Third Circuit Rules in Favor of Noteholders on Make-Whole Provision in Debt Indenture 

Bankruptcy, Insolvency & Restructuring Alert

November 22, 2016

Debt indentures often contain what is known as a “make-whole” provision, which requires the borrower, upon an early repayment of the debt, to make an additional payment to the lender to compensate the lender for its anticipated, bargained-for interest rate yield over the entire debt term. To date, a number of bankruptcy decisions have held that such make-whole payments are not required when a debt is accelerated on account of a borrower’s bankruptcy, allowing the debtor to refinance its debt at lower interest rates during the bankruptcy case without compensating the lender for its lost interest yield. In a November 17, 2016, decision in the Energy Future Holdings bankruptcy case1, the Third Circuit Court of Appeals rejected the existence of a “bright line” rule on this issue. The court held that, under the terms of the indentures governing the debtors’ issued notes, an “optional redemption” premium was payable to noteholders notwithstanding the automatic acceleration of the indebtedness upon bankruptcy pursuant to another provision of the indenture.


Energy Future Holdings Corp. and certain of its affiliates (collectively, the debtors) filed for Chapter 11 protection in the Bankruptcy Court for the District of Delaware. Soon thereafter, holders (noteholders) of the debtors’ secured notes (notes) pursuant to two indentures (indentures) sought a declaration from the Bankruptcy Court that they would be entitled to receive “make-whole payments” upon repayment of the notes through the debtors’ refinancing of them in the bankruptcy cases. While the noteholders’ actions were pending, the Bankruptcy Court authorized the debtors to refinance the notes without making the make-whole payment to the noteholders.

Both indentures contained a provision (although not worded identically) that gave the debtors the option to redeem the notes at any time prior to December 1, 2015, through payment to the noteholders of a redemption price, which included a premium. The indentures also, in a separate provision, provided for automatic acceleration of the debt upon a bankruptcy filing by the debtors, but the noteholders were permitted to rescind any acceleration of the notes and its consequences. The indentures were silent as to whether a make-whole payment would be required upon acceleration of the notes due to a bankruptcy filing.

The Bankruptcy Court and, on appeal, the District Court both agreed with the debtors that, because the debt was automatically accelerated on the bankruptcy filing date, there was no prepayment before maturity that triggered the make-whole provision. In addition, the debtors’ refinancing was not optional, because the notes had matured as a result of the automatic acceleration provision in the indentures. The Bankruptcy Court and District Court found support in a line of cases holding that, unless an indenture expressly specifies that a prepayment premium is owed following automatic acceleration upon a bankruptcy filing, the lender is not entitled to receive such a premium. Silence, in other words, was interpreted against enforcing the premium obligation.

Third Circuit Opinion

The Third Circuit reversed the Bankruptcy Court and the District Court and focused on the language contained in the operative provisions of the indentures. The indentures called for payment of premium upon an “optional redemption” occurring on or before December 1, 2015. Thus, the court found, the pertinent questions were: (1) did a redemption occur prior to the specified date certain (December 1, 2015) and (2) was the redemption “optional.” The court answered both questions in the affirmative.

Central to the court’s reasoning was its distinction between a “prepayment” and a “redemption” — the indentures made reference only to the latter. Prepayments, by definition, must occur before maturity — once a debt has become due, of course, it cannot be prepaid. Redemption, however, is a repayment of debt that can occur at any time, regardless of maturity. The court did not quarrel with other courts’ conclusions that, if a make-whole payment is stated to be triggered by “prepayment,” such a make-whole payment would not be due after the accelerated maturity date unless the language of the indenture clearly provided that the make-whole was payable even though the debt had matured. The indentures here, however, did not speak of “prepayment” but of “redemption.” Under the terms of the indentures, what mattered is that a redemption of the notes occur on or before December 1, 2015 — and the court found that it did as a result of the debtors’ refinancing, which occurred before that date. Acceleration of the debt had no bearing on that issue.

As to the “optional” nature of the redemption, the court held that the refinancing of the notes was voluntary, notwithstanding the automatic acceleration of the debt upon bankruptcy, because the debtors filed for bankruptcy voluntarily, and, once in bankruptcy, they immediately looked to refinance the notes at a more favorable rate rather than delaying the refinance or seeking to reinstate the notes later in the case under a Chapter 11 plan. The noteholders, in fact, had sought to rescind the acceleration of the notes but were prevented from doing so because of the automatic stay. The noteholders did not precipitate the early repayment of the debt; in fact, they openly resisted it. The automatic acceleration of the debt and the refinancing reflected the will of the debtors, not the noteholders. Under these facts, the court found that the debtors’ redemption of the notes was optional.


The Third Circuit made two important points in its opinion. One is that a make-whole protection is a general category of provision, of which there is more than one type. The court’s reasoning depended heavily on its distinction between a “prepayment premium,” which must be paid only if a debt is repaid prior to its stated maturity, and a “redemption premium,” which must be paid upon redemption of the debt, whether before or after maturity. A second key takeaway is that the language of the indenture matters. According to the Third Circuit, rather than simply assuming that an automatic acceleration clause, when triggered, negates the effect of a make-whole redemption provision even when it does not expressly provide for same, courts must look at the intention of the parties as reflected by the language of the agreement.

This opinion is particularly noteworthy because it is authoritative for all cases in the Third Circuit, which includes the busy Delaware Bankruptcy Court. Previously, prospective debtors may have, like the debtors here, counted on their having an ability to evade an indenture’s make-whole obligation following a bankruptcy filing and resulting acceleration of debt. In the wake of the Energy Future Holdings opinion, however, it is clear that careful consideration of the precise terms of an indenture to which the debtor is party, including determining the type of make-whole provision involved (redemption or prepayment), must be part of a debtor’s bankruptcy planning.

1 Delaware Trust Co. v. Energy Future Intermediate Holding. Co. LLC (In re Energy Future Holdings Corp.), 16-1351 (3d. Cir. Nov. 17, 2016)


Eric L. Scherling


(215) 665-2042

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