In an article published in 2007, two lawyers from our firm predicted that “the validity and application of prepayment clauses will continue to be the source of bankruptcy litigation, especially in low interest rate environments.”[1] How true that was. In recent years, there has been substantial litigation concerning the enforceability of prepayment penalties, or “make-wholes,” in Chapter 11 cases. That litigation has led to increased clarity in some areas, but has also led to new issues as the market has developed. In 2025, as in 2007, make-wholes in bankruptcy remain controversial, and they will continue to be a source of contention.
To level set, a make-whole is a provision in a loan agreement or bond indenture that requires the borrower to pay a “premium” to creditors in the event of an optional prepayment or redemption before maturity, or in the event of acceleration. The general purpose of a make-whole is yield protection: A make-whole ensures that creditors receive some or all the benefit of their expected bargain, in terms of yield on their investment, even if the borrower repays or otherwise satisfies the debt prior to maturity.
Although prepayment provisions take various forms, a standard high-yield bond indenture will, during the initial “non-call” period, condition redemption on payment of a make-whole, which is intended to capture the present value of both the interest payments and the fixed call premium the lender would have received had the debt been repaid on the first fixed call date. That present value is typically derived by using a discount rate tied to U.S. Treasury rates plus an agreed spread, so that the formula captures the loss that would be incurred by a lender that, on the one hand, is repaid before maturity (thereby losing the yield from future payments) but, on the other hand, mitigates its loss by reinvesting in a low-risk instrument. As maturity gets closer, high-yield debt instruments typically switch to fixed call premiums, under which the borrower can redeem the debt if it pays a flat premium calculated as a percentage of the principal redeemed, with the premium declining in the run-up to maturity. While these distinct forms of protection are sometimes grouped together under the “make-whole” label, a formula designed to compensate for lost yield is different, economically and otherwise, from a fixed premium.
Bankruptcy presents a series of questions regarding make-wholes and call premiums more broadly—some of which have been answered, and some of which have not. We provide below a detailed update on the state of play in this area, including observations on what may come next.
Does a bankruptcy filing itself defeat a make-whole?
In analyzing whether a make-whole will be enforced in bankruptcy, an initial question is whether—as a contractual matter—a Chapter 11 filing prevents payment of the make-whole. Multiple cases have considered whether the automatic acceleration of maturities due to a bankruptcy, which results in the full amount of the loan being due and owing immediately, prevents lenders from collecting a premium that, under the contractual language, is payable only upon “optional redemption” or a “prepayment.”
Almost a decade ago, two federal appellate courts split on that question. In 2016, in the Energy Future Holdings case, the Third Circuit (which covers Delaware) held that a debtor’s refinancing of secured debt in bankruptcy should be treated as an “optional redemption” subject to a make-whole, even though the debt at issue had been automatically accelerated by the Chapter 11 filing. The court concluded that, under New York law, the concept of a “redemption” is broad enough to include a prepayment following an acceleration caused by the borrower’s own decision to file for bankruptcy. By contrast, in the Momentive case, decided in 2017, the Second Circuit (which covers New York) held that, because the debtor’s Chapter 11 filing automatically accelerated the maturities of the relevant secured notes, the payment of the notes under the debtor’s Chapter 11 plan was a payment after maturity as opposed to an optional redemption, meaning that the make-whole was not payable under the applicable language.
These divergent decisions, each applying New York law, initially led to confusion and uncertainty. Over time, however, this split in authority has become less relevant, because market participants have responded to the split by “Momentive-proofing” their debt agreements in circumstances where financial distress is a foreseeable risk. A “Momentive-proof” make-whole elides the question presented in Momentive and EFH by stating, unambiguously, that a make-whole not only remains payable after a bankruptcy-induced acceleration, but is triggered by the acceleration itself. Based on this market development, bankruptcy filings themselves now often provide the contractual basis for a make-whole rather than a potential basis for the borrower to avoid a make-whole.
Does Momentive-proofing work?
“Momentive-proofing” has given rise to a new set of issues. On the one hand, there is little question that “proofing” provisions are effective insofar as they allow for payment of a make-whole when a debt is paid following bankruptcy but ahead of its original maturity. Creditors, in other words, can negotiate to avoid a result under which, as a matter of contract, the fact of bankruptcy prevents collection of a make-whole that would have been payable but for the bankruptcy.
On the other hand, “Momentive-proof” make-wholes are more controversial insofar as the premiums they require are payable immediately upon bankruptcy—before any refinancing or other repayment. As an economic matter, allowing a make-whole to be triggered by a bankruptcy has various implications. For one thing, bankruptcy usually precedes repayment (under a plan or otherwise) by some time, thus increasing the size of the make-whole relative to what it would have been at the time of repayment absent the filing. In addition, if a make-whole is payable as of the date of a bankruptcy filing, oversecured lenders entitled to post-petition interest during the bankruptcy case may recover both interest after the filing and the make-whole amount that is arguably intended to compensate for the loss of that additional interest.
Various legal objections have been raised to Momentive-proof make-wholes. One objection is that a make-whole triggered solely by a bankruptcy, rather than by repayment, is an impermissible “ipso facto clause”—a clause that penalizes the debtor for a bankruptcy filing. But while the Bankruptcy Code contains a general prohibition on ipso facto clauses in executory contracts, the Bankruptcy Code does not contain a similarly clear bar on ipso facto clauses in loan agreements. Courts have reached different conclusions on whether ipso facto provisions in a loan agreement should be enforced. Although some courts have enforced the clauses as written, other courts, including a Delaware court addressing a clause requiring default interest, have taken the view that any claims that “spring up” upon a bankruptcy are suspect.
Another issue is whether “reinstatement” of a debt instrument, under Section 1124(2) of the Bankruptcy Code, provides a path for a debtor to avoid a Momentive-proof make-whole. Reinstatement is a tool the Bankruptcy Code provides to debtors to enable them to preserve favorable economic terms of prepetition debt instruments as part of a plan of reorganization; if a debtor has no defaults other than bankruptcy-related defaults, or otherwise cures non-bankruptcy defaults, the debtor can reinstate the terms of the debt instrument “notwithstanding” provisions imposing accelerated payment obligations following a bankruptcy. At least one court, in the Mallinckrodt case in Delaware, has concluded that a bankruptcy-triggered make-whole could be de-accelerated and not paid when a loan was reinstated.
Are make-wholes subject to disallowance as unmatured interest?
Taking as a starting point that a lender or noteholder can contract to receive a make-whole following a bankruptcy filing, either based on the filing itself or at least when the debt is repaid or refinanced, there is still the question of whether the make-whole is enforceable under the claim allowance provisions of the Bankruptcy Code.
The allowance of claims in bankruptcy is governed by Section 502(b) of the Bankruptcy Code. Section 502(b)(1) sets the baseline: claims are generally allowed if they are enforceable under applicable state law. Under New York law, which governs many debt instruments, make-wholes have generally been enforced as a form of liquidated damages, so long as they have a connection to the lenders’ lost yield. New York courts, therefore, have generally enforced standard make-whole formulas that discount future interest payments to present value, taking into account the opportunity for reinvestment in other bonds of the same duration.
Section 502(b)(2), however, provides that a claim, even if otherwise enforceable under state law, must be disallowed as against the debtor if the “claim is for unmatured interest.” Whether make-wholes are claims for unmatured interest has been the subject of intense debate. Until recently, the apparent majority view was that, even though make-wholes are intended to protect a lender’s yield (i.e., interest due in the future), they are distinct from interest and should instead be treated as a fee or liquidated-damages charge. In recent years, however, the tide has turned, as two appellate courts—the Fifth Circuit in the Ultra Petroleum case (originating in Houston) and the Third Circuit in the Hertz case (originating in Delaware)—have concluded that standard formula-based make-wholes are the equivalent of unmatured interest and subject to disallowance under Section 502(b)(2).
Ultra Petroleum and Hertz arose out of unusual circumstances. First, both cases involved solvent debtors. And in both cases, the courts concluded that—under an equitable exception to Section 502(b)(2), the so-called “solvent debtor exception”—the make-whole amounts had to be paid before equity could recover, despite being the equivalent of unmatured interest. Accordingly, although Ultra Petroleum and Hertz held that the make-wholes at issue were covered by Section 502(b)(2), neither case actually resulted in non-payment of a make-whole.
Ultra Petroleum and Hertz were also different from many other make-whole cases because they involved unsecured rather than secured debt. As explained next, treating a make-whole as unmatured interest, so that it is disallowed under Section 502(b)(2), does not necessarily determine whether secured creditors can recover a make-whole.
Are secured make-wholes still enforceable in bankruptcy?
Under Section 506(b) of the Bankruptcy Code, oversecured creditors—creditors that have collateral worth more than the face amount of their claims—are entitled to receive “interest on” their secured claim as well as “any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.” It is therefore commonplace for oversecured creditors to receive post-petition interest at their contract rate, as well as payment of contractual fees and expenses.
Prior to Ultra Petroleum and Hertz, numerous courts held that make-wholes were “charges” or “fees” under Section 506(b), and thus had to be paid to oversecured lenders as long as they were “reasonable.” Generally speaking, make-wholes based on standard formulas were upheld as “reasonable” for purposes of Section 506(b), as they have been under New York law. Some courts, however, concluded that Section 506(b)’s “reasonableness” test is more stringent than New York law, raising the possibility that oversized make-wholes could be rejected in bankruptcy even if enforceable under New York law. In addition, one case suggested that a make-whole triggered by a bankruptcy filing, as opposed to repayment, is inherently unreasonable under Section 506(b), at least if the make-whole was negotiated at a time when bankruptcy appeared inevitable.
The treatment of make-wholes as unmatured interest complicates the analysis further. After Ultra Petroleum and Hertz, debtors and junior creditors can be expected to argue that a make-whole has to be characterized as interest (rather than a charge or fee) and that Section 506(b)—which permits an oversecured creditor to recover “interest on” its secured “claim”—only requires payment of interest during the pendency of the bankruptcy, not all the unmatured interest captured by a make-whole formula. If accepted, those arguments could result in disallowance of secured make-wholes, at least in insolvent cases. In response, secured lenders can be expected to argue that treating a make-whole as unmatured interest does not mean the make-whole is not also a “charge” payable under Section 506(b), and that the statutory requirement that “interest” be paid to oversecured creditors should be construed to cover all unmatured interest otherwise disallowed under Section 502(b)(2).
Make-wholes in bankruptcy: What comes next?
For better or worse, the story of make-wholes in bankruptcy is far from over. Looking ahead, we believe that borrowers and lenders, and courts, will continue to grapple with the following questions, among others:
- Limits on Momentive-proofing. The advent of “Momentive-proof” make-wholes, although resolving the split in authority as to whether a lender’s entitlement to a make-whole can survive bankruptcy and resulting acceleration, has created friction insofar as the make-wholes at issue are triggered by, and payable upon, the bankruptcy filing itself. Whether secured lenders can claim a make-whole triggered by and calculated as of a bankruptcy filing, rather than waiting for refinancing or repayment under a plan, remains an area for potential dispute and negotiation.
- Call protection as unmatured interest. Two federal appellate courts have now held that formula-based make-wholes should be treated as unmatured interest. It is not a foregone conclusion that other courts will agree. It also is not a foregone conclusion that a call premium that is not formula-based, including a fixed premium of the kind typically owed upon redemption closer to maturity, will be treated as unmatured interest. A fixed premium is arguably different from a formula-based make-whole because it does not purport to measure future interest, even discounted. At the same time, one might argue that formula-based make-wholes also are not a true proxy for future yield insofar as they discount future interest payments using a Treasury-based discount rate (effectively risk-free) rather than discounting based on the rate that would be available in the market for a similar high-yield instrument.
- Effect of recent decisions on oversecured debt. As noted, a significant open issue is whether the case law treating make-wholes as unmatured interest has any application to secured debt subject to Section 506(b) of the Bankruptcy Code. While there is a widely held view, grounded in Section 506(b) and market practice, that secured make-wholes should be treated differently and more favorably than unsecured make-wholes, courts have not fully resolved the issue.
- How big can a make-whole be? Challenges to make-wholes based on their size have had limited success in recent years, especially when the make-whole is calculated using a market-standard formula. Nonetheless, there is a dearth of recent case law on Section 506(b)’s “reasonableness” standard, and there is even less case law addressing the issue in the context of a Momentive-proof make-whole. In contentious situations, debtors and junior creditors may invoke Section 506(b)’s “reasonableness” requirement as a basis to try to negotiate the size of make-wholes or possibly to object to their allowance.
- Recovering make-wholes from junior creditors. While most attention on make-wholes has focused on the enforceability of make-wholes against the debtor, intercreditor agreements often contain provisions requiring junior creditors to “turn over” recoveries to the extent there are amounts owing under the senior creditor’s debt instrument that are disallowed or otherwise not recoverable from the borrower. Many intercreditor agreements specifically contemplate that post-petition interest disallowed against the debtor can be charged against the junior creditor’s recovery, and it has become increasingly common for any disallowed make-whole amount to be covered as well. Given the uncertainties relating to recovery of make-wholes in bankruptcy, it would not be surprising to see make-whole litigation between senior and junior creditors if and when make-wholes are challenged.
Given the complexities and open issues identified here, lenders and borrowers alike are well-advised to focus on the terms of make-whole provisions not only at the origination stage but also when debt is refinanced and in the context of exchange offers or other liability management exercises. Investors would also do well to focus on make-wholes when negotiating intercreditor agreements.
ENDNOTE
[1] Scott K. Charles & Emil A. Kleinhaus, Prepayment Clauses in Bankruptcy, 15 Am. Bankr. Inst. L. Rev. 537, 540 (2007).
This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “Make-wholes in Bankruptcy: The State of Play,” dated July 21, 2025.