In a prior blog post, “Making Sense of The Circuit Split on the Enforcement of Make-Whole Provisions in Bankruptcy,” we discussed the circuit split on the enforcement of a make-whole premium triggered by a bankruptcy petition.  Shortly after that post was published, the U.S. Bankruptcy Court for the Southern District of New York entered an order enforcing make-whole premiums for a prepetition default and acceleration of secured promissory notes.  In In re 1141 Realty Owner LLC, Case No. 18-12341 (Bankr. SDNY March 18, 2019), Judge Stuart Bernstein found that the make-whole premiums, or “Yield Maintenance Default Premiums,” contained in two promissory notes were akin to liquidated damages provisions, permissible under New York law (the law of the contract).  1141 Realty is interesting inasmuch as Judge Bernstein distinguished the Second Circuit’s decision in Momentive Perf. Materials Inc., et al. v. BOKF, NA, et al., Case No. 15-1682 (2d Cir. Oct. 20, 2017) (“Momentive”), and instead appears to have adopted at least part of the reasoning in the Third Circuit’s decision in In re Energy Future Holdings Corp., Case No. 16-1351, at 7 (3d Cir. Nov. 17, 2016) (“EFH”).  

In 1141 Realty, the debtor executed two promissory notes for a total $25 million loan secured by a mortgage on the debtor’s hotel property—the Flatiron Hotel in New York City.  Both promissory notes contained identical clauses for a Yield Maintenance Default Premium, defined as follows:

[the] amount equal to the greater of: (i) three percent (3%) of the principal amount of the Loan being repaid and (ii) the excess, if any, of (a) the present value (determined using a discount rate equal to the Treasury Rate at such time) of all scheduled payments of principal and interest payable in respect of the principal amount of the Loan being repaid provided that the Note shall be deemed, for purposes of this definition, to be due and payable on the Free Window Date, over (b) the principal amount of the Loan being repaid.

The lender sent the debtor a notice of default for the debtor’s failure to maintain a liquor license at the hotel and opted to accelerate the entire principal plus accrued interest, together with “all other sums due under the Loan Documents.”  According to the loan documents, any payment of the loan following an event of default was deemed a voluntary repayment that required the payment of the Yield Maintenance Default Premium.

After the debtor filed a chapter 11 case, the lender asserted a claim that included the Yield Maintenance Default Premium.  Although the debtor did not contest the default, the debtor argued that, because the default was “unintentional,” the default should not trigger the make-whole premium.  The debtor argued that the lender’s voluntary acceleration of the debt, which changed the maturity date to the date of default, required the disallowance of the premium.

Judge Bernstein noted that a make-whole premium is a prepayment clause in the mortgage that “insures the lender against loss of the bargain if interest rates decline.”  Although a lender that chooses to accelerate a loan generally forfeits the right to a prepayment premium because the acceleration advances the maturity date and, thus, the loan cannot practically be prepaid, there are exceptions to this general rule.  The first exception is where the contract clearly calls for payment of a prepayment premium even after default and acceleration, i.e. the liquidated damages clause exception.  The second exception is where the borrower intentionally defaults, triggering acceleration and escaping payment of the prepayment premium.

The 1141 Realty court found that the Yield Maintenance Default Premium satisfied the first exception as a valid liquidated damages provision.  The “parties contracted to deem any post-default payment to be a ‘voluntary prepayment’ that triggered the Yield Maintenance Default Premium.”  Using a similar analysis as the Third Circuit in EFH, the court advised that “to ensure that a make-whole premium is payable even after acceleration is to say so explicitly.  Another way to ensure that the make-whole premium is payable even after acceleration is to render acceleration irrelevant and . . . make the premium contingent on any post-default payment.”  The court distinguished the Second Circuit decisions in Momentive and U.S. Bank Tr. Nat’l Ass’n v. AMR Corp. (In re AMR Corp.), 730 F.3d 88, 103 (2d Cir. 2013), noting as a factual matter that parties can contract around the general rule articulated in Momentive and AMR that acceleration brings forward the maturity date and nullifies the make whole premium.

The fact that the acceleration here occurred prepetition makes the case one that could be considered strictly a case of contract interpretation.  Indeed, bankruptcy principles against unmatured interest were not addressed by the court in 1141 Realty because the Yield Maintenance Default Premium became due and payable in accordance with its terms prepetition.


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