Judge Dorsey of the U.S. Bankruptcy Court for the District of Delaware recently determined that Mallinckrodt plc and its affiliates (the “Debtors”) do not have to pay a $94 million make-whole payment (the “Make-Whole”) to holders (the “Noteholders”) of $495 million in first lien notes (the “Notes”).1 The Noteholders objected to the reinstatement of their notes under the Debtors’ proposed plan of reorganization (the “Plan”) because it did not provide for payment of the Make-Whole. Judge Dorsey disagreed, finding that the Bankruptcy Code permits the Debtors to reinstate the Notes under the Plan without requiring them to pay the Make-Whole.
Background on Make-Whole Provisions
Generally, a make-whole premium is designed to compensate a lender for the loss of future interest payments if the debt is paid off before maturity. A make-whole premium typically represents the net present value of the remaining interest payments at the time of early payment. Make-whole provisions recognize that a lender has committed to the transaction based on an expectation of receiving an investment return over a period of time. Such provisions attempt to provide the lender the benefit of its bargain, recognizing lost opportunity cost. In other words, the make-whole protects the lender while providing the borrower the ability to repay debt before maturity.
A bankruptcy filing adds a wrinkle to entitlement to make-whole premiums because it automatically accelerates otherwise unmatured debt. Consequently, bankruptcy courts have had to address whether make-whole provisions should be honored or disallowed in bankruptcy cases and have reached different conclusions. Some courts have disallowed make-whole payments that result from acceleration caused by a bankruptcy filing,2 while other courts have allowed make-whole payments by labeling them liquidated damages3 or by relying on state law and contract language.4
Mallinckrodt Ruling
In the Mallinckrodt bankruptcy cases, the Noteholders asserted entitlement to a $94 million premium purportedly triggered by the Debtor’s bankruptcy filing, which filing constituted an event of default under the indenture governing the notes (the “Indenture”). The Debtors objected, asserting that the Notes could be reinstated under the Plan, which would provide for payment of the amount owed on the original maturity date with all terms of the Indenture remaining intact and thus obviate the requirement to pay the Make-Whole. The Debtors relied on section 1124(2) of the Bankruptcy Code, which governs reinstatement of unimpaired claims in chapter 11 plans, and argued that section permits them to “deaccelerate” the obligation provided that several criteria are met, including that defaults are cured. The Noteholders argued that section 1124(2) was inapplicable to the Make-Whole because it only applies to “accelerated” obligations. The Noteholders took the position that the obligation to pay the Make-Whole was not technically “accelerated” by the bankruptcy filing and therefore could not be deaccelerated through the statute.
On November 5, 2021, Judge Dorsey sided with the Debtors. In a bench ruling, he found that section 1124(2) allowed the Debtors to “deaccelerate” the Notes and “roll[] back the clock” to before the default that triggered the premium. Judge Dorsey noted that section 1124(2) requires debtors to cure defaults in order to reinstate debt. However, since the only default was premised on the chapter 11 filing itself, there was nothing to cure. He concluded that “[r]eading section 1124(2) to say that reinstating the Notes would prevent the acceleration of the principal [and] interest under the Notes, but allow the bankruptcy penalty to remain as a claim against the estate is simply inconsistent with that stated goal of 1124(2) as well as the Code as a whole.”5 Since section 1124(2) rolls back the clock to the time before the asserted default, Judge Dorsey reasoned that the Make-Whole was not triggered and, therefore, not due and owing. He noted that a contrary interpretation would amount to “a windfall solely because the Debtors filed for bankruptcy protection.”6
Takeaway
The Mallinckrodt court’s ruling that section 1124(2) allows reinstatement of the Noteholders’ claim without payment of the bankruptcy filing triggered Make-Whole will not be the last word on the allowability of make-whole premiums in bankruptcy cases. The enforceability of make-whole provisions in bankruptcy remains unsettled and, given the size of the foregone payment here, Judge Dorsey’s ruling may be appealed. The allowance of make-whole premiums in bankruptcy will turn on the language of the indenture, applicable state law, and the bankruptcy code. As such, noteholders and indenture trustees with make-whole provisions in their indentures should carefully review the contract language and enforceability under state law and, for now, continue to include them in their proof of claim.
1In re Mallinckrodt Plc, Case No. 20-12522 (JTD) (Del. Bankr. Nov. 5, 2021).
2 See In re MPM Silicones, L.L.C., 874 F.3d 787, 802 (2d Cir. 2017) (finding make-whole premium due only in the case of an “optional redemption” and not in the case of an acceleration resulting from a bankruptcy filing).
3 See In re Ultra Petroleum Corp., 624 B.R. 178, 189-92 (Bankr. S.D. Tex. 2020) (allowing make-whole premium as liquidated damages for harm caused by early debt prepayment).
4See In re 1141 Realty Owner LLC, 598 B.R. 534, 544 (Bankr. S.D.N.Y. 2019) (finding that parties can provide for payment of make-whole premiums after acceleration “with any language that plainly conveys their intent”).
5 Nov. 5, 2021 Hr’g Tr. at 109:2-7.
6 Id. at 108:4-5.
