Make-Whole Premiums: Good News for Creditors
A secured lender’s claim for a $23.7 million “make-whole premium” was allowed over the objections of an Unsecured Creditors’ Committee in an April 22, 2013 decision by the United States Bankruptcy Court for the District of Delaware. The $23.7 million make-whole premium was a significant portion of the lender’s total bankruptcy claim of $95 million in the case of In re School Specialty, Inc. School Specialty is an important decision that provides strong support for creditors seeking to recover the benefit of their contractual bargain through the enforcement of make-whole provisions in loan documents when a borrower files bankruptcy.
The Pre-Bankruptcy Loan
In School Specialty, the borrower entered into a $70 million term loan agreement with Bayside Finance, LLC (the lender) approximately seven months before filing its Chapter 11 bankruptcy case. Pursuant to the terms of the loan agreement, the borrower was required to pay an “Early Payment Fee” (the make-whole premium) upon either prepayment or acceleration of the loan. A default occurred under the loan agreement, and the lender accelerated the loan. In January 2013, the borrower and the lender entered into a forbearance agreement that acknowledged the current loan principal balance of $67 million as well as the $23.7 million make-whole premium obligation (35% of the principal balance the loan).
The Bankruptcy Case
The borrower filed for Chapter 11 bankruptcy three weeks after entering into the forbearance agreement. Under the DIP Order entered into in the bankruptcy case, the borrower stipulated that it was liable to the lender in the aggregate amount of $95 million, which included the $23.7 million make-whole premium. The Unsecured Creditors’ Committee objected to the payment of the make-whole premium arguing: (i) that it was an unenforceable penalty under New York law, which governed the loan agreement; and (ii) that the Bankruptcy Code prohibits the inclusion of unmatured interest as part of a creditor’s claim.
The Bankruptcy Court overruled the Unsecured Creditors’ Committee’s objections and approved the $23.7 million make-whole premium component of the lender’s claim, finding that it was not “plainly disproportionate” to the lender’s loss because the make-whole premium was: (i) calculated so that the lender would receive its bargained for yield and (ii) the result of an arms-length transaction between sophisticated parties. The Court reasoned that under New York law, the test is whether the make-whole premium was disproportionate to probable loss, not whether it was disproportionate to the principal loan balance.
More importantly, the Court rejected the Unsecured Creditors’ Committee’s argument that the make-whole premium was a claim for unmatured interest. In doing so, the Court followed the majority of Bankruptcy Courts in concluding that the make-whole premium at issue in this case was best characterized as a properly drafted liquidated damages provision that should be allowed under Section 502(b)(2) of the Bankruptcy Code.
Practical Implications for Lenders and Investors
The School Specialty decision is from the prominent Delaware Bankruptcy Court that has influence throughout numerous jurisdictions, and is good news for lenders and distressed debt investors. Not only does School Specialty provide authoritative support to enable lenders to recover make-whole premiums in bankruptcy, the decision also provides helpful guidance to distressed debt investors in evaluating the likely return on a make-whole premium claim.
For additional information regarding this alert, please contact David A. DeFlece email@example.com | 215.864.7160.
 A “make-whole premium” is a provision in a loan agreement that requires a borrower, upon prepayment or acceleration of a loan, to pay the lender an additional sum usually calculated to capture the net present value of the remaining interest payments on the loan.
 In re School Specialty, Inc., No. 13-10125 (KJC), 2013 WL 1838513 (Bankr. D. Del. Apr. 22, 2013).