NEIL P. OLACK, Bankruptcy Judge.
There came on for trial on March 16-19, 2010 (the "Adversary Trial"), in the above-styled adversary proceeding (the "Adversary"), the Complaint for Declaratory Judgment with Respect to Disputed Liquidated Damages Claims and Related Objections to Proofs of Claim Nos. 101, 102, 103, 104, 108 and 115 filed by U.S. Bank National Association Pursuant to Bankruptcy Rule 3007 (the "Complaint") (Adv. Pro.
At the Adversary Trial, Robert Alan Byrd represented the Debtors; Richard G. Wilson and Henry E. Chatham, Jr. represented U.S. Bank; and Sidney P. Levinson, Thomas B. Watson, and Richard A. Montague, Jr. represented the Noteholders. At the conclusion of the four-day trial, the Court directed the parties to file simultaneously post-trial briefs on all relevant issues, including, without limitation, the issue as to whether the Indenture is properly classified as an executory contract and if so, the potential implications on the claims asserted in this Adversary.
The Claimants on May 17, 2010, filed a Request of U.S. Bank National Association, Pacific Investment Management Company, LLC, Deutsche Asset Management and Castlerigg Master Investments Ltd. for Leave to File a Rebuttal Brief (Adv. Pro. Dkt. 93). In response, the Debtors filed on May 20, 2010, the Reorganized Debtors' Opposition to Defendants' Joint Request for Leave to File a Rebuttal Brief (Adv. Pro. Dkt. 95). After a hearing held on June 3, 2010, the Court granted the Claimants leave to file on or before June 17, 2010, a rebuttal brief and granted the Debtors leave to file a response on or before July 1, 2010. (Adv. Pro. Dkt. 98). On June 17, 2010, the Claimants filed the
The Court
The length of this opinion warrants a brief overview of its structure. The testimony and evidence presented at the Adversary Trial covered events beginning in 2002, when the Debtors started planning the construction of a casino along the Mississippi Gulf Coast, and ending in 2007, when the Debtors substantially consummated their plan of reorganization under chapter 11 of the Bankruptcy Code.
The discussion section of the opinion is divided into four major subsections. Subsection A sets forth the appropriate burden of proof. Subsection B examines whether the Indenture is an executory contract. That issue is discussed early because of its potential impact on the enforceability of the prepayment provisions in the Indenture. Subsections C and D focus upon the crux of the parties' dispute: Subsection C examines whether the prepayment provisions grant the Claimants the right to payment of an allowed secured claim under § 506(b) of the Bankruptcy Code; and subsection D explores the alternative argument raised by the Claimants—whether they have a right to payment of an allowed unsecured claim under § 502(b). Subsection D also discusses the amount of damages and interest to which the Claimants are entitled.
This Court has jurisdiction over the subject matter of and the parties to this proceeding. This matter is a core proceeding as defined in 28 U.S.C. § 157(b)(2). Notice of the Adversary Trial was proper under the circumstances.
The Debtors were formed in 2002 for the purpose of constructing the Hard Rock
The exterior design of the Resort featured a 112-foot guitar sign. The interior design of the Resort, encompassing 388,000 square feet, featured (1) a 50,000 square-foot casino with 1,500 slot machines and 50 table games, modeled after the Hard Rock Hotel & Casino Las Vegas; (2) an eleven-story hotel; (3) four restaurants; (4) a 20,000 square-foot concert/multi-purpose venue with capacity for more than 1,000 people; (5) a tropical-themed swimming pool; (6) a 7,800 square-foot fitness spa and salon; (7) a retail store; and (8) a 1,600-space parking garage. In accordance with Mississippi law, the casino areas of the Resort were designed to be built on barges moored to the shore and connected to the land-based portion of the Resort.
The Debtors sought to raise capital to finance the design, construction, furnishing, and operation of the Resort through an offering of notes.
Pursuant to the Indenture, the Debtors issued 10.75% first mortgage notes (the "Notes")
Section 4.22(a)(1) of the Indenture required the Debtors, until the Notes had been paid in full, to "keep its properties... adequately insured at all times by financially sound and reputable insurers."
To protect the Noteholders against the risk that the Debtors might refinance the Notes prior to their stated maturity date if interest rates declined, § 3.07(a) provided that, with one exception involving initial public offerings that is not relevant to this Adversary, "the Notes will not be redeemable at the Issuers' option prior to February 1, 2008"
The four-year period under which the Debtors were prohibited from redeeming the Notes (the "No-Call Period") covered the first half of the eight-year term of the Notes.
The Indenture allowed the Debtors, at their option, to redeem the Notes prior to their maturity date but not during the No-Call Period. The Debtors, however, had to pay a premium
Year Percentage 2008 .................................... 105.375% 2009 .................................... 102.688% 2010 and thereafter ..................... 100.000%
The optional redemption price decreased each year in patterned steps until it reached zero two years before the maturity date in 2012. Thus, during those last two years, the Debtors could repay the principal amount of the notes in favorable market conditions without incurring any extra expense.
Section 6.02 of the Indenture described two events of default that warranted immediate
Under certain enumerated conditions, the acceleration of the Notes entitled the Noteholders to collect an additional premium from the Debtors:
Year Percentage
2004 .......................... 110.75000%
2005 .......................... 109.40625%
2006 .......................... 108.06250%
2007 .......................... 106.71875%
Accordingly, under this provision of § 6.02, if the Debtors willfully caused the Notes to accelerate with the intention of avoiding the No-Call Provision during the period from February 1, 2006, to January 31, 2007, the Debtors were required to pay the Noteholders 108.0625% of the principal amount, or an additional premium of $12.9 million.
The Indenture contained a defeasance clause that allowed the Debtors, at their option, to repay the Notes prior to the end of the No-Call Period under certain conditions. More specifically, if the Debtors desired to obtain the release of their collateral without the consent of the Noteholders, then § 12.01 of the Indenture, entitled "Satisfaction and Discharge," enabled them to do so by arranging for payment of the Notes from an alternative source— noncallable government securities "in such amounts as will be sufficient, without consideration of any reinvestment of interest, to pay and discharge the entire Indebtedness on the Notes not delivered to the Trustee for cancellation for principal, premium and Liquidated Damages, if any, and accrued interest to the date of maturity or redemption."
The Indenture required Premier Finance to deposit most of the proceeds from the Notes, $143.5 million, into a Construction Disbursement Account.
The Debtors entered into a Disbursement Agreement on the same date as the Indenture.
The Disbursement Agreement established conditions for the funding of construction costs and procedures for approving change orders and amendments to the construction budget and schedule. Generally, the Disbursement Agreement authorized the Disbursement Agent to disburse funds to the Debtors to pay construction costs only if there were sufficient available funds in the Construction Disbursement Account to complete the Resort by December 31, 2005, within the limitations set by the budget. To facilitate enforcement of these key provisions, any disbursement of the proceeds of the Notes required the Debtors to submit to the Disbursement Agent a Construction Disbursement Request,
The term "Available Construction Funds" used in paragraph (i) was defined under the Disbursement Agreement to mean:
These provisions were designed to ensure that there were, on deposit at the time of any disbursement, sufficient funds to complete the Resort pursuant to the budget and schedule agreed to by the parties.
The Noteholders purchased the Notes from the Debtors, and thereafter on the financial trading market. Among the entities that either purchased the Notes, or managed funds that purchased the Notes, were PIMCO, Deutsche, and Castlerigg.
Using the proceeds from the Notes, the Debtors began construction of the Resort.
During the period of time that construction was underway, the Debtors obtained insurance policies for all risks with an aggregate policy limit per occurrence of approximately $88 million.
The Debtors completed the construction of the Resort, including the casino barges and the 112-foot guitar sign, on time and on budget and received a temporary certificate of occupancy on August 26, 2005.
On August 29, 2005, just a few days before the Resort's scheduled grand opening, Hurricane Katrina, one of the worst natural disasters ever to strike the continental United States, devastated much of the central Gulf Coast of the United States.
In the aftermath of Hurricane Katrina, the Debtors planned to reconstruct the Resort. To do so, however, required substantial changes to the original plans. In particular, the casino would no longer be built on two floating barges. Instead, the new permanent casino would be built in the same location but on concrete piers.
The Insurance Policies, bound just two weeks before Hurricane Katrina struck, proved providential. The Debtors, together with the Indenture Trustee, pursued recovery of the insurance proceeds in the full amount of the $181 million limit (the "Insurance Proceeds").
The process of collecting Insurance Proceeds took time; by the end of 2005, the Debtors had collected only about $25 million.
The amount of the Insurance Proceeds, together with the pre-Hurricane Katrina funds remaining in the Construction Disbursement Account (as defined in the Disbursement Agreement) and the equipment financing permitted under the Indenture, were sufficient to allow the Debtors to rebuild the Resort, commence operations, and satisfy all of the Debtors' trade debt, including all the debt that arose prior to Hurricane Katrina.
The Debtors began negotiations with the Indenture Trustee/Disbursement Agent for use of the Insurance Proceeds in order to begin full-scale rebuilding of the Resort and to pay the trade vendors and subcontractors who had rendered services prior to Hurricane Katrina,
For payment of pre-Hurricane Katrina constructions expenses, the Debtors submitted on or about October 12, 2005, Construction Disbursement Request No. 19 to the Disbursement Agent pursuant to § 4.2.2 of the Disbursement Agreement. On or about October 19, 2005, the Disbursement Agent denied the request based on the Noteholders' objection to the Debtors' use of any proceeds, whether loan proceeds or Insurance Proceeds, to pay unsecured claims that arose prior to Hurricane Katrina.
The Indenture Trustee and the Disbursement Agent in general embraced the position of the Noteholders that as a result of the damage and delay caused by Hurricane Katrina, the Debtors were unable to provide the certifications and representations required under the terms of the Disbursement Agreement to access the Insurance Proceeds. In particular, the Debtors could not certify and represent (1) that the existing budget (formulated before Hurricane Katrina) accurately set forth the anticipated costs to complete the Resort (which costs ballooned because of the need to reconstruct the Resort after Hurricane Katrina); (2) that there were sufficient funds in the Construction Disbursement Account (which did not include any of the Insurance Proceeds) to complete the construction of the Resort by December 31, 2005;
On October 27, 2005, the Debtors filed suit against U.S. Bank, as the Indenture Trustee and Disbursement Agent, in the United States District Court for the Southern District of Mississippi (the "First S.D. Miss. Action")
U.S. Bank and the Noteholders obtained, over the objection of the Debtors, a delay in the trial scheduled to place in October 2006 on the interpretation of the Indenture provisions in the Consolidated S.D. Miss. Actions until March 2007. The Debtors were concerned that the delay would jeopardize their Hard Rock license
On January 6, 2006, the Indenture Trustee formally notified the Debtors by letter that: (1) pursuant to § 6.01(o) of the Indenture, an event of default had occurred because of the failure of the Resort to open by December 31, 2005
The Debtors sought alternative sources of funding to reconstruct the Resort in the face of their unsuccessful efforts to gain access to the Insurance Proceeds. On or about April 25, 2006, Leucadia National Corporation ("Leucadia") acquired a controlling equity interest in PEB. Leucadia accomplished the purchase by making a capital contribution to GAR, LLC ("GAR")—through its subsidiary LUK-Ranch Entertainment, LLC ("LRE")— with GAR, in turn, acquiring from AA Capital Equity Fund, L.P. and AA Capital Biloxi Co-Investment Fund, L.P. (the "Sellers") all of the Sellers' equity interest in PEB for an aggregate cash purchase
The license agreement between Hard Rock and the Debtors required Hard Rock's consent to the acquisition by Leucadia. As noted above, the Hard Rock brand was central to the Debtors' business plan. To obtain Hard Rock's consent, Leucadia entered into a letter agreement with Hard Rock (the "Hard Rock Agreement"), under which it made several financing commitments.
As to its financing commitments, Leucadia represented to Hard Rock that Leucadia, or a subsidiary of Leucadia, would commence a tender offer for the Notes at 101% of par value, and would cause the tender offer to be funded independently of the Debtors' resources to avoid any impact on the capital structure of Premier Finance. Leucadia also informed Hard Rock that it intended to reconstruct the Resort using the Insurance Proceeds but agreed to lend up to $50 million to Roy Anderson Corporation ("RAC"), the general contractor on the Resort during both the first construction and the reconstruction, in the event that either:
Finally, Leucadia agreed to loan up to $11 million in unsecured financing to Premier Finance in the event the Debtors required additional working capital.
Consistent with the Hard Rock Agreement, the Debtors obtained two separate commitments, totaling $50 million, from BHR Holdings, Inc. ("BHR"), an affiliate of Leucadia. Under the first commitment, BHR agreed to provide bridge financing (the "BHR Bridge Facility") of up to $40 million by purchasing from RAC any receivables due RAC under the construction agreement entered into between the Debtors and RAC.
Under the second commitment, BHR agreed to provide up to $10 million in unsecured financing.
Pursuant to these commitments, BHR purchased $11.8 million in receivables from RAC under the BHR Bridge Facility. Moreover, Leucadia, through its subsidiary, BHR, infused $8 million into PEB in May 2006 and $100,000 in September 2006 by virtue of unsecured loans in order to pay critical vendors whose bills were unpaid and whose services were necessary for the rebuilding of the Resort.
Leucadia's purchase of a controlling interest in the Debtors triggered a requirement under § 4.16 of the Indenture for a "Change of Control" tender offer. Accordingly, BHR made a tender offer on May 5, 2006 at a price of 101 % of the principal amount, plus unpaid and accrued interest. No Notes were tendered as a result of this offer.
On June 16, 2006, RAC and the Debtors entered into an agreement for reconstruction
A hurdle to the Indenture Trustee's acceptance of the Comprehensive Rebuild Proposal was its interpretation of the "Event of Loss" provisions under the Indenture. The Indenture Trustee interpreted these provisions as requiring the Debtors to use the Insurance Proceeds in an offer to repurchase the Notes from the Noteholders prior to their use by the Debtors to rebuild the Resort.
In the first of two tender offers, PEB offered on June 30, 2006, to purchase $94 million of the $160 million in outstanding Notes in an amount equal to 100% of the principal amount of the Notes, plus accrued and unpaid interest.
On June 30, 2006, contemporaneous with PEB's Event of Loss offer, BHR offered
Each of these offers made on June 30, 2006, expired on August 2, 2006, with no Notes being tendered. The offers at 100% and 101% were far below the price of 105.375% required under the Indenture to redeem the Notes at the first permitted date on February 1, 2008, a year and a half later.
The Indenture Trustee initiated court proceedings in St. Paul, Minnesota, the principal place of its corporate trust business, to obtain approval from the State of Minnesota District Court, Second Judicial District, Ramsey County, pursuant to Minn.Stat. § 501B.16,
On June 30, 2006, the Indenture Trustee filed in the Minnesota Action the Third Petition of U.S. Bank National Association as Trustee for Instructions in the Administration of Premier Trust Pursuant to Minn.Stat. § 501B.16 (the "Petition to Approve the Comprehensive Rebuild Proposal"). Therein, the Indenture Trustee expressly acknowledged the following:
In April 2006, eight months after Hurricane Katrina, the Debtors engaged the services of several insurance experts to determine the appropriate level of insurance coverage for the 2006-2007 hurricane season, including Sawyer Foster/Beecher Carlson (insurance brokers), Shoecraft Burton LLP (insurance coverage attorneys), and Integro (insurance brokers and risk management advisors) (collectively, the "Debtors' Insurance Advisors").
The Debtors' Insurance Advisors collectively concluded that the worst case scenario was a storm similar in strength to Hurricane Katrina striking the Gulf Coast on October 31, 2006, resulting in the destruction of approximately $34.6 million of work.
In addition to the qualitative analysis provided by the Debtors' Insurance Advisors as to the type and amount of coverage necessary "adequately" to insure the Resort,
The Debtors informed the Indenture Trustee about the new insurance policy on the same date it was bound.
After the disclosure by the Debtors of the $50 million storm insurance coverage and approximately one week before the hearing set for August 8, 2006, on the
In their continued effort to gain access to the Insurance Proceeds, the Debtors met directly with some of the Noteholders on August 16, 2006, in Los Angeles, California. The Noteholders agreed to waive the event of default under the Indenture and release the Insurance Proceeds if the Debtors, in turn, agreed to provide (1) $75 million of storm insurance coverage for the remainder of the 2006 hurricane season; (2) $130 million of storm insurance coverage, with a $30 million deductible, for the 2007 hurricane season (at an estimated cost of $10-15 million); (3) $25.8 million or more for an eighteen-month interest reserve; (4) $6 million in reserve for the next annual insurance payment; (5) payment of the attorneys' fees of the Noteholders;
From August 24, 2006, through September 8, 2006, the Debtors submitted to the Disbursement Agent four Construction Disbursement Requests seeking disbursement of the following amounts from the Construction Disbursement Account: (1) $3,338,445 for reconstruction work performed and materials delivered in July 2006; (2) $2,936,94.88 for expenses incurred before Hurricane Katrina; (3) $2,975.156.08 for unpaid remediation expenses incurred after Hurricane Katrina; and (4) $5,946,577 for unpaid expenses relating to the opening of the Resort in 2005 and other subsequent expenses. The Disbursement Agent rejected the Construction Disbursement Requests as defective on their face, inter alia, because the required certifications unilaterally changed the deadline for completion of the Resort from December 31, 2005, to December 31, 2007, and incorrectly stated that as of that date no event of default existed.
On September 1, 2006, again in connection with an Event of Loss offer, PEB offered to purchase $66,816,000 of the $160 million in outstanding Notes in an amount equal to 100% of the principal amount of the Notes, plus accrued and unpaid interest.
On September 1, 2006, contemporaneous with PEB's Event of Loss offer, BHR offered to purchase all of the outstanding Notes in an amount equal to 101% of the principal amount of the Notes, plus accrued and unpaid interest.
After the Noteholders declined the Event of Loss Offers, the Indenture Trustee once again refused to allow the Debtors to use the Insurance Proceeds.
Following the initial efforts by the parties to reach agreement on the insurance
The Debtors' board of managers began discussing filing petitions for relief under chapter 11 of the Bankruptcy Code when it became clear to them that an impasse had been reached with the Claimants regarding the insurance coverage issue.
On September 19, 2006, the Debtors' board of managers
At the time of the bankruptcy filing, the Debtors were not confronting foreclosure and neither the Indenture Trustee nor the Noteholders had taken any action to accelerate the Notes.
Simultaneously, on September 19, 2006, (the "Petition Date"), PEB and Premier Finance filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code in Case Nos. 06-50975 and 06-50976, respectively (the "Petitions"). For procedural purposes only, the Court ordered the joint administration of the Debtors' chapter 11 cases under Case No. 06-50975
The Debtors' First Amended Schedules, dated October 20, 2006, showed approximately $200,000 in unrestricted cash, assets of $252,862,214.96, and liabilities of $230,142,366.45.
Together with their Petitions, each of the Debtors filed a Motion Pursuant to Section 363(c) of the Bankruptcy Code and Bankruptcy Rule 4001(b) for Order Authorizing the Use of Cash Collateral on an Interim and Final Basis, whereby they sought access to the Insurance Proceeds (the "Cash Collateral Motion") (Bankr. Dkt. 5). The Debtors did not seek to pay off the Notes under the Cash Collateral Motion. Rather, they sought access to the Insurance Proceeds to rebuild the Resort.
In a September 26, 2006, E-mail to O'Connor, Raziano mentioned a financial analysis for repaying the Notes and referred to a previous conversation along the same vein.
On October 3 and 4, 2006, the Bankruptcy Court held an evidentiary interim hearing on the Cash Collateral Motion. At that hearing, Joseph Billhimer, president of the Resort until 2008, testified that the
Given the opposition to the Cash Collateral Motion and the Noteholders' continued insistence on $160 million of insurance, the Debtors filed their Motion for Authorization to Obtain Postpetition Financing (the "DIP Financing Motion") (Bankr. Dkt. 71) on October 9, 2006, requesting authorization to obtain post-petition financing in an amount up to $180 million. Under the DIP Financing Motion, the Debtors proposed to replace the Notes with a substantially similar credit facility from BHR, at the same interest rate of 10.75%.
In the meantime, on October 10, 2006, the Court entered its Opinion (Bankr. Dkt. 75) and Interim Order (Bankr. Dkt. 76) approving the Debtors' use of approximately $26 million in Insurance Proceeds in accordance with the Debtors' 13-week projected budget for payment of current and ongoing reconstruction costs until December 17, 2006, or the date of a final hearing, whichever came first. On October 23, 2006, the Court entered an Order in Furtherance of Interim Order on Debtors' Motion for Use of Cash Collateral (Bankr. Dkt. 114), which reflected certain agreements of the parties with respect to the procedures for the release of the Insurance Proceeds and payment by the Debtors of fees and expenses of the Indenture Trustee and its counsel. The Court in its Order Extending Interim Order on Debtors' Motion for Use of Cash Collateral (Bankr. Dkt. 205) extended the expiration date through January 20, 2007, as limited by the Debtors' revised budget.
On December 21, 2006, the Indenture Trustee filed Proof of Claim Nos. 101, 102, 108, and 115 pursuant to Rule 3003 of the Federal Rules of Bankruptcy Procedure, as follows:
On December 21, 2006, the Disbursement Agent
Following a three-day hearing that began on January 16, 2007, the Court issued its Opinion (Bankr. Dkt. 299) and Order (Bankr. Dkt. 300), denying the Debtors' DIP Financing Motion, in part, because the payment the Debtors sought authorization to make would impair or modify the rights of the Noteholders under the Indenture over their objections (the "DIP Financing Opinion") (Bankr. Dkt. 299). The Court determined that allowing the case to proceed to the confirmation process would better protect the rights of all the parties and the estate.
Before the hearing on the DIP Financing Motion, the Debtors on December 11, 2006, filed their original Disclosure Statement for Debtors' Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code (Bankr. Dkt. 216). After this Court denied the DIP Financing Motion, the Debtors on February 23, 2007, filed their Second Amended Disclosure Statement for Debtors' Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code (the "Disclosure Statement") (Bankr. Dkt. 340) and related Plan of Reorganization (the "Plan") (Bankr. Dkt. 337). The Plan provided for a 100% recovery to the holders of allowed claims under the Plan. The Plan also provided payment to the Noteholders of the Notes at par value plus accrued unpaid interest through the effective date of the Plan.
Under the Plan, payment of the Notes would extinguish the liens of the Noteholders and thereby release the Insurance Proceeds to the Debtors. The Noteholders opposed the repayment of the Notes and insisted that in addition to payment in full under the Plan, they were entitled to damages if the Debtors paid the Notes before February 1, 2008, the end of the No-Call Period.
With regard to the Debtors' other creditors, the Plan provided that holders of general unsecured claims would receive 50% of their allowed claims, including post-petition interest at the federal judgment rate, upon the effective date of the Plan, and the remaining 50% no later than sixty (60) days thereafter. Other secured and priority claims would be paid in full, including interest, on the effective date of the Plan.
In the Disclosure Statement, the Debtors proposed to enter into a credit facility with BHR upon consummation of the Plan on substantially the same terms as those set forth in their DIP Financing Motion, which the Court had previously denied. The Disclosure Statement explained that BHR would provide an exit facility (the "Exit Facility")
On March 5, 2007, the Court entered its Second Supplemental Order in Furtherance of Interim Order on Debtors' Motion for Use of Cash Collateral (Bankr. Dkt. 349), extending the term of the Interim Order through April 14, 2007. By this point in the bankruptcy case, it became evident to all parties that the Debtors were going to complete and reopen the Resort using the Insurance Proceeds, which the Court authorized U.S. Bank to be release through the aforementioned series of supplemental cash collateral orders.
The dispute over storm insurance coverage came to crisis in the bankruptcy case at a hearing held on April 13, 2007, regarding the Debtors' further use of the Insurance
In the Claimants' Post-Trial Brief, the Claimants argued that prepayment of the Notes gave the Debtors the flexibility to spend much less on insurance than was required to comply with the Indenture's insurance covenant. Indeed, in the years following the confirmation of their Plan, the Debtors obtained only $100 million of catastrophic storm insurance coverage, spending less than $4 million per year in premiums for that amount since 2008.
The Plan was accepted by every secured and unsecured creditor that voted on the Plan, other than the Noteholders, who voted overwhelmingly to reject the Plan.
The Court held a week-long confirmation hearing on June 18-22, 2007.
Just days after the confirmation hearing, the Resort reopened to much fanfare on June 30, 2007. As expected, the release of the Insurance Proceeds through the series of cash collateral orders allowed the Debtors to fund the reconstruction of the Resort.
On July 30, 2007, the Court issued an Opinion (the "Confirmation Opinion") (Bankr. Dkt. 468) and Order (the "Confirmation Order") (Bankr. Dkt. 469) confirming the Plan, conditioned upon a modification to increase the Disputed Liquidated Damages Escrow by $2,960,115.32.
On August 1, 2007, the Debtors filed the Second Modification to Debtors' Joint Plan of Reorganization under Chapter 11 of the Bankruptcy Code, dated February 22, 2007 (Bankr. Dkt. 470). This modification increased the Disputed Liquidated Damages Escrow to $13,710,115.32.
On August 2, 2007, the Noteholders filed a Notice of Appeal (the "Noteholders' Confirmation Appeal") (Bankr. Dkt. 473) and
On August 10, 2007, the Bankruptcy Court issued an Opinion (the "Bankruptcy Court Stay Opinion") (Bankr. Dkt. 492) and an Order (Bankr. Dkt. 493) denying the Bankruptcy Court Stay Motion for failure to satisfy the four factors articulated by the Fifth Circuit necessary to obtain a stay.
On August 10, 2007, the Debtors filed their Notice of Substantial Consummation and Occurrence of Effective Date of Debtors' Confirmed Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code (Bankr. Dkt. 494). The Debtors substantially consummated the Plan, by, among other things:
As a result of the Debtors' substantial consummation of the Plan, the Debtors repaid the Notes before February 1, 2008, the end of the No-Call Period.
On August 16, 2007, the Indenture Trustee filed the U.S. Bank National Association's Amended Motion to Amend or Modify the July 30, 2007 Order Pursuant to Rule 9023 to Address Unresolved Plan Confirmation Issues (the "9023 Motion") (Bankr. Dkt. 501). The Indenture Trustee sought clarification regarding its role post-confirmation and, more particularly, its compensation for certain services specified in the Plan rendered post-confirmation. The parties agreed to resolve the 9023 Motion, as follows: (1) the Indenture Trustee agreed to continue to serve in its role as such from and after August 10, 2007, for the limited purpose set forth in the Plan until such time as it fulfilled its duties; (2) the Debtors agreed to pay the Indenture Trustee $69,542.80 for its fees and expenses incurred on or prior to August 10, 2007; (3) the Debtors agreed to pay the Indenture Trustee an annual administrative fee in the amount of $6,000, plus hourly charges; (4) the Debtors agreed to authorize the Indenture Trustee to draw from the $1 million previously received from the Debtors for payment of the Indenture Trustee's reasonable fees and expenses incurred in connection with the Disputed Liquidated Damages Claims and the Disputed Liquidated Damages Escrow; and (5) the Debtors agreed to seek dismissal of the Consolidated S.D. Miss. Actions against the Indenture Trustee without prejudice. Following the substantial consummation of the Plan, on September 7, 2007, the Debtors filed a Motion to Dismiss Appeal of Confirmation Order as Moot (D.C. App. Dkt. 3) in the District Court, seeking to dismiss the Noteholders' Confirmation Appeal as equitably moot.
On October 31, 2007, the Indenture Trustee filed a Notice of Appeal to the United States District Court for the Southern District of Mississippi, appealing the Confirmation Order (Bankr. Dkt. 561).
On November 8, 2007, as provided under the Plan, the Debtors initiated this Adversary against the Indenture Trustee by filing the Complaint to adjudicate the Disputed Liquidated Damages Claims and the parties' entitlement to the proceeds of the Disputed Liquidates Damages Escrow. (Adv. Pro. Dkt. 1). In the Complaint, the Debtors sought to obtain a declaratory judgment that (1) § 6.02 of the Indenture was inapplicable; (2) repayment of the Notes under the Plan did not equate to "voluntary" prepayment of the Notes under the Indenture; (3) the prepayment
On December 27, 2007, the Indenture Trustee filed an Answer and Counterclaims of U.S. Bank National Association, as Indenture Trustee Under the Trust Indenture, Dated as of January 23, 2004, to Debtors' Complaint (the "Indenture Trustee Answer") (Adv. Pro. Dkt. 7). In the Indenture Trustee Answer, the Indenture Trustee pled five affirmative defenses: (1) failure to state a claim upon which relief can be granted; (2) lack of subject matter jurisdiction; (3) unjust enrichment; (4) failure to join the Noteholders as indispensable parties; and (5) estoppel and/or collateral estoppel. (Adv. Pro. Dkt. 7). The Indenture Trustee named the Noteholders as "nominal defendants" but sought no relief from them and asserted four counterclaims against the Debtors.
On January 22, 2008, the Debtors filed a Motion to Strike Certain Affirmative Defenses and Joinder of Majority Bondholders and to Require Defendant to Replead Counterclaims Pursuant to Fed.R.Civ.P. 12 and 14 and Fed. R. Bankr.P. 7008 (the "Motion to Strike") (Adv. Pro. Dkt. 10). On January 28, 2008, the Noteholders filed an Answer to Counterclaims of U.S. Bank National Association and Counterclaims of Pacific Investment Management Company, LLC, Deutsche Asset Management, Western Asset Management, and Castlerigg Master Investments Ltd. Against Premier Entertainment Biloxi LLC (d/b/a Hard Rock Hotel & Casino Biloxi) and Premier Finance Biloxi Corp. (Adv. Pro. Dkt. 17). The Indenture Trustee and the Noteholders filed separate responses to the Motion to Strike on February 12, 2008 (Adv. Dkt. Pro. 21 & 22). On March 4, 2008, this Court entered an Order (Adv. Pro. Dkt. 29), granting the Debtors an additional twenty days to respond to the counterclaims filed by the Indenture Trustee subsequent to the Court's resolution of the Motion to Strike. Later, this Court entered an Order (Adv. Dkt. Pro. 36) holding the Motion to Strike in abeyance pending the final outcome of the Confirmation Appeal.
On March 19, 2008, the District Court entered a Memorandum Opinion and Order Granting Appellees' Motion to Dismiss (the "District Court Dismissal Order") (D.C. App. Dkt. 28), dismissing the Confirmation Appeal as equitably moot. On April 17, 2008, the Noteholders filed a Notice of Appeal to the United States Court of Appeals for the Fifth Circuit (D.C. App. Dkt. 29), appealing the District Court Dismissal Order. Shortly thereafter, the Indenture Trustee likewise appealed the District Court Dismissal Order to
Just prior to a rescheduled hearing on the Motion to Strike in the Adversary, the parties agreed to resolve the jurisdictional and joinder issues. In that regard, the Court entered a Stipulated Order (Adv. Pro. Dkt. 49) on November 3, 2009, in which the Indenture Trustee agreed to omit certain affirmative defenses from the Indenture Trustee Answer and the Debtors, in turn, agreed to allow the Noteholders to intervene as defendants and counter-claimants.
More specifically, the Claimants contend that they are entitled to payment from the Disputed Liquidated Damages Escrow under § 506(b) or, in the alternative, under § 502(b). As oversecured creditors, they insist that they are entitled under § 506(b) to an allowed secured claim in the amount of $10,750,000 plus default interest of $3,284,125. The secured claim, according to the Claimants, is for an additional premium payable under § 6.02 of the Indenture, resulting from the Debtors' willful breach of the Indenture with the intention of avoiding the prepayment premium for early redemption of the Notes. The Claimants declare that the Debtors willfully defaulted in two ways: (1) they filed their Petitions on September 19, 2006, which constituted an event of default under § 6.01(j) of the Indenture; and (2) they filed and consummated a plan of reorganization providing for prepayment of the Notes in violation of § 3.07(b) of the Indenture. The Claimants maintain that the additional premium under § 6.02 constitutes a "reasonable charge," and, along with the default interest that has accrued since August 10, 2007, is payable as an allowed secured claim under § 506(b).
In the event that this Court determines that § 506(b) is inapplicable, the Claimants also argue that they are entitled under § 502(b) to an allowed unsecured claim for damages that exists under non-bankruptcy law in one of the following amounts, depending upon the approach adopted by
The burden of proof in a claim against the assets of a bankruptcy estate lies with the claimant, who must establish the validity and amount of its claims by a preponderance of the evidence. See Calif. State Bd. of Equalization v. Official Unsecured Creditors' Comm. (In re Fidelity Holding Co.), 837 F.2d 696, 698 (5th Cir. 1988). Thus, the Claimants bear the burden of proof to show that the Debtors owe them a prepayment premium under the terms of the Indenture.
Prior to the Adversary Trial, none of the parties had addressed in any pleading whether the Indenture was an executory contract within the purview of § 365 at the time the Debtors filed their Petitions. If so, then § 365(e)(1)(B) would arguably render unenforceable any termination or modification of the Debtors' rights under the Indenture based solely on the Debtors' filing of their Petitions and § 365(b)(2)(D) would arguably render unenforceable any prepayment premium. See 11 U.S.C. § 365. At this Court's request, the Claimants and the Debtors both discussed in their post-trial briefs the decision of In re Texaco, Inc., 73 B.R. 960, 964 (Bankr. S.D.N.Y.1987), where the court found that a trust indenture similar to the Indenture at issue here was an executory contract.
Executory contracts, unlike other types of contracts, are afforded special treatment under the Bankruptcy Code. 11 U.S.C. § 365. The term "executory contract," however, is not defined in the Bankruptcy Code. A majority of courts applying § 365, including the Fifth Circuit, has adopted the definition formulated by Professor Vern Countryman: A contract is executory when "the obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance could constitute a material breach excusing the performance of the other." See Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L.Rev. 439, 460 (1973); Vern Countryman, Executory Contracts in Bankruptcy: Part II, 58 Minn. L.Rev. 479 (1974); Phoenix Exploration, Inc. v. Yaquinto (In re Murexco Petroleum, Inc.), 15 F.3d 60, 62-63 n. 8 (5th Cir.1994).
Both the Debtors and the Claimants contend that the Indenture does not satisfy Professor Countryman's definition because a breach by the Indenture Trustee of its continuing obligations, such as its duty to tender notices of default to the Debtors, would not be sufficiently material
Under § 506(b), to the extent that an allowed claim is oversecured, "there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement under which such claim arose." 11 U.S.C. § 506(b). In general, a prepayment premium is recognized as encompassed in the term "charges."
The general rules that govern the allowance or disallowance of a claim are set out in § 502. The extent to which such an allowed claim is secured, however, is determined by reference to § 506. 4 Collier on Bankruptcy ¶ 506.01 (16th ed. 2010). Consequently, there are two requirements for including a charge as part of an allowed secured claim under § 506(b). First, the charge at issue must satisfy the provisions of § 502(b)(1), that is, it must be included in a contract provision that is enforceable under applicable state law. E.g., Noonan v. Fremont Fin. (In re Lappin Elec. Co.), 245 B.R. 326 (Bankr.E.D.Wis.2000); Fin. Ctr. Assoc. of East Meadow, L.P. v. TNE Funding Corp., 140 B.R. 829, 835 (Bankr.E.D.N.Y. 1992); but see In re A.J. Lane & Co., 113 B.R. 821, 825 (Bankr.D.Mass.1990) (state law is not binding on federal courts but provides guidance in evaluating prepayment charges). If it does not, the claim is disallowed under § 502(b)(1). Second, the charge must be "reasonable," as determined by federal law. Blackburn-Bliss Trust v. Hudson Shipbuilders, Inc. (In re Hudson Shipbuilders, Inc.), 794 F.2d 1051, 1056 (5th Cir.1986). Thus, the Claimants had the ultimate burden of proving at the Adversary Trial that an additional premium of $10.75 million was in fact due and payable to the Noteholders under § 6.02 of the Indenture, that the premium is valid under New York law,
Section 6.02 of the Indenture provided that if before February 1, 2008, an event of default was caused by a willful action of the Debtors done with the intention of avoiding the No-Call Provision, then a prepayment premium was due. The Claimants rely upon two separate events of default: a) the filing of the Petitions (the "Petition Default"); and b) the consummation of the Plan under which the Debtors redeemed the Notes prior to the end of the No-Call Period (the "Plan Default").
As to the Petition Default, the Debtors concede that the filing of the Petitions constituted an event of default under § 6.01(j) of the Indenture. However, as to the Plan Default, the Debtors argue that the repayment of the Notes was not an event of default, as that term is defined under § 6.01 of the Indenture. As to both alleged events of default, they challenge the Claimants' contractual right to the premium under § 6.02 on two grounds. First, they dispute that either event of default was "willful." Second, they dispute that they had any "intention" of using either event of default to avoid the Indenture's prohibition on early redemption of the Notes. As to the Plan Default only, the Debtors further argue that the repayment of the Notes was not a breach of the Indenture because the Notes were accelerated automatically by the Debtors' filing of the Petitions, which caused the Notes to "mature."
Much of the evidence presented at the Adversary Trial focused upon whether the filing of the Petitions by the Debtors was "willful" and taken by the Debtors "with the intention of avoiding the prohibition on redemption of the Notes" during the No-Call Period. In that regard, the fact that the Debtors filed their Petitions voluntarily does not in itself resolve the issue. Instead, this Court must engage in a fact-specific inquiry into the particular circumstances surrounding their filings.
According to the Debtors, they filed the Petitions to gain access to the Insurance Proceeds in order to rebuild the Resort by December 31, 2007, as they had agreed to do under the Hard Rock Agreement,
Both the Debtors and the Claimants, citing New York law, argue in favor of using the definitions of "willful" and "intention," taken from Black's Law Dictionary. See Swezey v. Marra, 143 A.D.2d 827, 829, 533 N.Y.S.2d 244 (N.Y.App.Div. 1988) (relying on Black's Law Dictionary to define "willful" in a contract dispute when the contract failed to provide a definition). "Willful" is defined as "[v]oluntary and intentional, but not necessarily malicious," and willfulness is defined as "[t]he fact or quality of acting purposefully or by design; deliberateness; intention." Black's Law Dictionary 1737 (9th ed. 2009). "Intention" is defined as "[t]he
The Debtors proved at the Adversary Trial that just prior to the Petition Date, they had only $200,000 in cash, $230 million in outstanding liabilities, and a Resort that was not generating any revenue.
At the Adversary Trial, the Claimants cast the Debtors as "willfully" rushing to bankruptcy court without exploring all the options available to them. The Debtors, however, had been negotiating for the release of the Insurance Proceeds for over a year before they commenced their bankruptcy cases. In the aftermath of Hurricane Katrina, the Debtors tendered several disbursement requests to the Disbursement Agent, who denied them all on the ground that the Debtors could not certify that the Resort would open by December 31, 2005. The Debtors then filed the Consolidated S.D. Miss. Actions seeking release of the Insurance Proceeds, which if successful would have left the Notes in place. Then, on January 6, 2006, the Indenture Trustee formally notified the Debtors that they were in default of the Indenture because of the failure of the Resort to open by December 31, 2005. During the summer of 2006, the Debtors put together the Comprehensive Rebuild Proposal with the input and assistance of the Indenture Trustee, which also would have kept the Notes in place.
The Claimants take issue with when the Debtors filed their Petitions—less than one week before a scheduled judicial settlement conference was scheduled to take place in the Consolidated S.D. Miss. Actions on September 25, 2006. They contend that it was entirely possible that the settlement conference would have resolved their dispute over the adequacy of storm insurance coverage and that the bankruptcy cases would have been unnecessary. However, it was just as likely that the settlement conference would have proven pointless since it was not the first such attempt at settlement between the parties. While Rule 16(a)(5) of the Federal Rules of Civil Procedure authorizes courts to facilitate settlement, that provision does not authorize courts to impose settlement on an unwilling litigant. Moreover, the Claimants delayed the trial date of the Consolidated S.D. Miss. Actions from October 2006, to March 2007, indicating they were unconcerned about the Debtors' deadline of December 31, 2007.
The Claimants make light of the Debtors' purported cash-flow problems because on the Petition Date the Debtors had access to more than $40 million in financing from Leucadia, through BHR, to move forward with the reconstruction of the Resort. However, Leucadia and its affiliates already had invested approximately $150 million of unsecured funds into the Resort and had funded all of the pre-petition reconstruction work.
The Claimants next insist that the Debtors at least knew that, given the existing impasse over storm insurance, it was at least foreseeable that the Debtors would repay the Notes in their bankruptcy cases. They rely on the deposition testimony of O'Connor, who served in the dual roles of vice-president of Leucadia and a member of the Debtors' board of managers.
Although Leucadia apparently was aware of the existence of a prepayment premium in the Indenture,
Also, Billhimer testified at the Adversary Trial, as follows:
According to the Claimants, however, other evidence offered at the Adversary Trial confirms that the replacement of the Notes was not only foreseen at the time of the bankruptcy filing but was in fact planned and desired. Such evidence included the tender offers made by BHR. As discussed previously, Leucadia, through BHR, sought to purchase all of the outstanding Notes at a price of 101% of par through numerous tender offers, including the last one that extended until September 29, 2006, ten days after the bankruptcy filing. Although the Change of Control offers and the two Event of Loss offers made by the Debtors were required under the Indenture, those made by BHR were not.
The Debtors cite In re Public Service Co. of New Hampshire, 114 B.R. 813 (Bankr. D.N.H. 1990), in support of the proposition that a debtor can be "forced to come into the federal bankruptcy court" even where the filing is voluntary, a point this Court has already recognized. Id. at 816. In that case, the debtor owned an interest in the Seabrook Unit 1 nuclear generating station, which had cost its investors more than $1.7 billion to build. Unfortunately, the final licensing proceeding for the Seabrook Unit 1 had not been completed, which meant the plant was "producing neither electricity nor income." Id. A state statute prohibited any public utility from basing rates on construction costs unless the utility was actually providing service to its consumers. Id. The debtor petitioned the New Hampshire Public Utilities Commission for an emergency rate surcharge anyway, on the ground that the statute was unconstitutional. Shortly after the New Hampshire Supreme Court rejected the debtor's constitutional challenge, the debtor commenced its chapter 11 case. Id. at 815-16. During the plan confirmation process, an issue arose as to whether bondholders were entitled contractually to premium payments under certain indentures because of the early redemption of the bonds proposed under the plan. The prepayment premium provisions of the indentures were triggered only if prepayment was at the debtor's "option." The bankruptcy court found that because the debtor was a "regulated utility whose sole source of income was subject to regulatory decisions," the debtor "was in fact forced to come into the federal bankruptcy court," despite having filed a "voluntary" petition. Id. at 815-16, 819. For that reason, the bankruptcy court held that the prepayment of the bonds in the plan "was in no sense an exercise of a voluntary `option' by the debtor." Id. at 819.
The Debtors liken the situation they faced just before the Petition Date to that faced by the debtor in Public Service Company because their business was not producing any revenue and would not begin to do so until the Resort was rebuilt using the Insurance Proceeds. They argue that just like the debtor in Public Service Company, the Debtors' ability to rebuild was subject to the control of a third party, the Noteholders. The Noteholders, on the other hand, attempt to distinguish Public Service Company because of its unique factual circumstances involving a public utility. Id. at 815-16.
The Court finds the facts in Public Service Company to be sufficiently analogous to lend support for the Debtors' argument that the bankruptcy filings were not willful or intentional within the meaning of § 6.02 of the Indenture. Issues of willfulness and intention often involve elusive factual questions. Not surprisingly, the Claimants did not present any direct evidence at the Adversary Trial that established the Debtors' willfulness or intention to escape the prohibition in the Indenture on the early payment of the Notes. Such evidence
As with the Petition Default, the Claimants argue that the Debtors' consummation of the Plan, providing for redemption of the Notes prior to the end of the No-Call Period in violation of § 3.07 of the Indenture, was both willful and done with the intention of avoiding the prohibition on redemption of the Notes. Thus, the Claimants contend that they are entitled to payment of an additional premium under § 6.02 of the Indenture.
In the Debtors' Post-Trial Brief, the Debtors protest that the consummation of the Plan is not listed as an event of default under § 6.01 of the Indenture and that the Claimants' assertion that the Debtors breached the No-Call Provision in § 3.07 does not make the payment of the Notes an event of default within the meaning of § 6.01. Unless the Plan consummation constituted an event of default, then § 6.02, which provides for payment of a premium under certain circumstances, does not apply. In the Claimants' Supplemental Post-Trial Brief, which the Claimants filed specifically in order to address this argument, the Claimants identified both § 6.01(d) and § 6.01(e) as events of default arising out of the Debtors' breach of § 3.07. However, the Claimants identified only § 6.01(d) in their Amended Answer
As to the Joint Pre-Trial Order, Rule 16(d) of the Federal Rules of Civil Procedure, made applicable to bankruptcy proceedings by Rule 7016 of the Federal Rules of Bankruptcy Procedure, provides that a pre-trial order controls the course of the trial and that a court may reject any issue not contained in that order except to prevent manifest injustice. In that regard, the Fifth Circuit has held on numerous occasions that a joint pre-trial order supercedes all previously filed pleadings. See Elvis Presley Enter., Inc. v. Capece, 141 F.3d 188, 206 (5th Cir.1998); see also Bayou Louie Farm, Inc. v. White (In re Heigle), 401 B.R. 752, 765-66 (Bankr. S.D.Miss.2008). Here, although the issue regarding the effect of the alleged breach of the No-Call Provision of the Indenture was well known to the parties at the time of the Adversary Trial, the particular provision of the Indenture that the Claimants relied upon to establish their claim for damages was not. Still, in the interest of fairness, the Court will consider whether § 6.01(d) provides a remedy. Although
Section 6.01(d) provided that the following constituted an Event of Default:
Assuming for the sake of argument that a breach of § 3.07 qualified as an event of default under § 6.01(d), the Debtors make the additional argument that the filing of the bankruptcy case resulted in the automatic acceleration of the Notes under the Indenture and thus the Notes were mature when the Debtors repaid them as part of the consummation of the Plan. Section 6.01(j) defined the commencement of a "voluntary case" under "the Bankruptcy Law" as an event of default.
The Claimants challenge the Debtors' acceleration argument for two reasons. First, they contend that under New York law, the acceleration provision in § 6.02 of the Indenture is not self-operative. Second, they contend that Judge Gaines had already found, in denying the DIP Financing Motion, that the Indenture prohibited early repayment of the Notes and that under the principle of collateral estoppel, the Debtors cannot re-litigate that finding. The Court will address these two challenges in turn.
The starting point in analyzing any contract, including the Indenture at issue here, is the language of the agreement itself. See Stroll v. Epstein, 818 F.Supp. 640, 643 (S.D.N.Y.), aff'd, 9 F.3d 1537 (2d Cir.1993) ("Under New York law,... the Court must look first to the parties' written agreement to determine the parties' intent and [must] limit its inquiry to the words of the agreement itself if the agreement sets forth the parties' intent clearly and unambiguously."). Under New York law, courts must construe a contract in a manner that avoids inconsistencies and reasonably harmonizes its terms. See James v. Jamie Towers Hous. Co., 294 A.D.2d 268, 269, 743 N.Y.S.2d 85 (N.Y.App.Div.2002); Barrow v. Lawrence United Corp., 146 A.D.2d 15, 18, 538 N.Y.S.2d 363 (N.Y.App.Div.1989) ("Contracts are also to be interpreted to avoid inconsistencies and to give meaning to all of its terms."). The fundamental precept of contract interpretation is that agreements are construed in accord with the parties' intent. See Slatt v. Slatt, 64 N.Y.2d 966, 967, 488 N.Y.S.2d 645, 477 N.E.2d 1099 (N.Y.1985) ("The best evidence of what parties to a written agreement intend is what they say in their writing."); Slamow v. Del Col, 79 N.Y.2d 1016, 1018, 584 N.Y.S.2d 424, 594 N.E.2d 918 (N.Y.1992). Thus, a written agreement that is complete, clear, and unambiguous
Here, the Indenture clearly stated that the Notes accelerated immediately and without further action or notice. The effect of the acceleration was to change the maturity date from February 1, 2012, to the Petition Date, which then became the new maturity date. See Black's Law Dictionary 12 (9th ed. 2009) (defining acceleration as the "advancing of a loan agreement's maturity date so that payment of the entire debt is due immediately."). It is undisputed that the Indenture does not include language that expressly preserves the right of the Noteholders to collect a premium after acceleration or that requires payment of a premium during the No-Call Period. Yet, in Northwestern Mutual Life Ins. Co. v. Uniondale Realty Assocs., 11 Misc.3d 980, 816 N.Y.S.2d 831, 836 (N.Y.Sup.Ct.2006), the trial court, applying New York law, held that prepayment penalties are not allowed when a loan is paid after default and acceleration "unless clear contract language requires it." Therefore, the absence of any such provision in the Indenture authorizing payment of a premium means that the Claimants are not entitled to a prepayment premium as an allowed secured claim. 11 U.S.C. § 506(b). In the Claimants' Supplemental Post-Trial Brief, the Claimants attempt to distinguish Northwestern Mutual on the ground that it involved a foreclosure action commenced by the lender. The court in Northwestern Mutual, however, did not limit its thoughtful analysis of the historical development of commercial prepayment clauses to any specific factual scenario.
In further support of their position that under New York law automatic acceleration provisions are not self-operative, the Claimants rely on a case decided almost half a century ago, Tymon v. Wolitzer, 39 240 N.Y.S.2d 888 (N.Y.Sup. Ct.1963). There, the trial court held that a provision under which a debt became immediately due and payable was not self-operative but "could be brought into being only by an election to accelerate affirmatively exercised by the plaintiff obligees," with such election to be "evidenced by some unequivocal overt act evidencing the election to accelerate or by the institution of a lawsuit on the obligation as accelerated." Id. at 896.
The Tymon court, however, did not foreclose the ability of parties to draft acceleration provisions that would be self-operative. The clause at issue in Tymon read as follows:
Tymon, 240 N.Y.S.2d at 893. The Tymon court established a rule of construction for similar acceleration clauses, but not a general prohibition on all self-operative acceleration clauses. See Tymon, 240 N.Y.S.2d at 895-96; see also 1 Mortgages and Mortgage Foreclosure in New York § 28:6 (2009) ("If so specifically written, it is possible for an acceleration clause to be self-executing."). Such rules are simply meant to fill gaps in incomplete contracts and only govern if parties do not contract around them. Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 Yale L.J. 87 (Oct. 1989). This principle is
Tymon is also distinguishable because the policy concerns in that case are not present here. The Tymon court reasoned that holding acceleration clauses to be self-operative would be unfair to lenders because it would enable a debtor to commit an intentional default for the purpose of forcing the lender to accept immediate repayment whenever market conditions rendered the loan unfavorable. Id. at 896. Because the acceleration clause in Tymon provided for automatic acceleration upon any default, a borrower could exploit this provision by simply foregoing an interest payment. Tymon, 240 N.Y.S.2d at 893-96. By contrast, § 6.02 of the Indenture at issue here called for automatic acceleration only if the Debtors found themselves in bankruptcy, whether voluntary or involuntary. As to all other events of default, § 6.02 called for permissive, rather than automatic, acceleration depending on whether the Indenture Trustee or the Noteholders declared the Notes accelerated. It would not be necessary to distinguish defaults by bankruptcy from defaults by other means if the parties did not intend for acceleration to take place automatically in some instances. Because the Indenture's acceleration clause contained this specific, bargained-for exception, Tymon's construction rule that automatic acceleration clauses are not self-operative does not apply. To hold otherwise would
More recently, under circumstances very similar to those in this proceeding, the bankruptcy court in Solutia found that an automatic acceleration provision was self-operative and, therefore, disallowed the noteholders' claims for prepayment penalties. Solutia, 379 B.R. at 478. The indenture in Solutia contained an almost identical acceleration clause that declared that the notes "shall become immediately due and payable without any declaration or other act on the part of the Trustee or any Holder" upon the filing of a case for reorganization under any applicable law. Id. All other defaults required an action by a specified percentage of noteholders and the giving of notice to effectuate acceleration. Id. After the debtor in Solutia filed for chapter 11 protection, the noteholders sought damages because the debtor's repayment of the notes under the plan of reorganization prior to the maturity date stated in the indenture deprived them of an uninterrupted payment stream. Id. The court recognized that under New York law a borrower may not prepay an instrument absent a prepayment clause, based on a policy that the "mortgagee has bargained for a stream of income over a fixed period of time." Id. at 488. However, the court in Solutia held that the noteholders expressly gave up their expectation of a stream of future income in favor of an immediate right to collect their entire debt when they agreed to an automatic acceleration clause in the indenture. Id. at 478. Accordingly, that court disallowed the noteholders' claim for prepayment penalties. Id.
The Claimants contend that the bankruptcy judge in Solutia misinterpreted New York law and criticize the decision for failing to distinguish the decision of the New York state court in Tymon. In contrast to Solutia, the Claimants rely on an earlier case also rendered by the bankruptcy court for the Southern District of New York, but by a different judge, in In re Calpine Corp. (CalGen), 365 B.R. 392 (Bankr.S.D.N.Y.2007). There, each of the indentures at issue contained no-call provisions and none of them included a premium for repayment prior to the end of the no-call period. For that reason, the CalGen Court described them as "antiquated" and "Model T" indentures. The indentures also provided that a bankruptcy filing by CalGen constituted an event of default resulting in an automatic acceleration of debt. The bankruptcy court found that the debt had been accelerated by virtue of CalGen's bankruptcy filing and thus was due and payable immediately. Id. at 398 & n. 7. The Claimants point out that notwithstanding the automatic acceleration, the court awarded CalGen's lenders a claim for damages for breach of the agreements. Id. at 399. What the Claimants fail to point out is that the court awarded them an unsecured claim. The bankruptcy court did not grant the lenders an allowed secured claim under § 506 because of the absence of a premium provision in any of the indentures.
Next, the Claimants rely on the decision on appeal to the District Court for the Southern District of New York in In re Calpine Corp., No. 05-60200(BRL), 2007 WL 4326738, at *9 (S.D.N.Y. Nov.21, 2007), in support of their position that Solutia was wrongly decided. The issue in Calpine did not involve no-call provisions but rather conversion rights under an indenture that the court held had expired as the result of a filing of the bankruptcy petition and the automatic acceleration of the maturity date. In reaching its decision, the district court distinguished the no-call provisions at issue in CalGen from the conversion rights at issue in Calpine:
Id. at *11. The Claimants contend that the decisions in CalGen and Calpine are consistent with Tymon but fail to demonstrate how. Neither CalGen nor Calpine cites Tymon, or holds that New York law prohibits acceleration provisions from operating automatically.
Citing LHD Realty Corp., 726 F.2d at 332, Sharon Steel Corp. v. Chase Manhattan Bank, NA, 691 F.2d 1039, 1053 (2d Cir.1982), and In re Skyler Ridge, 80 B.R. 500, 507 (Bankr.C.D.Cal.1987), the Claimants argue that any automatic acceleration of a debt that occurs upon the filing of a bankruptcy case does not eliminate the right to a prepayment premium unless it is accompanied by an affirmative act by the lender seeking prepayment of the debt. The Claimants' argument, however, fails to note the distinction between an automatic acceleration effectuated by the Bankruptcy Code and an automatic acceleration effectuated by a contractual provision. The automatic acceleration of a debt under the Bankruptcy Code allows a lender to file a proof of claim for the unmatured principal amount of the debt under § 502 without violating the automatic stay, but such acceleration is relatively limited and does not change the maturity date of the debt. See In re Manville Forest Prods. Corp., 43 B.R. 293, 298 (S.D.N.Y.1984) (Bankruptcy operates to automatically accelerate the principal amount of all claims against the debtor because of the "expansive [Bankruptcy] Code definition of `claim' [pursuant to 11 U.S.C. § 101(4)(A)], which allows any claim to be asserted against the debtor ... and from the Code's provision in Section 502 that a claim will be allowed in bankruptcy regardless of its contingent or unmatured status."), aff'd in part & rev'd in part on other grounds sub nom Official Comm. of Unsecured Creditors v. Manville Forest Prods. Corp. (In re Manville Forest Prods. Corp.), 60 B.R. 403 (S.D.N.Y.1986); accord Skyler Ridge, 80 B.R. at 507.
On the other hand, a contractual acceleration provision, like the one at issue here, goes beyond allowing a creditor to file a claim for unmatured principal and actually advances the maturity date of the debt. See Solutia, 379 B.R. at 488; Calpine, 2007 WL 4326738 at *9. The cases
LHD Realty Corp., 726 F.2d at 332. Thus, whether the Claimants ever engaged in any overt, affirmative acts to accelerate the Notes is irrelevant. Moreover, whether the acceleration that occurred as a result of the bankruptcy filing was "conditional" in nature because the Debtors could have decelerated the Indenture under the Plan and reinstated the Notes pursuant to § 1124 of the Bankruptcy Code also is irrelevant.
In summary, automatic acceleration clauses are self-operative under New York law when they provide for acceleration without notice upon an event of default by bankruptcy. See Calpine, 2007 WL 4326738 at *9 ("A fair reading of the Indentures . . . indicates that `Maturity,' consistent with general understanding, occurred when the Notes became `due and payable' by virtue of automatic acceleration upon the Debtors' bankruptcy filing."); see also CalGen, 365 B.R. at 398 ("In addition, each of the [indentures] provides that a bankruptcy filing by CalGen is an event of default resulting in an automatic acceleration of debt. As such, the [debt] has been accelerated by virtue of the Debtors' bankruptcy filing and thus is `due and payable immediately.'"); accord Solutia, 379 B.R. at 484 ("There can be no dispute that the 2009 Note Indenture provides for automatic acceleration upon filing of a petition for reorganization. Upon acceleration the entire debt becomes due and owing."). The reason these clauses exist is to allow lenders to accelerate the debt without first having to petition the bankruptcy court to lift the automatic stay. Solutia, 379 B.R. at 484 ("It was entirely appropriate to provide for automatic acceleration in the Original Indenture since the giving of a notice of acceleration postpetition would violate the automatic stay."). Contractual acceleration provisions are only limited in what they can do by the parties' imaginations—in the absence of fraudulent, exploitive, overreaching, or unconscionable conduct. See, e.g., Fifty States Mgt. Corp. v. Pioneer Auto Parks, Inc., 46 N.Y.2d 573, 577, 415 N.Y.S.2d 800, 389 N.E.2d 113 (N.Y.1979) ("[A]greements providing for the acceleration of the entire debt upon the default of the obligor . . . [i]n the vast majority of instances . . . have been enforced at law in accordance with their terms.").
Just like the noteholders in Solutia, by investing under the Indenture, which included an automatic acceleration provision, the Claimants gave up their expectation to a payment stream in the future. The Claimants chose to forego any prepayment premium in favor of an immediate right to collect their entire debt after a bankruptcy event of default. The parties to the Indenture are sophisticated investors who bargained for the risks and benefits of this undertaking of considerable size. Simply put, the Indenture itself did not provide the Claimants a premium or liquidated
The Claimants maintain that certain findings made in the DIP Financing Opinion by Judge Gaines, before whom this case was pending at that time,
Collateral estoppel is only one of several inter-related doctrines regarding the finality of judgments. In general, collateral estoppel prohibits re-litigation of issues fully and vigorously litigated and necessarily decided in a previous suit between the same parties.
Thus, Judge Gaines was merely comparing provisions of the Indenture in this case with the one in Calpine, rather than prohibiting repayment of the Notes.
Judge Gaines' ruling addressed whether the Debtors could pay the Notes under the auspices of a motion filed under § 364 of the Bankruptcy Code. That issue is far from identical to the one presented in this Adversary. In addition, it can hardly be said that the issue of whether the Debtors could repay the Notes under a plan of reorganization was litigated at the hearing when the DIP Financing Opinion makes clear that, in denying the DIP Financing Motion, Judge Gaines intended to "allow the case to proceed to the confirmation process."
In summary, this Court finds that with respect to the filing of the Petitions, the Claimants failed to establish that the Debtors acted willfully or intentionally to avoid the prohibition on prepayment of the Notes. With respect to the Plan itself, the Claimants likewise failed to establish that the payment of the Notes constituted an event of default. Because the Claimants
Even though the Debtors do not owe the Noteholders a premium under § 6.02 of the Indenture as a secured claim, the Claimants contend, in the alternative, that the Noteholders are entitled to allowance of an unsecured claim for damages incurred as a result of the Debtors' breach of § 3.07 of the Indenture's No-Call Provision. This is so, according to the Claimants, because the Debtors were solvent and as creditors of a solvent debtor, the Noteholders are entitled, under § 502(b), to damages for breach of their pre-petition contractual rights under applicable non-bankruptcy law.
The Debtors complain, as a preliminary matter, that the Noteholders have no contractual rights under the Indenture because no-call provisions are unenforceable in bankruptcy cases. CalGen, 365 B.R. at 397 ("no-call provisions that purport to prohibit optional repayment of debt are unenforceable in chapter 11 cases. The `essence of bankruptcy reorganization is to restructure debt . . . and adjust debtor-creditor relationships.' It would violate the purpose behind the Bankruptcy Code to deny a debtor the ability to reorganize because a creditor has contractually forbidden it.") (quotations & citations omitted); see Cont'l Sec. Corp. v. Shenandoah Nursing Home P'ship, 193 B.R. 769, 774 (W.D.Va.1996) (affirming bankruptcy court's holding that "[w]hile there is a prepayment prohibition, [it] is not enforceable in this [chapter 11] context"), aff'd, In re Shenandoah Nursing Home P'ship, 104 F.3d 359 (4th Cir.1996); In re 360 Inns, Ltd., 76 B.R. 573, 575-76 (Bankr.N.D.Tex. 1987) (authorizing repayment of a note despite ten-year prohibition on repayment). The Debtors point out that this Court acknowledged in its Confirmation Opinion that no-call provisions that purport to prohibit the optional repayment of debt are unenforceable in chapter 11 cases.
The Debtors next engage in an exercise in semantics by arguing that they did not "prepay" the Notes but "satisfied" the Noteholders' allowed claims under the Plan pursuant to § 1129, thereby nullifying any damages claim for early repayment. They assert that the primary function
This Court does not disagree with the Debtors' general pronouncements of the law. However, allowing the Debtors to repay the Notes early under the Plan did not foreclose the issue as to whether the Claimants are entitled to damages. Section 1123(b) specifically authorizes the post-confirmation pursuit of a claim for damages, and the Plan specifically contemplated the litigation of this Adversary and provided for retention of this Court's jurisdiction for that purpose.
Next, the Debtors maintain that this Court should not award contractual damages to the Claimants because the Indenture did not contain a provision awarding the Claimants any such expectation damages. The Debtors rely upon In re Vest Assocs., 217 B.R. 696, 699 (Bankr. S.D.N.Y.1998), for its holding that a bankruptcy court cannot "read into a contract damage provisions which the parties themselves have failed to insert regarding the liquidation or calculation of damages arising out of the prepayment of a loan." Id. That case, however, turned on the mandate in § 506 that a secured claim include only those reasonable fees, costs, or charges provided for under the agreement under which such claim arose. 11 U.S.C. § 506. This Court has already found that the Claimants do not have a secured claim under § 506. The Court in Vest Associates did not address the possibility of an unsecured claim under § 502, perhaps because the solvency of the debtor was not known at that time.
Moreover, the Debtors ignore CalGen, in which the bankruptcy court held that, despite the absence of any provision in the Indenture requiring payment of a premium
In sum, the unavailability of specific performance as a remedy and the lack of a stipulated liquidated damages provision in the Indenture do not prohibit the allowance of an award of expectation damages to the Claimants as an alternative remedy for breach of the No-Call Provision, as an unsecured claim. At the time of contract formation, the Claimants contemplated performance of the Indenture, including the No-Call Provision.
The Claimants and the Debtors agree that when a debtor is solvent, bankruptcy courts generally will enforce the debtor's contractual obligations to the extent they are valid under applicable state law. In those bankruptcy cases involving solvent debtors, "the task for the bankruptcy court is simply to enforce creditors' rights according to the tenor of the contracts that created those rights." In re Chicago, Milwaukee, St. Paul & Pac. RR, 791 F.2d 524, 528 (7th Cir.1986); see, e.g., Welzel v. Advocate Realty Invs., LLC (In re Welzel), 275 F.3d 1308, 1318 (11th Cir. 2001); In re 139-141 Owners Corp., 306 B.R. 763, 772-73 (Bankr.S.D.N.Y.2004). In synthesizing the long line of cases involving both secured and unsecured creditors of solvent debtors, the Sixth Circuit in Official Comm. of Unsecured Creditors v. Dow Corning Corp. (In re Dow Corning Corp.), 456 F.3d 668, 678-79 (6th Cir.2006), cert. denied, 549 U.S. 1317, 127 S.Ct. 1874, 167 L.Ed.2d 385 (2007), observed that "in solvent debtor cases, rather than considering equitable principles, courts have generally confined themselves to determining and enforcing whatever pre-petition rights a given creditor has against the debtor." Dow Corning, 456 F.3d at 679. The Sixth Circuit offered the following reasoning:
Id. (emphasis added) (citations omitted).
This principle has been applied to obligations arising out of the prepayment of debt. For example, in UPS Capital Bus. Credit v. Gencarelli (In re Gencarelli), 501 F.3d 1 (1st Cir.2007), the solvent debtors, whose cases had been consolidated, disputed their obligation to pay prepayment penalties under two commercial loan agreements that they had entered into prior to commencing their bankruptcy cases. The bankruptcy court found the penalties unreasonable in amount and, therefore, unenforceable in their entirety under § 506(b). On appeal, the district court affirmed. In reversing both lower courts, the First Circuit Court of Appeals held that where a debtor is solvent, prepayment penalties are in fact allowable as unsecured claims under § 502(b), obviating the need to satisfy the reasonableness requirement of § 506(b):
Id. at 7 (citing Debentureholders Protective Comm. of Cont'l Inv. Corp. v. Cont'l Inv. Corp., 679 F.2d 264, 269 (1st Cir. 1982)) (emphasis in original); see Ruskin v. Griffiths, 269 F.2d 827, 832 (2d Cir. 1959), cert. denied, 361 U.S. 947, 80 S.Ct. 402, 4 L.Ed.2d 381 (1960) (in bankruptcy cases involving solvent debtors, it is "the opposite of equity to allow the debtor to escape the expressly-bargained-for result of its act"); see also In re Vanderveer Estates Holdings, Inc., 283 B.R. 122, 131-32, 134 (Bankr.E.D.N.Y.2002); In re 360 Inns Ltd., 76 B.R. at 575 (the debtor's solvency warranted a distribution under the plan on account of a prepayment premium).
The Debtors insist that whether they were solvent vel non is irrelevant because they had no unfulfilled contractual obligations under the Indenture. For the reasons previously set forth in this opinion, this argument fails.
The Debtors next insist that they were "equitably" insolvent on the Petition Date and thereafter because they could not pay their debts as they became due. The Claimants counter that the Debtors were solvent at all relevant times because, simply put, their debts never exceeded their assets, notwithstanding any perceived cash-flow problems.
The Claimants' evidence presented at the Adversary Trial of the Debtors' solvency on a balance sheet basis included the following: (1) the schedules filed by the Debtors in the underlying bankruptcy case showing that the Debtors scheduled $252,862,214.96 in assets and $230,142,366.45 in liabilities (Bankr. Dkt. 106); (2) the "100% percentage recovery" for general unsecured creditors under the Plan, plus post-petition interest at the federal judgment rate, and the shareholders' retention of equity;
The term "insolvent" means—
11 U.S.C. § 101(32). In his formal solvency analysis, Solomon used the asset approach as his valuation methodology.
The asset approach, as its name suggests, required Solomon to focus on the value of the Debtors' underlying assets. Using a cost-basis balance sheet prepared in accordance with Generally Accepted Accounting Principles ("GAAP") and dated September 19, 2006, Solomon made two notable adjustments to the value of the property listed therein by the Debtors. He did so because of the requirement in § 101(32) that the property be shown on the balance sheet "at a fair valuation," which he construed as fair market value premised on the Debtors' "going concern" status. First, Solomon changed the value of the Hard Rock license from its book value of $472,916, the amount shown in the bankruptcy schedules, to an amount he considered reflected its fair market value, $11,754,000,
Other evidence of the Debtors' solvency relied upon by Solomon was the purchase by Leucadia in April, 2006, of a controlling interest in the Debtors at a price of $89 million. Also, the Debtors' ability to obtain exit financing from Leucadia in order to consummate the Plan, according to Solomon, constituted anecdotal evidence of solvency as of August 10, 2007.
The Debtors, eschewing the balance sheet test, maintain that as of the Petition Date, they only had approximately $200,000 in usable cash but were in debt approximately $20 million, not including the $160 million they owed the Noteholders.
This Court finds that the appropriate solvency test under these facts is the adjusted balance sheet test, which is the test used by Solomon and which, more importantly, is the traditional bankruptcy test of insolvency. See H.R. No. 100-11, 100th Cong.2d Sess. 5-6 (1988). The Debtors' argument that this Court should adopt an equitably insolvency test that applies under the Bankruptcy Code only in limited factual circumstances is unconvincing and appears to have been based on its outcome rather than on its appropriateness. In that regard, the Debtors have not cited any case that has applied the equitably insolvency test for the purpose offered here, and the Court has not found one. In applying the adjusted balance sheet test, this Court finds that the solvency of the Debtors at all relevant times was established to this Court's satisfaction by Solomon's expert testimony and other documentary evidence presented by the Claimants. The Debtors' liabilities clearly did not exceed their assets when those assets were valued according to their fair market price.
Because Claimants have shown that the Debtors were solvent, the Claimants are entitled to pursue an unsecured claim for damages under § 502 for the Debtors' breach of the Indenture. See United States v. Winstar Corp., 518 U.S. 839, 885, 116 S.Ct. 2432, 135 L.Ed.2d 964 (1996) (holding that damages are always the default remedy for breach of contract unless the parties agree otherwise); In re 360 Inns Ltd., 76 B.R. at 576; In re Lappin Elec., 245 B.R. at 330 ("this court is in agreement with a majority of courts that view a prepayment charge as liquidated damages, not as unmatured . . . interest that would be disallowed under section 502(b)(2)"). The issue then becomes the appropriate measure of damages, to which this Court now turns.
In a financing such as the Indenture sub judice, a "no-call" provision allocates between the borrower and the lender the risk associated with future interest rate fluctuations and provides an essential protection to the noteholder. As explained in the Commentaries on Model Debenture Indenture Provisions:
American Bar Foundation Corporate Debt Financing Project, Commentaries on Model Debenture Indenture Provisions 475 (1971). Based on the testimony offered at the Adversary Trial by the Claimants' damages expert, Christopher Kearns ("Kearns"), there is no dispute that, as a result of the prepayment of the Notes that occurred under the Plan, the Claimants were deprived of the present value of an expected payment stream under their Notes. Moreover, Kearns provided uncontroverted testimony that even assuming the Noteholders were able to reinvest the principal immediately, the market rate of yields on investments for comparable debt instruments was considerably less than the contract rate under the Indenture. Both Kearns and David Behenna, a financial consultant for PIMCO, further explained that, while one can calculate the spread between contract and market rates on comparable paper on a present value basis, it is difficult to quantify damages resulting from the delay and cost in finding alternative investments with comparable risk in which to reinvest the proceeds and the risks of having to a make second investment decision.
First, the Claimants contend that the defeasance clause provides the appropriate basis for awarding damages in the amount of $12,834,827. That amount is what § 12.01 required the Debtors to pay if they had chosen to be relieved from the obligations and covenants contained in the Indenture during the No-Call Period. Approaching damages in this way, according to the Claimants, gives effect to the benefit of the bargain struck by the parties to the Indenture. Indeed, the Claimants describe § 12.01 of the Indenture as an "alternative performance clause." See Carlyle Apartments Joint Venture v. AIG Life Ins. Co., 333 Md. 265, 635 A.2d 366, 372 (1994) (finding prepayment provision to be alternative performance clause rather than liquidated damages clause). Under that provision, the Debtors could have chosen to deposit with the Indenture Trustee cash or noncallable government securities "in such amounts as will be sufficient, without consideration of any reinvestment of interest, to pay and discharge the entire Indebtedness on the Notes not delivered to the Trustee for cancellation for principal, premium and Liquidated Damages, if any, and accrued interest to the date of maturity or redemption."
The Debtors contend, and this Court agrees, that defeasance under § 12.02 is inapplicable for two reasons. First, defeasance is a borrower's remedy, not a lender's
Second, § 12.01(2) required as a condition precedent to any defeasance that "no Default or Event of Default has occurred...." Thus, in order for the Debtors to have defeased the Notes, an event of default could not have existed. Am. Answer and Countercl. ¶ 22 (Adv. Pro. Dkt. 51); see CalGen, 365 B.R. at 399 (defeasance provision inapplicable because it provided that the debt could not be defeased if an event of default occurred and was continuing); Solutia, 379 B.R. at 488 (holding the defeasance clause was irrelevant since the debtors were not seeking to effect defeasance). Clearly, the Claimants asserted that events of default occurred both pre-petition and post-petition. See Indenture § 6.01(o); Amended Answer and Countercl. ¶¶ 28, 31 (Adv. Pro. Dkt. 51).
The Claimants contend that the Debtors could have sought a cure or waiver of the events of default in the Plan pursuant to § 1123(a)(5). Indeed, Sylvester testified at the confirmation hearing that the Noteholders would have agreed to waive any event of default if the Debtors had elected to defease the Notes.
In short, this Court concludes that applying defeasance in this case would run counter to both the plain meaning of the Indenture and to the fundamental tenets of defeasance itself. Given these circumstances, it is inappropriate for this Court to measure damages based upon the amount of the payment that the Claimants would have received if Debtors had exercised their right to defease, an amount that equals $12,834,827.
The second approach for the measure of damages urged by the Claimants is not based upon any specific provision in the Indenture but, rather, upon the present value difference between the market interest rate and the contract interest rate of 10.75% at the time the Notes were repaid. Kearns testified at the Adversary Trial that, as of August 2007, the market yield on investments comparable to the Notes-secured debt issued by gaming companies with profiles comparable to the Debtors
The Court finds that this second approach best approximates the Claimants' actual damages, taking into account that the Debtors would have exercised their option under § 3.07(b) of the Indenture to redeem the Notes on February 1, 2008, to reduce their debt costs. The Indenture expressly provides "[a]ll remedies are cumulative to the extent permitted by law,"
The final approach for the measure of damages, which was mentioned at the Adversary Trial only briefly,
"In a bankruptcy case, interest is the tail of the dog, but it is a long tail and it wags a lot." Dean Pawlowic, Entitlement to Interest under the Bankruptcy Code, 12 Bankr.Dev. J. 149, 150 (1995). Generally, where a debtor is insolvent, the Bankruptcy Code does not allow payment of post-petition interest on unsecured claims in a chapter 11 case. See Nicholas v. United States, 384 U.S. 678, 685, 86 S.Ct. 1674, 16 L.Ed.2d 853 (1966) ("the accumulation of interest on a debt must be suspended once an enterprise enters a period of bankruptcy administration beyond that in which the underlying interest-bearing obligation was incurred."); United Savs. Ass'n of Tex. v. Timbers of Inwood Forest Assocs. (In re Timbers of Inwood Forest Assocs.), 793 F.2d 1380, 1385 (5th Cir.1986) (generally, creditors are not allowed to recover interest that accrues on their debts during the pendency of a bankruptcy case); see 11 U.S.C. § 502(b)(2) (excluding "unmatured" interest from a creditor's allowed claim). There is an exception, however, in those rare instances where a debtor is solvent. See Debentureholders Protective Comm. of Cont'l Inv. Corp., 679 F.2d at 271 ("It is a general rule of federal bankruptcy law that if the alleged bankrupt proves solvent, creditors have a right to receive post-petition interest at the statutory general rate ... before any surplus reverts to the debtor."). The basis for the exception does not rest on the pre-petition contract between the debtor and its unsecured creditor, but instead rests on § 726, which provides for payment of interest at "the legal rate" prior to the return to the debtor of any surplus that exists after full payment of all claims having a higher priority. 11 U.S.C. § 726(a)(5)-(6). Section 726 applies indirectly to chapter 11 cases by virtue of the "best interests of creditors" test in § 1129, under which distributions proposed under a plan of reorganization under chapter 11 must at least equal the amount that would have been paid in a liquidation under chapter 7. See 11 U.S.C. §§ 1129(a)(7), 1225(a)(4), 1325(a); see also In re Schoeneberg, 156 B.R. 963, 972 (Bankr.W.D.Tex. 1993) (applying § 726(a)(5) in context of § 1129(a)(7)). Absent the solvency of a debtor and application of the "best interests of creditors" test, however, § 502(b) prohibits payment of any unmatured interest to unsecured creditors.
Because the Debtors in this case were solvent, the Court finds that the Claimants are entitled to interest on the amount of the premium owed them by the Debtors.
There is a split of authorities regarding the appropriate "legal rate" at which to calculate post-petition interest on unsecured claims in the context of a solvent debtor. Under the first approach, the legal rate is defined under state law and, accordingly, that interest is generally "payable either at the contract rate, at the statutory rate (if a specialized statute establishes a specialized rate of interest for a particular creditor), or, if there is no applicable statute and no rate was contracted for, at the state judgment rate." See Schoeneberg, 156 B.R. at 972. Under the second approach, the legal rate refers to a single uniform rate, the federal judgment rate established by 28 U.S.C. § 1961. See In re Melenyzer, 143 B.R. 829, 832 (Bankr. W.D.Tex.1992). The problem with the first approach, as explained in Melenyzer, is that under state law different rates of interest could apply to different unsecured creditors, depending on the terms of the pre-petition contracts and on the provisions of the applicable state statutes. Id. Indeed, this case illustrates the problem: Because the Plan defines a "General Unsecured Claim" to include interest at the federal judgment rate as of the Petition Date,
Finally, in balancing the equities of this case, this Court is mindful of the fact that the amount of post-confirmation interest that accumulated on this debt is in large part the result of a delay in the Adversary Trial. Although the Debtors initiated the Adversary on November 8, 2007, it was held in abeyance for over one year because of the Confirmation Appeal prosecuted at the behest of the Claimants. The purpose of § 726(a)(5), in providing for post-petition interest, is "to prevent debtors from abusing the bankruptcy process by using it to delay payments and avoid interest obligations when at the time of filing the petition the debtor was actually solvent." Thompson v. Kentucky Lumber Co. (In re Kentucky Lumber Co.), 860 F.2d 674, 676 (6th Cir.1988). Awarding the Claimants a default contract rate of
In short, the Court finds that the federal judgment rate approach, rather than the state law approach, provides the appropriate measure of interest and, therefore, post-confirmation interest on the amount of the premium should be calculated at the federal judgment rate in effect on August 10, 2007. See In re Country Manor of Kenton, Inc., 254 B.R. 179 (Bankr.N.D.Ohio 2000) (legal rate means federal judgment rate, not contract rate); In re Chiapetta, 159 B.R. 152, 160-61 (Bankr.E.D.Pa.1993) (a § 502 claim is "like a judgment entered at the time of the bankruptcy filing" and interest should be calculated at the federal judgment rate). The equities of the case favor this result, especially since the Claimants did not object to the application of the federal judgment rate in the Plan. Finally, applying the federal judgment rate promotes uniformity within bankruptcy law and is consistent with the approach of the United States Supreme Court in its decision in Till v. SCS Credit Corp., 541 U.S. 465, 124 S.Ct. 1951, 158 L.Ed.2d 787 (2004) (in selecting cramdown rates, courts should treat similar creditors similarly).
In summary, this Court finds that the Claimants have established that the Debtors breached the No-Call Provision in § 3.07 of the Indenture and that, therefore, the Noteholders are entitled to an unsecured claim under § 502(b) for damages against the Debtors, who were solvent at all relevant times under the adjusted balance sheet test. The amount of their damages is the present value difference between the market interest rate and the contract interest rate at the time the Notes were repaid with interest accruing at the federal judgment rate.
For the reasons set forth above, this Court concludes that the Noteholders are entitled to an allowed unsecured claim in the amount of $9,574,123, plus interest at the federal judgment rate in effect on August 10, 2007, from that date until paid in full but in no event are entitled to more than the amount in the Disputed Liquidated Damages Escrow. Accordingly, U.S. Bank should distribute the amount of the allowed unsecured claim to the Noteholders solely from the Disputed Liquidated Damages Escrow and should return any amount that remains to the Debtors. The Court further concludes that U.S. Bank should return to the Debtors any amount that remains in the Fee Reserve after final payment of the Indenture Trustee's
A separate final judgment will be entered in accordance with Federal Rule of Bankruptcy Procedure 7058.
SO ORDERED.
Id.
Id.
Indenture § 6.02, Trial Ex. 1.
11 U.S.C. § 101(5).
