The United States Bankruptcy Court for the Southern District of New York (the Bankruptcy Court) recently issued a memorandum decision in the American Airlines, Inc. (the Debtor) bankruptcy cases holding that the Debtor does not have to pay a make-whole premium when repaying certain of its outstanding note and EETC financings, due to the plain language of the underlying financing arrangements.¹ The dispute arose in October 2012 when the Debtor filed a motion (the Refinancing Motion) seeking (a) authority to obtain replacement financing for three separate financings (which debt totaled over $1.3 billion) and (b) a declaratory ruling that the proceeds from the replacement financing could be used to repay the existing debt without the need to pay the make-whole premium required under each of the underlying trust indentures (the Indentures) in connection with a voluntary redemption. In the Refinancing Motion, the Debtor stated that its interest savings by repaying the debt, without make-whole, at then-current interest rates, would amount to over $200 million. The indenture trustee under each Indenture (collectively, the Indenture Trustees), acting on behalf of the lenders under the Indentures, objected to the Refinancing Motion on the grounds that such repayments were voluntary redemptions that required the payment of the make-whole premium.

Facts of the Case

The Indentures provided financing for three groups of aircraft purchased by the Debtor prior to the petition date, and each financing benefited from the protections provided by section 1110 (Section 1110) of the United States Bankruptcy Code, 11 U.S.C. §§ 101 et seq. (the Bankruptcy Code). Under the Indentures, the parties agreed that make-whole premium would be payable by the Debtor if it repaid the debt early, but that no make-whole premium would be due if the debts were accelerated. Further, the Indentures provided that the debt would be automatically accelerated in the event that the Debtor filed for bankruptcy, and that no make-whole would be payable upon such a bankruptcy acceleration.

The Debtor filed for chapter 11 bankruptcy protection before the Bankruptcy Court on November 29, 2011. In late December 2011 and early January 2012 (well within the first 60 days after the chapter 11 petition date), the Debtor made Section 1110(a) elections for each of the Indentures. In so doing, the Debtor agreed to cure and timely perform all obligations under these financings in order to retain the protections of the automatic stay under section 362 of the Bankruptcy Code – at least for the period that these financings were subject to such Section 1110(a) election agreements. Then, on October 9, 2012, ten and one-half months after the petition date, the Debtor filed the Refinancing Motion, seeking authority to obtain replacement financing for the accelerated debt without paying the make-whole premium.

Court Adopts Plain Reading of Contractual Entitlement to Make-Whole Premium After Bankruptcy Acceleration

The Bankruptcy Court ruled that the Debtor is not required to pay make-whole premium when repaying the bankruptcy accelerated financings based upon a plain contractual reading of the Indentures. This ruling is not surprising because the documents (a) expressly provide that the financings automatically accelerate upon a bankruptcy filing and (b) also expressly provide that no make-whole premium is due when the debt is so accelerated. Although the Bankruptcy Court noted that make-whole premiums are recognized as valid under law, it held that entitlement to a make-whole premium is dependent upon the terms of the contract at issue. Given the plain language of the Indentures, the Bankruptcy Court determined that no make-whole premium was required to be paid because the debt was automatically accelerated upon the Debtor’s chapter 11 filing.

The Bankruptcy Court’s decision is currently subject to appeals pending before the United States Court of Appeals for the Second Circuit (the Second Circuit), with oral argument currently scheduled for June 20, 2013.

Troublesome Aspects of Ruling for Aircraft Financiers

Although the Bankruptcy Court’s ruling that no make-whole premium is required appears to be grounded in well-established contractual construction principles, the Bankruptcy Court made additional rulings that were both unnecessary and lacking firm foundation, especially in light of the Section 1110(a) election made by the Debtor with respect to the Indentures.

First, the Bankruptcy Court ruled that the Indenture Trustees could not decelerate the debt. In so holding, the Bankruptcy Court reasoned that such a deceleration would take away from the Debtor’s contractual rights and, accordingly would be barred by the automatic stay. Such a ruling, however, was not necessary because none of the Indenture Trustees ever actually decelerated the debt. Substantively, the ruling also is suspect because it fails to recognize the existing contractual rights of the Indenture Trustees under the Indentures. Contrary to the Bankruptcy Court’s reasoning, a deceleration of the debt does not “change” the contractual rights between the parties – such rights are expressly fixed by the Indentures – but changes only which contractual terms are applicable given the actions of the parties.

Second, because these transactions are subject to the protections provided by Section 1110, the Bankruptcy Court’s decision fails to recognize that the Debtor is required to honor all contractual obligations (other than defaults triggered by ipso facto provisions of the contracts) during the period in which a Section 1110(a) election is in effect. Unless specifically excused by the Bankruptcy Code, a chapter 11 debtor’s failure to honor a contractual term would normally create a default under the contract that would allow a Section 1110(a) protected financier to exercise its remedies against its aircraft collateral. In the instant case, if the Indenture Trustees had actually decelerated the debt (and not simply sought relief from the automatic stay to seek to decelerate in the future) and the Debtor did not honor this right, this breach should provide grounds under Section 1110 for the Indenture Trustees to have exercised remedies against their aircraft collateral. In sum, the Bankruptcy Court’s rulings that narrow the rights enjoyed by Section 1110 financiers lack basis.

Instead of actually decelerating the debt, the Indenture Trustees requested relief from the automatic stay so as to decelerate the debt and force the Debtor to effect a voluntary redemption of the debt – which would require the payment of the make-whole premium. The Bankruptcy Court denied stay relief, reasoning that deceleration amounts to an action to “exercise control over property of the estate” and “assess claims against the estate.”² This reasoning, however, also appears suspect because the Bankruptcy Code expressly recognizes the rights of parties to assert claims against a debtor to the full extent of their contractual rights³ unless prohibited under Section 362 (such as prohibitions upon enforcement of claims and assessing levies to support claims). Similarly, the automatic stay does not invalidate proper claims made under a contract (unless, like claims for unmatured interest, such claims are expressly prohibited under the Bankruptcy Code), but prohibits actions to assess claims against a debtor. Accordingly, absent some additional action, it is hard to see how a deceleration of debt would be a violation of the automatic stay. Deceleration, in fact, seems to be the exact opposite of an effort to assess claims against a debtor.

In reaching its decision, the Bankruptcy Court did not have to rely upon any of these suspect rulings. Rather, the Bankruptcy Court could have supported its contractual rights interpretation ruling with its findings that Indenture Trustees waited too long to enforce their rights (whether under the theories of waiver or laches or the like). By waiting nearly an entire year before petitioning the Bankruptcy Court for permission to decelerate the debt, the Indenture Trustees allowed the Bankruptcy Court to view their actions as a money grab intended to deprive the Debtor’s estate of property rights in violation of the automatic stay – instead of actions to protect their contractual rights.

Conclusion

Regardless of the outcome of the appeal of the Bankruptcy Court’s decision, there are several lessons that aircraft financiers can and should take away from the Bankruptcy Court’s decision to deny the financiers any make-whole premium.

• Importance of Acting Early to Protect Section 1110 and Contractual Rights. Here, the Indenture Trustees failed to act early to assert and protect their Section 1110 and other contractual rights. Each of the Indenture Trustees would have been prudent to seek to enforce or preserve the right to decelerate the Indenture debt as soon as practicable upon the Debtor’s making its Section 1110(a) elections on the Indenture transactions, thereby protecting the right to claim the make-whole premium granted under the Indentures. If the Indenture Trustees had asserted these rights at the time of the Section 1110(a) elections, the focus of any dispute would have been whether the Indenture Trustees could enforce contractual rights under their respective Indentures. By waiting to enforce the right to the make-whole premium until after the Debtor filed the Refinancing Motion, the Indenture Trustees allowed the focus of the dispute to become the Indenture Trustees’ efforts to deprive the Debtor of a refinancing opportunity. Here, timing no doubt greatly influenced the Bankruptcy Court’s decision. Further, the Indenture Trustees could have issued a deceleration notice in a manner that minimized the risk that the Bankruptcy Court would view the issuance as a violation of the automatic stay by (a) raising these issues in response to the Debtor’s Section 1110(a) election agreement notices and (b) making the deceleration notices expressly conditioned upon whether the right of deceleration is a contractual right protected under Section 1110 of the Bankruptcy Code.
• Importance to Actually Move to Decelerate the Debt. Further, by failing to actually decelerate the debt, the Indenture Trustees allowed the Bankruptcy Court to avoid the issue of the interplay between Section 1110(a) and the automatic stay regarding the lenders’ exercise of statutorily protected contractual rights under Section 1110(a). The Indenture Trustees made a strategic error by never actually decelerating the debt.
• Importance of Contract Terms. Another important lesson in the Bankruptcy Court’s make-whole decision is the primary importance of the controlling contractual provisions. The entitlement to make-whole premium is only as good as the express contractual terms granting such make-whole premium. Aircraft financiers and other lenders should carefully consider whether to carve-out make-whole premiums for debt that is automatically accelerated upon a bankruptcy filing. If the commercial arrangement is that the make-whole should be due and owing in connection with a repayment that is made after an automatic bankruptcy acceleration, the parties to the contracts should make sure that this arrangement is clearly set forth in their financing transactions–and expressly state that the make-whole remains due after an automatic bankruptcy acceleration.

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The impact and scope of the Bankruptcy Court’s decision upon aircraft financing and the sanctity of the protections provided by of the Bankruptcy Code Section 1110, of course, is highly dependent upon the forthcoming appellate ruling of the Second Circuit. Nevertheless, the Bankruptcy Court’s decision highlights the importance for aircraft financiers to carefully review the terms of their financings and ensure that they act promptly to preserve the protections provided under their contracts and Bankruptcy Code Section 1110.

If you have any questions about this article, please contact Michael J. Edelman at +1 (212) 407 6970.

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