Over the past decade, there have been several court rulings on whether particular set-off bonuses should be allowed as part of a creditor’s claim in bankruptcy, such as momentary,1 EFH,2 American Airlines,3 and Ultra Oil.4 While these and other decisions set out the legal standards to be applied and resolve the specific claims at issue, the decisions provide little guidance or clarity on the admissibility of comprehensive claims in future cases. In a recent decision by the Hertz bankruptcy case,5 the United States Bankruptcy Court for the District of Delaware allowed some relief claims, but denied others, continuing that uncertainty for future situations.
Offset premiums are amounts that the borrower/issuer is contractually obligated to meet, in addition to the full amount of obligations otherwise outstanding, if they choose to repay loans or repay obligations before their scheduled maturities. These premiums are designed to compensate lenders and bondholders for the loss of anticipated yield and are most often based on a formula tied to the present value of future interest payments that the borrower/issuer avoids by repaying the anticipated debt. Bankruptcy courts look to state law to determine whether such claims should be allowed as part of a bankruptcy claim.
In general, for a contract repair premium to have a chance of being recoverable in bankruptcy, it must be due and payable according to the wording of the underlying loan document or deed of obligation. Then, assuming the documentation authorizes the creditor for such recovery, various additional steps might be necessary, such as an analysis to determine whether the particular relief at issue could constitute a penalty (in which case it would not be recoverable) or whether it would be more appropriate to characterize them as damages (which may be recoverable in certain circumstances). In bankruptcy, courts also sometimes require that the compensation premium not be considered “unearned interest”, which is specifically denied in a bankruptcy claim under Bankruptcy Code 502 ( b) (2).
II. Bankruptcy court ruling in Hertz
Hertz, the car rental company, filed for bankruptcy in May 2020, after its revenue plummeted following the COVID-19 pandemic. The company considered several exit strategies and ultimately agreed on a reorganization plan that would fully repay its outstanding funded debt. The issue that resulted in litigation was whether the holders of various series of unsecured notes were entitled to payment of contractual compensation premium claims as part of this full payment.6
As part of a motion to dismiss such litigation, the Hertz The court focused on the first criterion in determining whether a set-off premium should be permitted in bankruptcy, that is, whether the wording of the trust indentures provided for such a payment in the circumstances. The indentures for certain Notes provided that the make-up premiums would become due and payable if there was a redemption prior to “maturity”. These notes automatically accelerated upon filing for bankruptcy, and so the court ruled that the subsequent repayment under the reorganization plan at the end of the bankruptcy case did not trigger a repair premium, as the notes had already “matured” as a result of filing for bankruptcy.7
The indentures of certain other notes provided that the make-up premiums would become due upon redemption at any time prior to a specified date, rather than at maturity. Since this certain date had not yet occurred, the court ruled that the compensation premium had been earned when the notes had been redeemed under the scheme and therefore met this allocation threshold. The court then noted that such claims could still be dismissed if the compensatory premium were to be determined to constitute the economic equivalent of the unearned interest, and the court requested additional factual evidence from the parties on this point.8
The main takeaway Hertz and other decisions referenced herein that may shed light on how the courts will deal with compensation premium disputes in future bankruptcy cases is that such claims stand no chance of being allowed unless the applicable provisions permit such claims do not entitle creditors to such amounts in the circumstances. Beyond that, any future forensic analysis will depend heavily on events and facts that have not yet occurred. For these reasons, interested parties should be careful not to rely on any single decision regarding the potential admissibility of future block reward claims and should be skeptical of any predictions regarding the outcome of any future litigation. Indeed, there is significant uncertainty that parties must consider when investing in debt securities that contain offset premium clauses, and it would not be advisable to assume that any particular offset claim will be permitted. in a future case of bankruptcy.