Last week the United States Bankruptcy Court for the Southern District of New York approved debtor-American Airlines’ motion to enter into a secured financing transaction and repay certain pre-petition aircraft financing without paying make-whole premiums. The indenture trustee sought to ground the motion by asserting that the make-whole had to be paid, but it was the indenture trustee, not American, that crashed and burned. As we have blogged before, “not all make-whole provisions are created equal, and whether a particular make-whole really does ‘make whole’ rather than ‘make a hole’ requires a close contractual reading.” Here, the Bankruptcy Court interpreted the contractual provisions against the indenture trustee, thus clearing American’s secured financing for take-off. A copy of the decision can be found here.
However, don’t assume the brace position just yet. The Court did not permanently ground make-whole premiums along with the 787 Dreamliner. In fact, the Court said make-whole premiums are alive and well and can pass inspection. However, in American, the indentures explicitly stated that make-whole premiums were not payable following a bankruptcy default. Although the indenture trustee argued to the contrary, the Court refused to read an obligation to pay make-whole into a contract that explicitly said it was not due under the circumstances. While the indenture trustee will presumably appeal the decision, the lesson remains clear: to avoid turbulence, know your contract, and make sure the make-whole provisions are favorable, explicit and unambiguous.
By way of (simplified) background, American issued various series of equipment notes under indentures. Each of the indentures provides that American’s voluntary bankruptcy filing in November 2011 constituted an event of default that automatically accelerated the notes and caused all amounts due thereunder to become immediately due and payable. The key fact is that the indentures carve out the payment of make-whole in these circumstances. Specifically, the indentures provide that where an event of default has occurred following a voluntary bankruptcy filing “the unpaid principal amount of the Equipment Notes then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder (but for the avoidance of doubt, without Make-Whole Amount), shall immediately and without further act become due and payable . . . .” Additionally in the priority of payment section, the indentures specifically provide that “no Make-Whole Amount shall be payable on the Equipment Notes as a consequence of or in connection with an Event of Default or the acceleration of the Equipment Notes.”
The language seems clearer than the blue sky at 30,000 feet, but the indenture trustee tried to cloud the situation, arguing that (1) it did not affirmatively accelerate the debt, (2) it had the right to decelerate the debt, and (3) the acceleration provision was an unenforceable ipso facto clause. The Court dismissed all of the these arguments, noting that the automatic acceleration provisions were explicit in the indentures. The Court held that efforts to decelerate the notes would violate the automatic stay because doing so adversely affected American’s contractual rights under the indentures by triggering additional amounts owing. Further, the Court noted that ipso facto clauses are only prohibited in connection with executory contracts and unexpired leases and that the parties had acknowledged that the indentures did not fall into either category.
The indenture trustee also argued that the make-whole premium was due because American was voluntarily redeeming the notes in order to take advantage of low interest rates currently available in the aircraft financing market. The Court followed settled case law which concludes that once notes are accelerated, they cannot voluntarily be repaid.
As noted above, true believers in make-whole amounts should not jump out of the plane without parachutes. According to the Court: “There is no dispute that make whole amounts are permissible. The entitlement to such payments, however, is a matter of contract, not policy.” A few lessons learned and make-whole claims can still fly high. First, whether you are buying already-issued notes in the market or are engaging in a negotiated financing, make especially sure the make-whole provisions are in the upright position. Second, the documents should not explicitly exclude make-whole following acceleration (or under any circumstances except payment on the original stated maturity date). Third, in a negotiated financing, take it one step further and explicitly state that make-whole will be due following acceleration – this is a common provision in private placement note purchase agreements but, with rare exception, still has not charted its course in the public note indenture airspace. While underwriters, not prospective holders, typically draft public indentures, holders still have their choice of make-whole flight paths in real estate and project finance negotiated deals.
Fourth, an especially important contractual question is whether you have the little “md” or the big “MD.” That is, is the make-whole due anytime payment is made prior to the “maturity date” or the “Maturity Date”? The term “maturity date” could potentially be interpreted as the date on which payment becomes due following acceleration (i.e. it is an “acceleration of maturity”) instead of the fixed original stated maturity date of the notes when issued. The first interpretation results in a zero make-whole. Instead, use a clearly defined term (such as “Original Stated Maturity Date”) to refer to the original stated maturity date of the notes when issued to clarify that any payment prior to such date triggers make-whole, irrespective of default or acceleration.
In sum, whether you are buying notes in the market or negotiating a new financing, don’t assume that all make-whole provisions are the same or that a make-whole is due in every payment or default scenario. As we have clearly seen from a number of Bankruptcy Court decisions, with American being the latest, only some make-whole claims get to ride in first class. Others don’t even get peanuts.