Make whole premiums sound simple; they are prepayment premiums that are supposed to “make you whole.” More precisely, make whole premiums are intended to protect noteholders (or other debt holders) from the loss of future fixed coupon interest payments due to the early repayment of debt if market interest rates have declined in the interim. Make whole provisions typically require the issuer to pay the positive difference (if any) between (i) the amount of principal and interest currently due and (ii) the net present value of the principal and interest payments that would have been made over time but for the prepayment. In practice, however, make whole premiums and their enforceability in bankruptcy can be complex, and there are numerous decisions that have examined the issue in great detail, with a heavy emphasis on the precise wording of the make whole provision itself. Indeed, the complexity of make whole premiums is readily apparent from a review of a recent Delaware bankruptcy decision in the chapter 11 cases of Trico Marine Services, a marine servicing company for the oil and gas industry. See In re Trico Marine Services, et. al., Case No. 10-12653 (Bankr. D. Del.) (BLS) (Opinion dated April 15, 2011).
The make whole premium at issue in Trico arose under notes issued by the company to finance the construction of two supply vessels. The notes were guaranteed by the United States Secretary of Transportation, on behalf of the Maritime Administration (“MARAD”). Although the notes themselves were unsecured, the MARAD guarantee was secured by a first-priority lien on the two supply vessels. Following Trico’s chapter 11 filing, and as part of the company’s liquidation of its towing and supply business, Trico entered into an agreement to sell the two vessels that served as collateral for the secured guarantee. In exchange for its consent to the sale, MARAD required the company to pay off the notes in full to ensure the indenture trustee for the noteholders would not call upon the guarantee. In connection with the payoff, the indenture trustee asserted that it was entitled to receive the make whole premium due under the indenture. The company disagreed that it was obligated to pay the make whole premium and filed a motion with the Bankruptcy Court to determine the validity and priority of the premium.
The company contended, among other things, that the make whole premium was, at best, a general unsecured claim that was not covered by the MARAD guarantee and therefore not subject to the MARAD liens on the two supply vessels. According to the company, under the plain language of the indenture, the guarantee only extended to “principal or interest” outstanding under the indenture, and the make whole premium was neither principal nor interest. In response, the indenture trustee contended that the company had voluntarily redeemed the notes in connection with the sale of the supply vessels, and the make whole premium was therefore due and owing, and constituted an allowable claim under the Bankruptcy Code. The trustee further contended that the issue of whether the claim was secured or unsecured was moot because a prior Court order that authorized the sale of the vessels, required the make whole premium to be paid, if allowed (whether allowed as a secured or unsecured claim), from an escrow created from the proceeds of the sale of the vessels.
After an examination of the issues, and based on the statutory authority that enabled MARAD to issue the guarantee, the Court ruled that the MARAD guarantee only applied to the payment of principal and interest due on the notes. In addition, following what it found to be the majority position, the Court further ruled that the make whole premium was a claim for liquidated damages, rather than for interest, and was therefore not covered by the secured guarantee. While this finding was not helpful to the noteholders in this particular case, it is overall a positive for noteholders in general because the Bankruptcy Code disallows claims for unmatured interest. As a result, if a make whole premium is deemed to comprise unmatured interest, it could well be disallowed in its entirety.
The Court also rejected the Indenture Trustee’s contention that the make whole premium could be paid from the escrow regardless of whether the make whole premium was deemed secured or unsecured. The Court disagreed with the Indenture Trustee’s interpretation of the sale order and found that the sale order could not change the nature of the Trustee’s claim and convert it to a secured claim. As such, the make whole premium was deemed to be an unsecured claim for liquidated damages, and the Court reserved the issue of the ultimate allowance of the claim for a later date.
The Trico decision was ultimately unfavorable for the indenture trustee who can now only hope to recovery pennies on the dollar for its unsecured claim for the make whole premium, rather than the full amount of the premium from the proceeds of the sale of the vessels. However, the Delaware Court’s decision in Trico is not the first unfavorable decision for noteholders seeking to enforce make whole premiums. Courts view make whole premiums as creatures of contract and, where the contractual provision appears to be ambiguous, the court will not hesitate to interpret the provision in a manner adverse to the noteholders. At the same time, where make whole provisions are unambiguous, courts have enforced them as written, often in favor of noteholders.
In sum, not all make whole provisions are created equal. Whether a particular make whole provision really does “make whole” rather than “make a hole” requires a close contractual reading and, where the provision can be legitimately interpreted in two different ways, courts typically side with the more restrictive interpretation.