In its second go-around before the Court of Appeals for the
Second Circuit, Chesapeake Energy Corp. was required to pay
noteholders a make-whole of $440 million for its 2013 early
redemption of senior notes. The notes, with a total value of $1.3
billion, were issued in 2012 at 6.775% and were scheduled to mature
in 2019. The supplemental indenture provided Chesapeake with two
separate redemption rights. Under 1.7(b), Chesapeake could conduct
a Special Early Redemption at a special redemption price of par
plus accrued interest. Under 1.7(c), Chesapeake was obligated to
pay a customary make-whole if it redeemed at "any time after
March 15, 2013, to the Maturity Date." In either case, the
supplemental indenture required Chesapeake to provide 30 to 60
days' notice to holders before commencing a redemption.
In the face of falling interest rates, Chesapeake announced on
February 20, 2013, that it planned to redeem the notes at the
special redemption price. Although there were less than 30 days
before the March 15 deadline, the company asserted that March 15
was the deadline to give notice to holders of the Special
Early Redemption, not the deadline for the redemption itself. On
this basis, the company sought a declaratory judgment from the
District Court that it was exempt from paying the make-whole.
The District Court ruled in favor of Chesapeake in May 2013, and
the company completed the redemption several days later. However,
BNY Mellon, the indenture trustee for the notes, succeeded on
appeal in 2014 in having the ruling overturned by the Second
Circuit. The Second Circuit rejected the company's
interpretation of the indenture, holding that the notes could only
be redeemed at par if the redemption itself was completed,
upon 30 to 60 days' notice, no later than March 15, 2013. Thus,
Chesapeake's providing notice on February 20 precluded the
redemption from qualifying as a Special Early Redemption. The
Second Circuit remanded to the District Court to determine just how
much the company owed noteholders.
On remand, Chesapeake asserted that it did not have to pay the
make-whole as calculated under the indenture, which used the rate
on Treasury notes of a comparable term plus 50 bps as the discount
rate for calculating the present value. It argued that an
equitable, or "restitutionary," measure of damages was
appropriate, on the grounds that it had attempted a
Special Early Redemption in good faith. The noteholders should be
economically returned to the position they would have been in had
there been no redemption – by giving them the economic
equivalent of the interest payments they would have received to
maturity – but no better. On this theory, Chesapeake
maintained, present value should be determined based on a market
discount rate, which would generate a smaller present value. The
company relied on cases that awarded restitution to defendants who
forfeited money under compulsion of a trial judgment and later
prevailed on appeal. By analogy, Chesapeake argued that it
conducted the redemption in reliance on the District Court's
initial ruling that it qualified as a Special Early Redemption,
which was later reversed on appeal.
The District Court ruled against the company in July 2015,
explaining that restitution is commonly utilized in circumstances
where no contract defines the litigants' relationship. The
notes, in contrast, were governed by a valid and enforceable
indenture, which did not have a carve-out for botched early
redemptions, even a failed redemption made in good faith.
In a brief decision, the Second Circuit recently affirmed the
District Court's holding that Chesapeake was obligated to pay
the make-whole prescribed by the indenture. The Second Circuit
reiterated the lower court's basic premise that, where a valid
and enforceable contract governs the relevant subject matter, the
equitable remedy of restitution is generally not appropriate. It
also observed that substituting out the prescribed make-whole on
equitable grounds would confound investors' valid expectations.
The appellate court's ruling ends Chesapeake's attempts to
avoid paying the make-whole premium. The result will be costly for
Chesapeake – $380 million plus prejudgment interest, for a
total of $440 million.
While there is not much that is surprising in the end game of
Chesapeake's failed attempt to evade its contractual
obligations under the indenture, the basic lessons remain the same.
Indentures will be strictly construed in accordance with their
terms. Reliance on a lower court decision will not excuse failure
to perform under the terms of the indenture, as ultimately
interpreted by an appellate court. And restitutionary damages,
formulated to approximate actual damages suffered by noteholders,
will not be substituted for the express payment obligations of the
issuer under the indenture.
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