A case currently before the U.S. Bankruptcy Court of the Southern District of Texas, In re Ultra Petroleum, No. 16-3302 (Bankr. S.D. Tx. filed April 29, 2016), has raised again the issue of how make-whole payments due from a borrower to bondholders, pursuant to the terms of credit documents governed by New York law, should be treated in the event of the borrower's bankruptcy. Because the court's decision on the make-whole payment issue in Ultra Petroleum will decide the fate of $200 million, this issue may continue to be litigated on appeal regardless of the bankruptcy court's decision.

What Is Make-Whole?

Make-whole provisions are a yield protection mechanism that allows bondholders to rely on a guaranteed rate of return on their investment, particularly for long-term, fixed-rate investments. These provisions provide that upon the repayment or acceleration of a loan prior to its intended maturity (whether via certain voluntary prepayments, upon an event of default such as the filing of a petition for bankruptcy, or otherwise), a certain sum shall automatically become due and owing to the bondholders. The amount of this make-whole payment is generally calculated with respect to a formula that represents the amount the bondholders were owed over the remaining term of the investment, discounted to present value. Notably, borrowers may benefit from this yield protection mechanism by obtaining more favorable interest rates or fees than would otherwise be available absent such a yield protection mechanism.

There are several theories traditionally advanced by a debtor's counsel in bankruptcy controversies that argue that make-whole payments should be disallowed. Specifically, those arguments center around make-whole payments constituting (1) “unmatured interest” disallowed under 11 U.S.C. §502(b)(2), and (2) unenforceable liquidated damages. This article will evaluate the case law and various arguments with respect to the validity of make-whole payments, and will argue that make-whole payments should be allowable in bankruptcy because (1) make-whole payments are not unmatured interest, (2) make-whole provisions are not unenforceable liquidated damages provisions, and (3) deferring to the plain language of make-whole payment provisions increases predictability, a core tenet of New York commercial law, and thereby benefits bondholders and borrowers alike.

Make-Whole Payments as Unmatured Interest

Some argue that make-whole payments are unmatured interest in economic substance, notwithstanding that they are presented as liquidated damages. As in the note purchase agreement at issue in Ultra Petroleum, where the “Make-Whole Amount” on any date was calculated as the “Discounted Value of the Remaining Scheduled Payments,” the make-whole payments are generally calculated with respect to a formula that represents the amounts that the lenders expected to receive after a certain date, discounted to present value.1 This, debtors in bankruptcy often argue, is merely a means for noteholders to receive unmatured interest.

However, courts have generally agreed that make-whole provisions are not unmatured interest. In re Trico Marine Servs., 450 B.R. 474, 480-81 (Bankr. D. Del. 2011). The reasoning behind these findings has varied to some degree, but has largely centered on the following two characteristics of make-whole payments: (1) make-whole payments are enforceable liquidated damages, not “interest,” (See, e.g., In re Lappin Elec., 245 B.R. 326, 330 (Bankr. E.D. Wis. 2000)), and (2) even if the make-whole payments were interest, the interest has already “matured” by virtue of the automatic acceleration in the credit documents (See, e.g., In re Outdoor Sports Headquarters, 161 B.R. 414, 424 (Bankr. S.D. Ohio 1993)).