Advertisement

July 25, 2014

AMR Decision Highlights Bankruptcy Court Split on Enforceability of Ipso Facto Clauses

A recent ruling in the American Airlines bankruptcy case enforcing an automatic acceleration upon bankruptcy provision serves as a reminder that the enforceability of so-called ipso facto provisions in debt instruments remains an unsettled, forum-dependent question.      

In the American Airlines case, the question of the enforceability of an automatic acceleration upon bankruptcy provision arose in an unconventional context: the invalidity of the provision was argued not by the debtor but by the indenture trustee.  The issue in dispute was whether a refinancing of certain taxable debt would require the debtor to pay (i) a make-whole premium due upon an optional redemption of the debt or (ii) par per the indenture provisions automatically accelerating the debt at par upon a bankruptcy.  The U.S. Bankruptcy Court for the Southern District of New York held that the automatic acceleration provision had been triggered and controlled the amount due, so that the amount payable to satisfy the debt would be par, not par plus the make-whole premium.  The indenture trustee is in the process of appealing the court’s ruling, which also involved an interpretation of a specialized Bankruptcy Code provision relating to debt secured by aircraft.   .

The indenture trustee argued that the automatic acceleration upon bankruptcy provision in the indenture should be disregarded as an invalid ipso facto clause. The court disagreed, quoting the language of Section 365(e)(1) of the Bankruptcy Code, which precludes enforcement of contractual modifications triggered by a bankruptcy only if the relevant contractual provisions are located in “an executory contract or unexpired lease of the debtor.”  As all parties agreed that the applicable debt instruments were neither executory contracts nor leases, the court found no basis for invalidating the ipso facto acceleration provisions in such debt instruments.

The federal bankruptcy court in New York declined to follow a 2012 decision by a federal bankruptcy court in Delaware in the W.R. Grace bankruptcy that the prohibition of ipso facto clauses is not limited to the specific types of instruments referenced in Section 365(e)(1).  The New York court found precedents in other Southern District of New York bankruptcy cases more persuasive than the reasoning in In re W.R. Grace & Co., and also distinguished the W.R. Grace holding on the facts.

Except in special circumstances such as the ones presented in the American Airlines case, the enforceability or unenforceability of an automatic acceleration upon bankruptcy clause in a debt instrument should not make much of a difference to litigants, as generally debt is accelerated for claim purposes upon a filing in any event.  However, the potential enforceability in at least some jurisdictions of bankruptcy-triggered provisions in debt instruments may encourage creditors to require other types of ipso facto provisions in debt documents just in case they prove both enforceable and beneficial to such creditors in the event the borrower becomes a bankruptcy debtor.

©1994-2014 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. All Rights Reserved.

About the Author

Leonard Weiser-Varon, Corporate, Municipal, Finance, Attorney, Mintz Levin
Member

Len is active in both municipal finance and corporate finance, with an emphasis on financings for 501(c)(3) institutions, project finance, secured lending, structured finance transactions, workouts and restructurings, corporate debt, and Section 529 college savings programs.

His practice includes service as bond counsel, issuer’s counsel, underwriters’ counsel, and counsel to institutional purchasers and borrowers in connection with public offerings and private placements of, and defaults and bankruptcies involving, tax-exempt and taxable debt for public, nonprofit, and...

617-348-1758

Boost: AJAX core statistics

Legal Disclaimer

You are responsible for reading, understanding and agreeing to the National Law Review's (NLR’s) and the National Law Forum LLC's  Terms of Use and Privacy Policy before using the National Law Review website. The National Law Review is a free to use, no-log in database of legal and business articles. The content and links on www.NatLawReview.com are intended for general information purposes only. Any legal analysis, legislative updates or other content and links should not be construed as legal or professional advice or a substitute for such advice. No attorney-client or confidential relationship is formed by the transmission of information between you and the National Law Review website or any of the law firms, attorneys or other professionals or organizations who include content on the National Law Review website. If you require legal or professional advice, kindly contact an attorney or other suitable professional advisor.  

Some states have laws and ethical rules regarding solicitation and advertisement practices by attorneys and/or other professionals. The National Law Review is not a law firm nor is www.NatLawReview.com  intended to be  a referral service for attorneys and/or other professionals. The NLR does not wish, nor does it intend, to solicit the business of anyone or to refer anyone to an attorney or other professional.  NLR does not answer legal questions nor will we refer you to an attorney or other professional if you request such information from us. 

Under certain state laws the following statements may be required on this website and we have included them in order to be in full compliance with these rules.