A federal bankruptcy judge’s ruling in a closely watched corporate case seems to have made the distressed debt market a bit unhinged.
This week, Judge Robert D. Drain issued a ruling on the bankruptcy exit plan of Momentive Performance Materials, a specialty chemicals manufacturer owned by the private equity firm Apollo Global Management
As part of the ruling, the judge said that senior debtholders did not have to be paid a make-whole call payment provided for in their bonds. As reported by The Daily Bankruptcy Review, one analyst, seeking to get in good with the bankruptcy bench, went so far as to call the ruling “made up.”
The same article said that the ruling influenced the prices of other bankrupt issuers. (Speculating about market price movements is always a bit dicey, despite its long, illustrious history).
The irony is that until a few years ago, bankruptcy experts would have been shocked if anyone had argued that bondholders were entitled to a make-whole payment in a Chapter 11 case. Of course, that was in an age when traded debt was still mostly unsecured, and bondholders would have been happy to simply get paid full principal and interest.
As a general matter, in the world of traditional unsecured bonds, a callable bond will trade for less than its noncallable equivalent. The reason is straightforward: The callable bond gives the issuer the option to refinance, and the noncallable bond provides the investor with more likelihood of obtaining all of the expected cashflows.
A “make whole” call provision essentially splits the difference: The bond issuer retains the option to refinance, but must hand over most of the benefits of refinancing to the investors by paying them approximately what they would have received if the bond had not been called early.
In the “good ol’ days,” unsecured bondholders were often converted to equity, and there really was not much point in arguing over whether they should get the “make whole” payment too, because they were getting the equity no matter what.
The trick is that in the present case – as with many recent Chapter 11 cases – the fight is among differing layers of secured creditors. The rules for secured creditors are somewhat different.
If the bankruptcy reorganization plan in the Momentive case had been accepted, the senior creditors would have received cash. Because they objected, and the second lien creditors were getting the new equity, the bankruptcy code’s cramdown rules were invoked.
In the case of a secured creditor, these rules essentially provide that the objecting creditor must be paid in full. The question then was whether the “make whole” payment was part of getting paid in full.
The court said “no,” which is what has the distressed debt world in such a dither.
The judge’s basic argument was that a bankruptcy default was not the same thing as an early payment. Judge Drain left open the possibility that a future agreement might provide for a “make whole” payment as part of a bankruptcy claim, but he wanted to see that expressly set forth in the contract.
In short, rather than read the indenture to provide what distressed debt investors wished it said, the judge read the agreement as written. Given the long line of corporate finance cases that essentially say “if you want protection, spell it out in the contract,” that hardly seems unreasonable.
I get that the senior creditors want to make the junior creditors – who in this case are also the old shareholders, including Apollo Global Management – pay top dollar to keep equity of the reorganized company. Apollo has been playing hardball in a series of situations to save its investments in other over-indebted companies, and one would assume that in the future, Apollo-backed companies will pay a premium as a result.
But sometimes the contract actually governs, despite what we hope or wish it says.