The United States Bankruptcy Court for the District of Delaware (the “Court”) recently upheld a $23.7 million make-whole payment (the “Make-Whole Payment”) in In re School Specialty (Case No. 13-10125), denying the assertion by the Official Committee of Unsecured Creditors (the “Committee”) that the fee is unenforceable under the United States Bankruptcy Code and applicable state law.

In May of 2012, School Specialty Inc. (“School Specialty”) borrowed $70 million from Bayside Finance LLC (“Bayside”) pursuant to a credit agreement containing a make-whole provision designed to ensure that Bayside would receive its bargained-for yield in the event that School Specialty prepaid the loan.

Less than a year later, School Specialty breached the credit agreement’s minimum liquidity covenant, which triggered the borrower’s obligation to make the Make-Whole Payment. The parties thereupon entered into a forbearance agreement, which recognized the borrower’s obligation for the Make-Whole Payment.

Shortly thereafter, School Specialty filed a chapter 11 bankruptcy petition and sought an order approving debtor-in-possession financing to be provided by Bayside (the “DIP Loan”). The DIP Loan request acknowledged School Specialty’s debt to Bayside, including a roll-up of the prepetition indebtedness into the post-petition DIP loan and the Make-Whole Payment. The Court approved the DIP Loan on an interim basis. Shortly thereafter, the United States Trustee appointed the Committee and the Committee thereupon filed a motion seeking to disallow the Make-Whole Payment claiming, among other things, that the Make-Whole Payment was an unenforceable penalty under New York state law because the amount was disproportionate to Bayside’s probable loss, the payment was an unreasonable fee under federal bankruptcy law, and the payment constitutes a claim for unmatured interest.

The Court denied the Committee’s motion and upheld the Make-Whole Payment. Under the basic federal rule in bankruptcy that state law governs the determination of property rights in the assets of a debtor’s estate, the Court applied New York law to analyze the enforceability of the Make-Whole Payment. The Court determined that prepayment premiums, such as the Make-Whole Payment, are enforceable under New York law: (1) when the actual damages are difficult to determine, and (2) the sum is not plainly disproportionate to the possible loss considering the reasonableness of the damages determined at the time of contract, not at the time of breach. In considering whether the amount of the Make-Whole Payment was plainly disproportionate to Bayside’s possible loss, the Court determined that the fee was calculated so that the lender would receive its bargained-for yield and the fee was the result of an arms-length transaction with which the Court should not interfere.

The Court next held that that, even if the reasonableness standard applicable to fees under 11 U.S.C. § 506(b) is applicable to the Make-Whole Payment, such payment satisfied this standard because it was not an enforceable penalty nor plainly disproportionate to Bayside’s probable loss.

Finally, the Court held that the Make-Whole Payment was not a claim for unmatured interest, siding with the majority view that make-whole premiums should be analyzed as prepayment penalties rather than claims for unmatured interest.

By endorsing the general trend upholding make-whole payments when the credit agreement is clear and unambiguous, the stipulated amount is not plainly disproportionate to the lender’s potential loss, and the contract was the product of an arm’s length negotiation, the School Specialty decision should provide comfort to lenders that elect to structure and price their credit agreements using make-whole premiums.


Alan H. Martin, Practice Group Leader
714.424.2831 (office)

Edward H. Tillinghast, III
, Practice Group Leader
212.634.3050 (office)

Todd L. Padnos
, Editor
415.774.2938 (office)