In a pair of decisions in 2015, the United States Bankruptcy Court of the District of Delaware determined that neither the first lien notes trustee nor the second lien notes trustee of Energy Future Intermediate Holdings Corp. ("EFIH"), a subsidiary of Energy Future Holdings ("EFH"), was entitled to receive a make-whole on the repayment of the corresponding indebtedness resulting from the acceleration of that debt in the EFH bankruptcy case. Those decisions are now on appeal to the Third Circuit.1 In the interim, however, Bankruptcy Judge Sontchi has addressed another issue in the case, namely whether the turnover provisions providing for the subordination of the second lien debt to the first lien debt nonetheless required the holders of the second lien debt to make a payment in the amount of the make-whole to the first lien debt holders.

EFH and its affiliates, including EFIH, filed for voluntary petitions for bankruptcy under Chapter 11 of the Bankruptcy Code in April 2014. Delaware Trust Co. serves as successor indenture trustee for the 10% first lien notes of EFIH due 2020 and the 6.875% first lien notes of EFIH due 2017. Delaware Trust Co. also serves as successor collateral trustee under a collateral trust agreement with respect to the first lien notes. Computer Trust Co. and Computer Share Trust Co. of Canada together serve as successor trustee for the 11% second lien notes of EFIH due 2021 and the 11.75% second lien notes of EFIH due 2022. The first lien trustee sought a declaratory judgment that the second lien trustee must turn over future distributions receives from EFIH in the bankruptcy case until the first lien trustee receives payment of not less than $488 million, which was the amount of the make-whole that the first lien trustee claimed it was due, plus interest.

Both the first lien debt and the second lien debt are subject to the provisions of a collateral trust agreement. Pursuant to the collateral trust agreement, the second lien trustee is required to hold in trust for the holders of the first lien notes, and to remit to the first lien trustee upon demand, all funds that it receives in respect of the second lien notes that are proceeds of collateral or proceeds from the sale of collateral, until the first lien notes obligations are satisfied in full in cash. Moreover, the collateral trust agreement provides that no payment may be made to any representative of junior lien debt, to wit, the second lien trustee, from the proceeds of, or proceeds from the sale of, collateral until payment in full is received by the holders of second lien debt, to wit, the first lien noteholders. Thus, the first lien trustee argued that even if it were prevented from collecting the make-whole from EFIH by operation of the bankruptcy code, the second lien trustee is nonetheless obligated to turn over to it any funds received until the amount of the make-whole is paid in full to the holders of the first lien notes.

In June 2014, using the proceeds of DIP financing, EFIH paid all the first lien noteholders their full principal and accrued interest, but certain first lien noteholders retained rights to litigate their entitlement to the prepayment make-whole. Subsequently, in March 2015, the court rendered a decision determining that under the relatively standard (for the time) provisions of the first lien indentures, the holders of the first lien notes were not entitled to receive a make-whole, or as it is customarily called in indenture parlance, the "Applicable Premium." The first lien notes were automatically accelerated under the terms of the indentures upon the filing of the bankruptcy petition of EFH and its affiliates. There was no provision, the court observed, to require payment of the Applicable Premium upon an automatic acceleration, and under New York Law, an indenture must contain express language requiring payment of a prepayment premium upon acceleration. While under its indenture, the first lien trustee had the right to rescind the automatic acceleration of the first lien notes – in which case the repayment of the first lien debt would have been optional and subject to the make-whole payment obligation – such rescission was barred by the automatic stay, which the court declined to lift.

At the same time, in March 2015, the court approved a partial payment of the second lien notes. The court preserved the right of the first lien trustee to seek a turnover of the paydown, as well as any future payments to the holders of second lien notes, to recover any first lien note payment deficiency, and in particular, any obligation to pay the make-whole. Now, in a ruling on June 3, 2016, applying customary principles of contract interpretation under New York law, the court in its latest decision held that because the make-whole was not due to be paid to the holders of the first lien notes, the second lien trustee had no obligation to turn over the amount of the make-whole.

The court observed that the collateral trust agreement defined "obligations" to include "all interest accrued [on the first lien notes] after commencement of any Insolvency, liquidation ... even if such interest is not enforceable, allowable, or allowed as a claim in such proceeding." This express statement to include interest that was not unenforceable in the bankruptcy proceedings found no counterpart with respect to payment of the make-whole premium. Moreover, the court held that payment of Applicable Premium was not rendered unenforceable by reason of the bankruptcy. Rather, payment of the make-whole was simply not triggered by the automatic acceleration occasioned by the bankruptcy filing. The automatic stay, which the court declined to lift, barred a deceleration of the debt. As the first lien debt had not been decelerated, the make-whole was not due. Because the issuer had no obligation to pay the make-whole, it was not subject to turnover.

As a result of rulings in Momentive Performance Materials and other cases denying payment of a make-whole in bankruptcy, the standard make-whole provisions in corporate indentures quickly evolved to provide expressly that make-whole premiums are payable following a bankruptcy-driven acceleration. One such formulation provides that "in the event the Notes are accelerated or otherwise become due prior to their maturity date, in each case, in respect of any Event of Default (including, but not limited to, upon [an acceleration resulting from a bankruptcy event of default]), the premium applicable with respect to an optional redemption [of] . . . the Notes will also be due and payable as though the Notes were optionally redeemed."

We do not expect there to be a similar movement in the market with respect to collateral trust and intercreditor agreements on the turnover issue presented in Judge Sontchi's most recent ruling in EFH. Market observers were not surprised by the judge's ruling that to the extent first lien noteholders are not entitled to receive a make-whole from the company, they cannot receive the same make-whole from second lien noteholders. Rather, the focus will be on the Third Circuit's ruling on make-wholes under the old-style indentures, which still have a respectable presence in the market.


1. Kramer Levin represented the second lien notes trustee in the EFH bankruptcy, and continues to represent the second lien notes trustee in the Third Circuit appeal. Kramer Levin continues to believe the make-whole has merit and that the Third Circuit will find that the second lien noteholders are entitled to the make-whole.

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