Committee's Attack Upon Lender's Make-Whole Premium Denied

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...