Clarity in drafting loan documents and understanding what your loan documents say are vital to a lender’s success in enforcing its rights and remedies both in and out of bankruptcy.  

In June, the United States Supreme Court denied review of an important decision for lenders, effectively leaving intact the Second Circuit’s decision in Apollo Global Mgmt., LLC v. Bokf, NA (In re MPM Silicones, Inc.) (“Momentive”)¹.  In Momentive, the Second Circuit denied senior noteholders’ claim of entitlement to asserted make-whole claims² and, in doing so, re-emphasized the importance of upholding the contractual rights of lenders consistent with decades of contract jurisprudence.  While the result was not favored by the senior noteholders, the Momentive decision serves as a cautionary tale to lenders and underscores the importance of careful attention to both drafting and enforcement of loan documents.

Under the New York rule of “perfect tender,” a borrower cannot prepay debt.  Parties to a loan agreement, however, may, and often do, amend this general rule by providing to the borrower a specific right of prepayment in exchange for agreed consideration that compensates the lender for its expectancy of interest payments through the stated maturity date, which stream of payments will cease by the prepayment.  These bargained-for premiums are often referred to as “yield maintenance clauses”, “exit fees” or “prepayment penalties” and may be charged as percentage of the outstanding indebtedness, a fixed fee or a calculation based on the difference between the contract rate and market rate at the time of prepayment.  Commercial loan documents often provide for the payment of a prepayment premium if the borrower makes a voluntary prepayment of the indebtedness prior to maturity.  

If a lender accelerates the loan (following declaration of a default) or if the loan is automatically accelerated following an event of default, a lender forfeits the right to prepayment consideration.  Under New York law, the standard rule is that, once the loan is accelerated, the lender forfeits its right to a prepayment fee because the acceleration effectively advances the maturity date and, by definition, any subsequent payment cannot be a prepayment as maturity is deemed to have occurred.  New York courts recognize two exceptions to this rule: (1) when the borrower intentionally defaults in order to trigger acceleration and evade the prepayment fee and (2) when the parties agree in the loan documents pursuant to a clear and unambiguous clause imposing a prepayment fee after acceleration.  In the event a court concludes that the borrower intentionally defaulted in order to trigger acceleration and thereby evade the prepayment fee, the prepayment fee may be collected by the lender, notwithstanding the general rule that collection of a prepayment premium after acceleration requires an express agreement.

In Momentive, the indenture trustees for the holders of approximately $1.1 billion of First Lien Notes and $250 million of 1.5 Lien Notes (together, the “Senior Notes”) asserted their entitlement to a make-whole premium as a result of the Momentive Debtors’ repayment of the Senior Notes under the plan of reorganization before the stated contractual maturity date.  The Momentive Debtors argued that the First Lien Notes were not entitled to the make-whole because the indebtedness was automatically accelerated when the Momentive Debtors filed Chapter 11.  Under the terms of the indentures, the maturity date of the Senior Notes was contractually advanced and the indebtedness accelerated.  The Second Circuit held that the holders of Senior Notes had bargained for the early repayment of the Senior Notes upon Momentive’s bankruptcy and, therefore, forfeited their right to a prepayment premium.  Further, because the indentures did not contain any language that “clearly and specifically” provided for the payment of the make-whole notwithstanding the automatic acceleration, no make-whole was due.

Best practice for lenders is to clearly and unambiguously include language in the governing loan documents to preserve lender’s right to receive a prepayment fee even after acceleration or default of the loan.  Such a clause provides that the borrower’s repayment of the debt after acceleration of the loan will be deemed an evasion of the prepayment restrictions, requiring the borrower to, nonetheless, pay a prepayment premium. If the lender intends to include within the scope of its evasion clause that a borrower cannot avoid a prepayment after a foreclosure proceeding has been initiated, whether by exercise of borrower’s equity of redemption or pursuant to a sale of the property, the language must clearly and unambiguously require enforcement in such cases.  The key is to ensure that the loan agreement provides either (a) that the make-whole or prepayment fee shall be payable notwithstanding the acceleration (automatic or declared) of the loan (by default or otherwise) or that (b) the borrower shall be required to pay a make-whole or prepayment fee whenever the debt is repaid prior to its original stated maturity date.   Further, in light of the Momentive decision, it would be prudent to have loan documents expressly provide that the make-whole is payable after a bankruptcy event of default.

Although the Second Circuit upheld the denial of the noteholders’ make-whole claim in Momentive, the decision is useful to lenders generally because the Court went to great lengths to enforce the bargained-for rights of the parties in the applicable indentures and notes.  While the Senior Notes in Momentive didn’t recover their make-whole, it would be a far worse result for lenders if the courts were to intervene and rewrite the parties’ rights and obligations under the loan documents.  Thus, the onus is on the drafters to ensure that, if a prepayment fee or make-whole is negotiated, the conditions to payment are clearly defined and protect the lender from losing entitlement based on acceleration. TSL

¹ See 2017 U.S. App. LEXIS 20596 (2d Cir. 2017), cert. denied, 2018 U.S. LEXIS 3753  (June 18, 2018).

² The Second Circuit’s decision in Momentive is also noteworthy for its reversal of the decisions of the District Court and Bankruptcy Court regarding the method of calculating the appropriate interest rate for the replacement notes issued to holders of senior lien notes under the debtors’ confirmed plan of reorganization.  Although significant, this article does not include a discussion of the portion of the Second Circuit decision addressing cramdown rate of interest in Chapter 11.