Bankruptcy: Energy Future 1st-Lien Noteholders Lose Another Make-Whole Bid

The bankruptcy court overseeing the Chapter 11 proceedings of Energy Future Holdings (EFH) today ruled against first-lien noteholders of Energy Future Intermediate Holdings (EFIH) who claim they are entitled to make-whole payments arising out of the early prepayment of their debt as a result of the company’s bankruptcy filing.

The ruling by Wilmington, Del., Bankruptcy Court Judge Christopher Sontchi effectively closes off the noteholders’ last legal avenue to establish their right to the make-whole payment.

Specifically, Sontchi ruled that there was insufficient cause to lift the automatic stay provisions of the Bankruptcy Code in order to allow the indenture trustee for EFIH’s 10% first-lien notes to waive the company’s default under the notes’ indenture arising from the company’s bankruptcy filing.

Lifting the Bankruptcy Code’s automatic stay provision and allowing such a waiver would have, in turn, allowed the noteholders to decelerate the automatic acceleration of the notes caused by the company’s Chapter 11 filing (which, according to a prior ruling, did not trigger the make-whole provisions of the indenture), and reinstate the make-whole payment requirement.

As reported, in connection with the company’s Chapter 11 filing on April 29, 2014, and the related DIP facility that rolled-up EFIH’s first-lien debt, the company made a tender offer to first-lien noteholders (consisting of $3.48 billion of 10% notes due 2020 and $502.7 million of 6.875% notes due 2017) to repurchase debt that incorporated a settlement of the make-whole claim asserted by lenders. Holders of only about 34% of the 10% notes tendered into the offer (although holders of 92.7% of the 6.875% notes tendered), with the rest contending that they were entitled to the entire make-whole payment (which would amount to about $431 million for the non-tendering noteholders).

Despite numerous objections, the EFIH DIP was ultimately approved, and on June 19, 2014, the company repaid, among other things, its first-lien notes.

On May 15, 2014, meanwhile, the indenture trustee for the 10% notes filed an adversary action in the bankruptcy case seeking the make-whole payment. In addition, the trustee for the notes also filed a motion seeking a declaration that it could decelerate the notes prepayment without violating the Bankruptcy Code’s automatic stay provisions, or alternatively, seeking relief from the automatic stay.

The adversary action was bifurcated into two proceedings, with Phase One to determine whether the company was liable for the make-whole claim, and if so, with Phase Two to determine the company’s solvency, and if the company was deemed insolvent, to determine whether the make-whole claim should be limited as a result.

Both the company and the trustee for the notes filed cross-motions for summary judgment with respect to phase one of the proceeding, basically saying that there were no issues of material fact in the dispute over the company’s liability for the make-whole claim, and asking the bankruptcy court to issue a legal ruling – i.e., to interpret the meaning of the indenture language – to decide on the matter.

For purposes Phase One, Sontchi explained, the company was assumed to be solvent.

On March 26, 2015, Sontchi ruled on part of the Phase One summary judgment motions, in in favor of the company. He found that under the terms of the indenture, the acceleration of the first-lien debt caused by the company’s bankruptcy filing did not trigger the indenture’s make-whole provisions. As Sontchi read the language of the indenture, the make-whole payment would be triggered only by the company’s optional decision to prepay the notes, not by a decision to file Chapter 11, even though the automatic acceleration of the notes was a consequence of that decision.

Sontchi’s summary judgment ruling, however, did not decide whether noteholders could waive the default of the indenture triggered by the bankruptcy filing and decelerate the notes.

“A genuine issue of material fact exists that requires a trial on the merits as to whether the trustee can establish cause to lift the automatic stay nunc pro tunc to a date on or before June 19, 2014 [the date of the repayment of the notes], to allow the trustee to waive the default and decelerate the notes,” Sontchi said in the March ruling.

Today’s ruling
Generally, the Bankruptcy Code’s automatic stay is intended to freeze all legal proceedings affecting a debtor’s liabilities, but a party can seek a lifting of the automatic stay if it can establish that the harm it incurs as a result of the stay remaining in place outweighs the harm incurred by the debtor by lifting the automatic stay.

The trial was held from April 20 through April 22. The trustee for the 10% notes argued at trial that since EFIH was solvent, the company’s creditors would not incur any harm from lifting the automatic stay (and the subsequent deceleration of the notes and imposition of make-whole liability), since creditors would still get paid in full.

The noteholders further argued that they, on the other hand, would incur significant harm since the automatic stay prevents them from establishing their claim to the $431 million make-whole payment.

Sontchi rejected that argument, however, on the grounds that, in evaluating the harm to a debtor caused by lifting the automatic stay, the interests of equity holders, along with those of creditors, needed to be considered as well.

Thus, even if the company is solvent, and creditors would therefore not incur harm from the assertion of a make-whole claim, the economic claims of equity holders would be harmed.

In this case, Sontchi said, the harm to the company from lifting the automatic stay would far outweigh the harm to the noteholders caused by leaving the stay in place, since a decision favoring the 10% noteholders would also cause the trustees for the EFIH second-lien notes and PIK notes to also seek to waive the bankruptcy default, and assert their own make-whole claims.

While the potential harm to the 10% noteholders is $431 million, Sontchi noted, the total make-whole claims against the company could ultimately amount to $900 million.

It is worth noting that even without establishing the additional harm to the company from additional make-whole claims, Sontchi said that the 10% noteholders still would not have established cause – and in all likelihood would never be able to establish cause – for lifting the automatic stay, given the zero-sum nature of a debtors’ assets and liabilities.

“The court is cognizant that its ruling makes it extremely unlikely that a creditor operating under a contract with provisions substantially similar to [the 10% notes indenture] will be able to obtain relief from the automatic stay to waive a default arising from an issuer’s bankruptcy filing and to rescind acceleration,” Sontchi said.

The reason, Sontchi explained, “is a result of the fact that the harm to the debtor’s estate and its stakeholders, including equity if the debtor is solvent, from lifting the stay is, by definition, the same as the harm to the creditor seeking the make-whole payment from maintenance of the stay. … [T]he harm to the creditor cannot substantially outweigh the harm to the debtor’s estate, under the totality of the circumstances, [and] relief from the automatic stay is almost certainly unavailable, regardless of the creditor’s likelihood of success on the merits.”

Indeed, Sontchi’s prior ruling in March acknowledged that if the 10% noteholders case seeking to waive the bankruptcy default and decelerate the notes were allowed to proceed, the 10% noteholders had “demonstrated a likelihood of success on the merits.” (In today’s ruling, Sontchi noted that the company disagrees with this, and argues that even if the automatic stay were lifted, “the … attempt to decelerate the notes would not be permitted due to the automatic acceleration of the notes by operation of the Bankruptcy Code.”)

But regardless, Sontchi ruled that in light of his ruling that he would not lift the automatic stay, he “need not address” this dispute.

Still, perhaps trying to temper the obvious Catch-22 raised by his ruling, Sontchi goes on to assert that his ruling does not mean “that a creditor can never successfully pursue a make-whole claim,” adding, “For example, unlike in this case, an indenture might provide for payment of a make-whole claim in a manner that does not implicate the automatic stay.”

But Sontchi concluded, “Whether such a claim would be successful is an issue for another day.” – Alan Zimmerman

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