The linked Mintz Levin client advisory discusses a recent Third Circuit Court of Appeals ruling that held a “make-whole” optional redemption premium to be due upon a refinancing of corporate debt following its automatic acceleration upon bankruptcy. As noted in the linked advisory, the Second Circuit Court of Appeals also is considering this issue; whether it will come to the same conclusion remains to be seen. One way or another, these decisions will have spillover effect on judicial interpretation of optional redemption provisions in municipal bond transactions, and shine a spotlight upon the discrepancies between optional redemption provisions and other early payment provisions in most municipal bond indentures.

The Third Circuit case involved a debtor, Energy Future Holdings, that filed for bankruptcy for the explicit purpose of refinancing the debt at favorable interest rates while avoiding the hefty make-whole premiums payable upon an optional redemption of the refinanced notes. The bankruptcy court and the federal district court found nothing in the applicable corporate indenture requiring payment of a make-whole following an acceleration.  The Third Circuit reversed, interpreting the applicable corporate indenture’s “optional redemption” provisions to be applicable to the bankruptcy-triggered acceleration followed by repayment of the accelerated debt via a refinancing.

The Third Circuit’s ruling that the repayment following acceleration was an “optional redemption” may have been driven by the factual context of what could be characterized as an “optional bankruptcy” filed solely or primarily to jettison the make-whole payments and lock in lower rate replacement financing. The indenture’s acceleration provision was, as is usual, a remedial provision entirely separate from the indenture’s optional redemption provisions, and, as is typical but not universal, did not specify a premium to be due upon payment of the accelerated debt. Although once the accelerated payment was due there was nothing “optional” about paying it, the appellate panel opined that the payment on the applicable date was “optional” because the issuer chose to file for bankruptcy and chose not to deaccelerate the debt after the bankruptcy triggered the automatic acceleration.  The fact that the bondholders objected to repayment without a make-whole premium also seems to have factored into the court’s determination that the payment by the issuer was “optional.”

The federal appellate court also concluded that under New York law a “redemption” may occur at or before maturity of bonds, and that therefore a “redemption” is not synonymous with a prepayment.  (Indeed, the court suggested that if the make-whole premium had been labeled a “prepayment” premium rather than an “optional redemption” premium, it may have held the make-whole inapplicable, a curious distinction that leads back to the question of under what circumstances payment of an amount that has become due can be deemed optional.) The court disregarded indenture provisions that were technically inconsistent with its determination that the payment was an “optional redemption”, such as the optional redemption requirement of prior notice from the issuer to the bondholders. According to the court: “[The issuer] offers no reason why it could not have complied with [the redemption] notice procedures. In any event, it cannot use its own failure to notify to absolve its duty to pay the make-whole.”

By interpreting the indenture’s optional redemption provisions as applicable to the payment of the accelerated debt, the Third Circuit panel mooted and declined to address the noteholders’ alternate argument that the bankruptcy court should have granted relief from the bankruptcy stay to permit the bondholders to deaccelerate the accelerated debt. Whether that would have provided a more straightforward means of getting to the same result is debatable, as debt generally is deemed accelerated upon a bankruptcy whether or not it is contractually accelerated by the terms of the indenture.

The optional redemption provisions that are typical in municipal bond indentures refute the equivalence found by the Third Circuit between an optional redemption and a payment after acceleration. In contrast to the permissibility in corporate transactions of optional redemption at any time at a make-whole premium, the norm in municipal bond transactions is a lockout period (often 10 years) during which optional redemption is impermissible, followed by a declining fixed optional redemption premium. The fact that municipal indentures permit acceleration whenever there is an event of default, including upon bankruptcy, while imposing a lockout period for optional redemption, suggests that in the municipal bond context there may be less receptiveness by courts to the notion of deemed equivalence between an optional redemption and a payment following acceleration. Accordingly, a court may be less likely to deem an optional redemption premium applicable to a post-acceleration payment on a municipal bond absent express language requiring a premium in a post-acceleration context.

Whether corporate or municipal bonds are at issue, the best way to ensure the intended result is to draft clearly and specifically.  Municipal bond indentures often permit or require bonds to be paid ahead of schedule not only upon acceleration but upon a so-called extraordinary redemption.  These provisions, which typically permit payment ahead of schedule at par, are infrequently deployed relative to optional redemption provisions. Use of bankruptcy as a means of avoiding a prepayment premium is less likely in the municipal context, where the prepayment premium is typically 3% or less versus the often substantially larger make-whole premium, but “default refundings” of municipal bonds have been attempted to circumvent the optional redemption lockout period. There is no difference in the economic impact to a bondholder of early payment, no matter the degree of optionality or lack of optionality from the issuer’s perspective, and whether an early payment premium is expressly provided by the indenture in cases other than “optional redemption” is primarily a risk allocation question.

Drafting acceleration provisions and/or extraordinary redemption provisions in a manner that applies an equivalent premium to the optional redemption premium upon their exercise during the post-lockout period, and a make-whole or other premium during the optional redemption lockout period, provides better protection against any perceived risk of abuse of those provisions than reliance on the courts to figure out what the parties intended and/or is equitable in borderline scenarios.


The linked Mintz Levin client advisory, which discusses a recent bankruptcy court ruling regarding the applicability of a make-whole premium upon a refinancing of corporate debt following such debt’s automatic acceleration upon bankruptcy under the terms of the governing documents, may also be of interest to holders of municipal bonds with call protection and/or early redemption premiums.  In  the context of make-whole premiums, court decisions suggest that the applicability of the premium upon a refinancing in bankruptcy will be governed by the wording of the debt documents, and that if an automatic acceleration  is triggered by the documents and the documents do not expressly provide for a prepayment premium in such circumstances, no prepayment premium will be payable by the issuer.  Municipal bonds typically feature fixed percentage optional redemption premiums rather than make-whole premiums, but courts may also be inclined to apply to municipal bonds the principle that such early redemption premiums are inapplicable upon an acceleration absent express contract language applying the premium in that context (or, as some courts have suggested, absent evidence that the issuer deliberately defaulted for the purpose of circumventing the call protection provisions.)


Following the advent of Build America Bonds (BABs) in 2009 and securities law rulemaking that has resulted in the posting of virtually instantaneous trading data on the EMMA website ( hosted by the Municipal Securities Rulemaking Board (MSRB), the IRS has repeatedly expressed concerns about how initial offering prices (a/k/a “issue prices”) on municipal bonds are determined on the primary market and whether certifications of such prices for tax purposes are correct.

Why the concern? Why has this concern been exacerbated in recent years? Why hasn’t the IRS addressed its concern by publishing new regulations?

The “issue price” determines the yield, for tax purposes, on the bonds. The lower the issue price for bonds bearing a stated interest rate, the higher the yield. IRS regulations specify that the issue price for tax-exempt bonds is, for each maturity, the first price at which ten percent of bonds is sold to parties other than underwriters. For a bona fide public offering of all of the bonds, issue price can be established based on reasonable expectations on the sale date. Typically, issuers rely upon issue price certifications provided at closing by the underwriters.

An erroneous issue price can cause the US Treasury to lose tax revenues. In the case of tax-exempt bonds, an erroneously low issue price may create an erroneously high bond yield and result in the issuer retaining impermissible arbitrage on taxable investments made with tax-exempt bond proceeds. In the case of BABs, a requirement of the federal subsidy is that the issue price cannot be higher by more than a de minimis amount than the par amount of the bonds. Accordingly, a determination by the IRS that the “issue price” was erroneously calculated could cause loss of tax-exempt status in the case of tax-exempt bonds and loss of subsidy in the case of BABs.

The IRS’s concerns with issue price first surfaced in the context of 32 BAB audits. Two factors account for the concern. First, a correct issue price is particularly critical in the context of BABs, because of Code Section 54AA(d)(2)(C)’s limitation on the amount of premium. Second, the relatively recent availability of live trade data on EMMA has made it increasingly feasible to spot what may appear to be discrepancies between issue price certifications delivered by underwriters upon issuance of bonds and the prices at which bonds are traded shortly after, and sometimes shortly before, such certifications are delivered.

In some of the BAB audits, the IRS observed suspicious trading activity which it still appears to be investigating. The suspicious activity included situations where (1) a portion of a maturity is sold at the initial offering price and another portion is sold at higher prices; (2) a portion of a maturity remains unsold by the underwriter with the rest sold at prices above the initial offering price; and (3) dealers purchase all or a portion of a maturity and quickly resell at higher prices in what appears to be the primary market. A common theme seems to be a trend of increasing prices when the public buys on the secondary market, sometimes on the same day the bond purchase agreement is signed by the underwriter.

In response to its concerns the IRS has launched two compliance check initiatives to educate issuers and learn more about how issuers “due diligence” the issue price on their bonds. In addition, the IRS has reached an agreement with the MSRB, announced on October 24 (see the MSRB press release), to allow the IRS access to the MSRB’s internal regulatory website, with its up-to-date trade data, and to other information available to enforcement agencies (such as FINRA) that the MSRB works with to regulate the municipal market. The IRS’s agreement with the MSRB regarding such access includes an acknowledgment that the MSRB’s regulatory website is designed to help administer the securities laws and not the tax laws and that its market data may be incomplete for federal tax purposes. For example, the data reported to the MSRB does not always distinguish between sales to dealers and sales to the “public.”

So far, the IRS seems to have learned that most issuers rely on the issue price certificate provided by the underwriters to establish issue price without further due diligence. The IRS’s compliance check initiatives contain questions relating to procedures an issuer uses to review available trading data to confirm compliance with federal tax requirements. These questions appear to encourage issuers to look behind the issue price certificate and to use publicly available municipal market data, such as data available on EMMA, to spot problems. In light of this increased scrutiny by the IRS of trade data, issuers, out of an abundance of caution, are well advised to review trading data on EMMA and to raise any questions with their underwriters and bond counsel whenever such data shows a quick uptrend on and immediately after the sale date and before the bond closing. Downtrends in issue price would tend to indicate that an issuer received excellent pricing on the sale date, a scenario the IRS is unlikely to question.

At this time, there is confusion about how much and what type of diligence an issuer must do on issue price, as well as on the facts about which sales are meaningful for purposes of issue price determinations. The bond community is still waiting for the IRS to solve these issue price conundrums by writing more manageable regulations which will help issuers more easily identify the line between the primary and secondary market and any requirements for testing issue price certifications.