Last week the Second Circuit issued its long-awaited opinion on the appeals of plan confirmation taken by the first lien, 1.5 lien and subordinated noteholders in In re MPM Silicones, LLC (“Momentive”).   With one exception, the Court determined that the plan confirmed by the bankruptcy court in September 2014 comports with Chapter 11 of the Bankruptcy Code.  The Court remanded to the bankruptcy court in order to address the process for determining the proper interest rate under the cramdown provision of Chapter 11.

The Bankruptcy Code allows debtors to issue replacement notes pursuant to which deferred cash payments are made to secured creditors, but ultimately these payments must amount to the full value of the secured creditors’ claims.  In order to ensure that the creditor receives the full present value of its claim, the payments must carry the appropriate rate of interest.  In this case, the bankruptcy court applied an interest rate based on the “formula” approach, and selected interest rates of 4.1% and 4.85% for the first lien and 1.5 lien notes, respectively.  It was undisputed that these rates were below market, but the debtors asserted that this method was required by the Supreme Court’s plurality opinion in the Chapter 13 case Till v. SCS Credit Corp., 541 U.S. 465 (2004).

The Second Circuit adopted the Sixth Circuit’s two-step approach in setting the cramdown interest rate on the replacement notes.  Under this approach, the bankruptcy court must (i) ascertain whether there exists an efficient market and if so, apply a market rate of interest to the replacement notes or (ii) if no such efficient market exists, the court should then employ the formula approach which begins with the national prime rate and takes into account other factors, which was endorsed by the Supreme Court in Till. 

Although the Second Circuit remanded the case to the bankruptcy court to determine which rate should be used, the Court noted that the senior noteholders presented expert testimony in the bankruptcy court that, if credited, would have established a market rate in the 5-6+% range.

In addition, the Second Circuit expressly rejected the analysis of the Third Circuit in the Energy Future Holdings case regarding the enforceability of “make-whole” premiums in bankruptcy.  As noted in a previous post, available here, the Third Circuit Court of Appeals held that the debtor could not use a voluntary Chapter 11 bankruptcy filing to escape liability for a “make-whole” premium if express contractual language required such payment when the borrower makes an optional redemption prior to a date certain.  The Second Circuit has taken the opposite position, finding that the petition date becomes the maturity date for outstanding notes, such that they were not repaid ahead of time and therefore not entitled to the make-whole premium.

The Second Circuit also rejected the subordinated noteholders’ arguments that they should have been repaid before a group of second-lien noteholders, determining that although the documentation was ambiguous, it did provide for the repayment of the second-lien holders ahead of the subordinated notes.  Further, the panel disagreed that the appeals should have been dismissed as equitably moot, finding that given the scale of the debtors’ reorganization, the possibility that the debtors may be required to provide, at most, $32 million of additional annual payments over the next seven years, depending upon the bankruptcy court’s analysis, would not unravel the plan or threaten the debtors’ emergence.

By LEN WEISER-VARON and BILL KANNEL

Today’s U.S. Supreme Court decision in Commonwealth of Puerto Rico v. Franklin California Tax-Free Trust puts an end to one of Puerto Rico’s multi-pronged efforts to deleverage itself.  Given the comprehensiveness of the First Circuit’s intermediate appellate opinion upholding the district court’s invalidation of Puerto Rico’s Recovery Act, it was surprising that the highest court took the case, a decision apparently prompted by Justice Sotomayor’s interest in obtaining a reversal.  Comments of some other Justices at oral arguments raised the possibility of Sotomayor attracting a majority for the proposition that the preemption provisions of Section 903 of the U.S. Bankruptcy Code were inapplicable to Puerto Rico, but in the end only Justice Ginsburg joined what turned out to be Sotomayor’s dissenting opinion in a 5-2 ruling upholding the relegation of the Recovery Act to the dustbins of history.

As  we have written previously, the Recovery Act was damaged goods from the beginning: even if the fairly clear preemption argument had not prevailed, the Contracts Clause constraints on non-federal bankruptcy legislation would have severely constrained, if not eliminated, the effective use of  the Recovery Act to break bond contracts. In any event, the Recovery Act, and the Supreme Court’s decision, were  a couple weeks away from being moot, as it appears evident that Congress will pass PROMESA, the federal oversight and debt restructuring legislation that has always constituted the logical legal mechanism for those favoring a less chaotic denouement to Puerto Rico’s debt woes.

By LEN WEISER-VARON and BILL KANNEL

A few thoughts on Tuesday’s oral arguments before the U.S. Supreme Court in the litigation over whether Puerto Rico’s Public Corporations Debt Enforcement and Recovery Act, an insolvency statute for certain of its government instrumentalities, is void, as the lower federal courts held, under Section 903 of the U.S. Bankruptcy Code:

Continue Reading You Can Lead a Horse to Water, But You Can’t Call it an Airplane: Supreme Court Oral Arguments Suggest Puerto Rico’s Recovery Act May Recover