedings that have examined the dispute over the nature and enforceability of make-whole premiums after the issuer has become subject to a chapter 11 proceeding are summarized below. In re Calpine Corp.1 On December 20, 2005, Calpine Corporation and its affiliates filed a Chapter 11 bankruptcy petition and an emergency motion for up to $2 billion in debtor-in-possession financing, which was granted by the bankruptcy court in January 2006. In January 2007, Calpine filed a motion to refinance the debtor-in-possession facility and repay approximately $2.5...