Make-Whole Premiums Get To 'Pass Go' In Bankruptcy Court

A make-whole premium is a lump-sum payment that becomes due under a financing agreement when repayment occurs before the stated maturity date, thereby depriving the lender of all future interest payments bargained for under the agreement. Make-whole provisions, ubiquitous in the bond market, are becoming more prevalent in commercial loan transactions, including in the distressed context. That trend is spurred by favorable court rulings for lenders enforcing make-whole premiums when the borrower files for bankruptcy protection. Tight, unambiguous contracts with respect to the lender's rights are not being second-guessed by the courts. An example are recent decisions from the bankruptcy courts in Delaware in In re School Specialty, Inc., No. 13-10125, 2013 WL 1838513 (Bankr. D. Del. Apr. 22, 2013), the Southern District of New York in In re AMR Corp., 485 B.R. 279 (Bankr. S.D.N.Y. 2013) and the Western District of Oklahoma in GMX Resources, Inc., No. 13-11456 (filed Apr. 1, 2013). Nevertheless, lenders' claims to make-whole premiums continue to be challenged by unsecured creditors and equity committees, as in the bankruptcy case of In re Rotech Healthcare, Inc., No. 13-10741 (Bankr. D. Del. filed Apr. 8, 2013).

THE SCHOOL SPECIALTY DECISION1

School Specialty entered into a credit agreement pre-bankruptcy to borrow $70 million from lender, Bayside Finance, LLC (Bayside). Under the terms of the parties' agreement, School Specialty was obligated to pay a make-whole premium to Bayside if the loan was prepaid or accelerated before the stated term. The parties' agreement calculated the make-whole premium as the present value of future interest payments that would have accrued between the date the principal was prepaid or accelerated and the loan's maturity date. The loan matured at the end of year 2014, but the maturity date could be extended to the end of 2015 under certain circumstances. School Specialty breached a covenant in the credit agreement that triggered its obligation to pay the make-whole premium. On January 4, 2013, School Specialty entered into a forbearance agreement with Bayside, acknowledging acceleration of the loan caused by the breach and the obligation to pay the make-whole premium in the approximate sum of $25 million.

The amount of the make-whole premium represented 37 percent of the loan principal, which was, in the court's words, large enough "to give the Court pause." 2013 WL 1838513, at *4. The premium was calculated based on interest payments that would have been due through the 2015 maturity date of the loan, at the U.S. Treasury rate plus 50 basis points.

On January 28, 2013, School Specialty and related entities (collectively School Specialty) filed voluntary petitions for Chapter 11 relief. School Specialty and Bayside entered into a debtor-in-possession financing arrangement, stipulating that School Specialty owed Bayside the principal of the loan and the make-whole premium of $23.7 million. Reacting to the magnitude of the premium that squeezed unsecured creditors out of the money, the Official Committee of Unsecured Creditors filed a motion to disallow the make-whole premium. Bayside opposed the Committee's motion.

The bankruptcy court conducted a trial, heard testimony and denied the Committee's motion. Applying the...