The Second Circuit’s *Momentive* decision addressed the enforceability of make‑whole premiums in bankruptcy. What is the general rule regarding make‑whole premiums when a debtor repays debt ahead of schedule in Chapter 11, and why do creditors often lose their claim to such premiums?
EliteModel answer
In Chapter 11, a debtor may seek to repay prepetition debt at par without paying a contractual make‑whole premium. The general rule, as clarified in Momentive, is that a make‑whole premium is equivalent to unmatured interest and is disallowed under Section 502(b)(2) of the Bankruptcy Code, unless the indenture clearly and specifically states that the premium is payable in the event of acceleration or optional redemption triggered by bankruptcy. Most indentures provide that the make‑whole is due upon optional redemption, not acceleration. When a debtor defaults and the debt is accelerated, the obligation to pay the make‑whole vanishes because it was tied to a voluntary repayment, not an acceleration. Creditors lose the premium because the automatic acceleration clause (or the trustee’s acceleration) eliminates the condition for the make‑whole. However, if the indenture explicitly says the premium is due even upon acceleration or if the noteholders can defeat the acceleration, the claim may survive. Momentive held that the indenture language was ambiguous and that the make‑whole was not allowed. This outcome hinges on the precise drafting of the acceleration and redemption provisions.
Follow-up pressure:
- How would a “solvent‑debtor” exception affect the analysis? If the debtor is solvent, can creditors recover the make‑whole based on state law damages?
- Why might a debtor choose to pay off the debt after filing Chapter 11 rather than continuing to accrue interest, and what does that do to the make‑whole claim?
- What steps can a lender take at the deal stage to protect its make‑whole premium in a future bankruptcy?
This is an advanced Superday-level question with a full model answer, part of IB Atlas's practice bank.
Start freeRelated topics
- Compare a pre‑packaged Chapter 11 filing to a traditional free‑fall Chapter 11. Under what circumstances is a pre‑pack infeasible, forcing a company into a contested Chapter 11 proceeding?
- In a Chapter 11 case, a debtor proposes to sell substantially all assets under Section 363. A stalking‑horse bidder has agreed to pay $500 million in cash, and the secured lender plans to credit bid its $450 million claim. How does a credit bid work, and what protections exist for other bidders and creditors? What are the risks for unsecured creditors?
- A debtor in possession seeks approval of a $120 million DIP facility that will prime the pre‑petition first‑lien lender’s $300 million claim. The first‑lien lender objects, arguing adequate protection is impossible because the collateral is worth only $250 million. What must the debtor demonstrate to obtain the priming lien, and how can it structure the DIP to overcome the objection?
- A distressed company is considering an out‑of‑court exchange but runs into the holdout problem: the indenture requires 100% consent to change payment terms, and holdouts could sue. Analyze the trade‑offs between initiating a pre‑packaged Chapter 11 and proceeding with a pure out‑of‑court exchange with exit consents. Assume the company has NOLs that would be limited under Section 382 if an ownership change occurs.
- A company enters Chapter 11 with a $50 million superpriority DIP facility (unsecured), $10 million in other administrative claims, $200 million of pre‑petition first‑lien secured debt (collateral valued at $250 million), and $100 million of general unsecured claims. If the enterprise value is $280 million, compute recoveries for every class and state which class is the fulcrum.