Second Circuit Overturns Ruling on Cram-Down Interest Rates in Momentive



  • Adopts Sixth Circuit Test for Selecting Interest Rate
  • Affirms District and Bankruptcy Court Determinations Regarding Senior Debt Status and Disallowing Make-Whole Payments
  • Rejects Debtor’s Equitable Mootness Argument

On October 20, 2017, the Second Circuit issued its long awaited ruling[1] on several appeals from a U.S. District Court (Bricetti, J.) determination affirming the United States Bankruptcy Court (Drain, J.) in the MPM Silicones, L.L.C. (“Momentive”) bankruptcy case.[2]   The Second Circuit rejected the lower court rulings applying a “formula rate” of interest to cram-down paper issued to senior secured lenders under the Momentive plan of reorganization and remanded the case to the bankruptcy court with instructions to apply an “efficient market rate” of interest if one could be ascertained. 

The appellate court affirmed the rulings of the lower courts, upholding the senior status of the Momentive second lien debt vis-à-vis the company’s subordinated debt (although for slightly different reasons than the lower courts) and disallowing make-whole payments on the senior debt under the provisions of the applicable agreements.  The Second Circuit also rejected Momentive’s request that the appeals be dismissed on equitable mootness grounds.

The decision is good news for senior lenders and aligns the Second Circuit with prior rulings of the Fifth and Sixth Circuit courts of appeal.  It will be interesting to see how the bankruptcy court will apply the Second Circuit’s directive in light of the fact that at the time of the confirmation hearing, Momentive had secured bids for takeout financing on the senior notes at interest rates ranging between 5 and 6+%.


Momentive, one of the world’s largest producers of silicone and silicone derivative products, filed a chapter 11 bankruptcy case in April 2014. At the time of its filing, Momentive had outstanding senior secured notes (referred to as the “senior lien notes”), second lien notes, and subordinated notes. The senior lien notes consisted of two series, one in the principal amount of $1.1 billion with an 8.875% interest rate (referred to as the “first lien notes”), and the other in the principal amount of $250 million with a 10% interest rate (referred to as the “1.5 lien notes”). Both series were to mature on October 15, 2020. The senior lien notes included a make-whole premium due upon voluntary redemption of the notes prior to October 15, 2015. As of the bankruptcy filing, the make-whole premium had a value of approximately $200 million.

Momentive’s chapter 11 plan offered two alternative treatments for the senior lien notes. If the holders of the senior lien notes voted to accept the plan, they would be paid all principal and accrued interest on the senior lien notes in full, in cash, upon the plan’s effective date, but would waive any right to receive a distribution in respect of the make-whole premium (the “Cash-Out Option”). Momentive had gone to the market and obtained proposals to fund the Cash-Out Option, which carried interest rates of between 5 and 6+%.

If the senior lien note holders rejected the cash option and sought to enforce the make-whole claim, the debtor proposed to provide cram-down paper paying the first lien notes over 7 years at an interest rate equal to the 7-year Treasury rate plus a 1.5% risk premium, totaling approximately 3.6% as of the confirmation hearing. The 1.5 lien notes would be paid over 7 ½ years, at the 7 ½-year Treasury rate plus a 2% risk premium, totaling approximately 4.1% as of the confirmation hearing.

Momentive’s plan gave holders of second lien notes equity in the reorganized company and paid nothing on the subordinated notes. The holders of the senior lien notes rejected the plan and challenged Momentive’s proposed interest rate on the cram-down paper and Momentive’s attempt to avoid payment of the make-whole premium. The bankruptcy court confirmed Momentive’s plan,[3] imposing a slightly increased rate on the cram-down paper and denying the make-whole claim in its entirety.[4]

Calculating Cram-Down Interest Rates

Section 1129(b)(1) of the Bankruptcy Code provides that a plan of reorganization may be confirmed over the rejection of the plan by an impaired class of creditors (“cram-down”) if, among other things, the plan is “fair and equitable” with respect to such rejecting class.  The question whether a plan is fair and equitable with respect to a class of secured claims is governed by section 1129(b)(2)(A).  That provision specifies that a plan is fair and equitable to a rejecting impaired class of secured claims if the creditors receive one of three alternatives: (i) their liens remain in place, and they receive new notes worth at least as much as their secured claims, (ii) their liens attach to the proceeds of any third-party sale of the collateral securing the lenders’ secured claims, or (iii) they receive the “indubitable equivalent” of their secured claims.

The Second Circuit addressed the first of these tests: the appropriate methodology for determining whether a secured note issued under a plan is worth at least as much as the rejecting class’s secured claim. The senior lien note holders objected to the proposed treatment under the plan and argued for the application of an “efficient market” approach that would apply an interest rate that lenders in the market would charge Momentive on a similar new loan.  Only this, they argued, would provide the true equivalent of a cash payout of their secured claims on the effective date of the plan. The senior lien note holders argued that the rate that would be produced in an efficient market was readily discernible, as evidenced by the rate obtained by Momentive on the proposals to fund the Cash-Out Option provided under the plan.

Interpreting precedent from the Supreme Court (Till v. SCD Credit Corp.)[5] and the Second Circuit (In re Valenti),[6] the lower courts had concluded  that the “formula approach,” under which a “risk premium” of 1‑3% is added to a base interest rate, was the correct method for determining a cram-down interest rate.  The district court acknowledged that both Till and Valenti involved the restructuring of fully encumbered auto loans of individual chapter 13 debtors where no established market for such loans existed, and that Till specifically posited that it might make sense in a chapter 11 case to “ask what rate an efficient market would produce.”[7]   That court concluded, however, that bankruptcy courts in the Second Circuit (unlike courts in the Sixth Circuit) were compelled to apply the formula approach as a matter of Second Circuit precedent in Valenti.  The Valenti court had stated that the function of interest payments under a bankruptcy plan is to provide creditors with the present value of their claims, “not to put the creditor in the same position that it would have been in had it arranged a ‘new’ loan,”[8] which would likely be an arm’s-length transaction resulting in a degree of profit for the lender.[9]

The Second Circuit rejected the lower court rulings and adopted the test applied by the Sixth Circuit in American HomePatient.  The American HomePatient court had ruled that when considering the appropriate interest rate on cram-down paper to be issued under a chapter 11 plan, a market rate should be applied where an efficient market exits and a formula rate should be applied only where an efficient market does not exist.[10]  The Second Circuit stated that “where, as here, an efficient market may exist that generates an interest rate that is apparently acceptable to sophisticated parties dealing at arms-length, we conclude, consistent with footnote 14 [of Till], that such rate is preferable to a formula improvised by the court,” and seemingly rejected, at least in situations where an efficient market exists, the lower courts’ determination that market rates contain an “imbedded profit.” [11]  The Second Circuit remanded the case to the bankruptcy court with instructions that it ascertain whether an efficient market rate exists “and if so, to apply that rate instead of the formula rate.”[12]

Subordinated Debt and Make-Whole Premiums

The Second Circuit affirmed the rulings of the lower courts, determining that the second lien debt constituted senior debt under the applicable subordination agreements and that the make-whole provisions of the senior lien notes had not been triggered by the bankruptcy filing.

Determination of Senior Debt Status

The Second Circuit upheld the lower court rulings that the second lien debt constituted senior debt under the applicable subordination agreements but did not agree with the lower court determinations that the terms of the applicable agreements were unambiguous.  Rather, the Second Circuit found that the agreements were, indeed, ambiguous and thus looked to extrinsic evidence to determine the intention of the parties.  Based on numerous public disclosures by Momentive regarding the status of the subordinated notes being junior in right of payment to the second lien notes, the court concluded that the parties all understood that the second lien notes constituted senior debt.[13]

Denial of Make-Whole Premium

The Second Circuit affirmed the rulings of the lower courts, concluding that the automatic acceleration of the senior lien notes upon the bankruptcy filing did not trigger a voluntary prepayment or an early redemption of the notes because, among other reasons, the commencement of the bankruptcy proceedings moved the maturity date of the notes up to the petition date, thus rendering any subsequent payment a “post-maturity payment.”[14]  In addition, like the lower courts, the Second Circuit left open the possibility that a make-whole premium may be allowed where the applicable documentation contains explicit and unambiguous language providing for a make-whole payment following default and acceleration of a debt upon a bankruptcy filing.[15]

Equitable Mootness

The Second Circuit also rejected Momentive’s motion to dismiss the several appeals from the district court rulings as equitably moot.  The court noted the exception to the general presumption that an appeal from a substantially consummated plan is equitably moot[16] where five factors first identified in In re Chateaugay Corp., 988 F2d 322 (2d Cir. 1993) (“Chateaugay II”) are met: “[W] here (i) effective relief can be ordered;  (ii) relief will not affect the debtor’s re-emergence; (iii) relief “will not unravel intricate transactions”;  (iv) affected third-parties are notified and able to participate in the appeal; and (v) appellant diligently sought  a stay of the reorganization plan.”[17] Based upon the limited nature of the remand order to the bankruptcy court, which was acknowledged by Momentive to potentially require, at most, an  additional payment of $32 million over seven years, the Second Circuit concluded that any potential relief that might be provided by the bankruptcy court on remand would not “materially implicate the concerns identified in Chateaugay II.”[18]

If you have any questions about any of the topics discussed in this advisory, please contact your Orrick attorney or any of the following attorneys:

Evan Hollander, Raniero D’Aversa, Lorraine McGowen, Laura Metzger and Douglas S. Mintz
[1] Momentive Performance Materials Inc. v. BOKF, NA (In re MPM Silicones, L.L.C.), __ F.3d __, 2017 WL 4700314 (2d Cir. Oct. 20, 2017).

[2] In re MPM Silicones, LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014) aff’d 531 B.R. 321 (S.D.N.Y. 2015).

[3] In re MPM Silicones, LLC, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014).

[4] The bankruptcy court determined that Momentive should amend its plan to include an additional risk premium (and the district court affirmed this finding). This resulted in an 0.5% increase to the 1.5% risk premium previously proposed by Momentive for the $1.1 billion first lien notes (resulting in a 4.1% interest rate) and a 0.75% increase to the 2.0% risk premium for the $250 million 1.5 lien notes (resulting in a 4.85% interest rate).

[5] 541 U.S. 465 (2004).

[6] 105 F.3d 55 (2d Cir. 1997).

[7] Till, 541 U.S. at 476 n. 14.

[8]In re MPM Silicones, LLC, 531 B.R. at 333 (citing Valenti, 105 F.3d at 63-64).

[9] “(W)hether the market for a loan is truly efficient or not has no bearing on the Second Circuit’s mandate in Valenti that the Bankruptcy Code does not intend to put creditors in the same position they would have been in if they had arranged a new loan.” In re MPM Silicones, LLC, 531 B.R. at 333.  Cf. In re American HomePatient, 420 F.3d 559 (6th Cir. 2005), (holding that the market rate was to be applied where an “efficient market” existed, and the “formula” rate should be applied in those cases where such a market does not exist).

[10] 2017 WL 4700314 at *9 (citing American HomePatient, 420 F.3d 559, 568 (6th Cir. 2005) cert. denied, 549 U.S. 942 (2006)).

[11] Id. at *10. (Interestingly, the Second Circuit cited its prior ruling in Valenti for the proposition that “the goal of the cramdown rate ‘is to put the creditor in the same economic position that it would have been had it received the value of its allowed claim immediately”‘ but declined to clarify other statements in Valenti upon which the district court had relied. (e.g.,  “[T]he value of a creditor’s allowed claim does not include any degree of profit.  There is no reason, therefore, that the interest rate should account for profit. . . .  Otherwise, the creditor will receive more than the present value of its allowed claim.”)  In re MPM Silicones, LLC, 531 B.R. at 333 (citing Valenti, 105 F.3d at 63).

[12] 2017 WL 4700314 at *10.  The court specifically noted that it was not directing the bankruptcy court to arrive at any particular outcome on remand.

[13] The court also noted that the interpretation urged by the subordinated note holders would have generated an irrational outcome that would have stripped all debt in the company’s capital structure of senior debt status.  This was because the subordinated note holders argued that the terms of the applicable agreements provided that only debt that was not subordinated to any other debt “in any respect” constituted senior debt.  The Second Circuit noted that all debt in the company’s capital structure was in some manner subordinated to some other debt.

[14] 2017 WL 4700314 at *11.

[15] The fundamental purpose of a make-whole premium is to protect bargained-for interest rates when market rates subsequently decline during the term of the loan. Essentially, make-whole premiums are intended to discourage borrowers from refinancing debt to take advantage of lower rates, thereby forcing an existing fixed-rate lender to redeploy funds at the lower, then-prevailing market rate. Make-whole premiums are intended to compensate lenders for the difference between their original contract rate and the subsequently prevailing market rates.

[16] In re BGI, Inc., 772 F.3d 102, 104 (2d Cir. 2014).

[17] 2017 WL 4700314 at *13 (citing In re Charter Commc’ns. Inc., 691 F.3d 476, 482 (2d Cir. 2012)).

[18] Id.