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UPDATE – After Trial And Despite Likelihood Of Success On The Merits, Bankruptcy Court Holds No “Cause” To Lift Automatic Stay, Ending Make-Whole Adversary Proceeding in EFH

Delaware Trust Co. v. Energy Future Intermediate Holding Co. (In re Energy Future Holdings Corp.), Adv. Pro. No. 14-50363 (CSS), — B.R. — (Bankr. D. Del. July 8, 2015)

Previously, the Delaware Bankruptcy Court determined that an evidentiary hearing was necessary on the issue of whether “cause” exists to lift the automatic stay with respect to the make-whole dispute.  For a general background of the facts and law, see our recent blog post here.  Now, after a three-day trial, Judge Sontchi has held that, under the totality of the circumstances, cause does not exist to lift the automatic stay to allow the Trustee* to waive the default, decelerate the Notes, and collect the Applicable Premium (the make-whole payment).  The Court recognized the great prejudice to the Debtors’ estates (which includes its equity holders and creditors of all Debtors) as well as the demonstrated fact that the harm to the creditors cannot “substantially outweigh” the harm to the Debtors’ estates.  The Court stated that given these circumstances “relief from the automatic stay is almost certainly unavailable, regardless of the creditor’s likelihood of success on the merits.”  Op. at 38.  Moreover, the Court made a further broad ruling that may have significant effects on how notes such as these are drafted:  “The Court is cognizant that its ruling makes it extremely unlikely that a creditor operating under a contract with provisions substantially similar to section 6.02 of the Indenture will be able to obtain relief from the automatic stay to waive a default arising from an issuer’s bankruptcy filing and to rescind acceleration.”  Op. at 37.  The Court went on: “That is not to say that a creditor can never successfully pursue a make-whole claim.  For example, unlike in this case, an indenture might provide for payment of a make-whole claim in a manner that does not implicate the automatic stay.  Whether such a claim would be successful is an issue for another day.”  Op. at 38.

For those that carefully studied the Court’s previous Opinion, this holding does not come as a surprise.  Judge Sontchi echoed in this ruling an important observation from his previous Opinion:  that lifting the stay may harm even a solvent debtor.  Op. at 21, 23.  Significant to this decision, the Court made clear that the entire estate must be considered, which is defined broadly to include equity holders and creditors from both sides of the corporate structure, when determining prejudice to the Debtors and weighing the relative harms to the Noteholders and the Debtors.  Once that principle is recognized, it is easy to accept that $431 million leaving the Debtors’ estate would cause great prejudice to the recoveries of all stakeholders.  Coupled with the fact that at best the relative harms are equal (and rejecting a “creative but unpersuasive” argument for harm based on percentages), the Court came to the logical conclusion—cause does not exist on these facts.

It was also evident through reading the ruling that the Court was not sympathetic to the Noteholders, which it described as “sophisticated investors” and “hedge funds engaged in litigation arbitrage.”  Op. at 33.  To add insult to injury, the facts showed that some of the Noteholders continued to buy up the Notes knowing that the Debtors would seek to refinance in bankruptcy and that the make-whole dispute would be litigated.  Op. at 11-13, 33.  Even more, the Court noted on several occasions the Noteholders had opportunities to mitigate their losses and choose not to.  Op. at 12, 13, 19, 30-31.  The Court seemed to consider these facts as showing minimal harm to the Noteholders’ expectations.

In the end, “the Trustee and the Noteholders…did not bargain for a make-whole premium in the event of an automatic acceleration following an event of default as a result of a bankruptcy filing by the EFIH Debtors, but they could have.”  Op. at 35.  They “must live with the consequences of their bargain.”  Id.

* All defined terms have the meaning ascribed to them in the previous blog post.