U.S. Bank Suit a Lesson in Contract Language

Even first-year law students have it drilled into them: Draft the terms of your contracts explicitly and plainly. If your contract ends up in court, you've lost even if you win. And research case precedent meticulously!

These lessons were brought home to the banking industry with the recent case of U.S. Bank Trust National Association v. American Airlines, played out in U.S. bankruptcy court for the southern district of New York.

In late 2011, American filed for Chapter 11, triggering a default on its debt and accelerating the repayment of notes that had been used by the airline to finance aircraft and related equipment. After the airline sought approval from the bankruptcy court to refinance those borrowings, U.S. Bank, as trustee for the loans, filed a lawsuit demanding that American pay a "make-whole premium" to compensate for the early repayment.

Banks often insert make-whole provisos into their loan agreements for their own benefit and for the benefit of investors who buy loans from them. Lenders and loan purchasers alike count on a specific return for the life of the note-a set rate for a set period of time. But those plans can be waylaid when a borrower pays off a loan early, a scenario lenders view as especially risky given the current low interest-rate environment and the resulting shortage of high-yielding reinvestment opportunities. In American's court documents, it noted that the refinancing represented potential savings for it in excess of $200 million.

On Jan. 17, the court held in favor of American, saying the airline was not obligated to pay the make-whole premiums.

U.S. Bank, the fifth-largest U.S. commercial bank and a subsidiary of the $354 billion-asset U.S. Bancorp, laid out a number of strategies in court, including trying to decelerate the loan notes and showing that American's availing itself of a bankruptcy code provision dealing with aircraft financing obliged it to pay the make-whole costs. American, the plaintiff argued, "admit(s) that they are pursuing the proposed refinancing because the market environment has improved and would certainly allow them to strategically refinance the notes at lower rates."

But the judge relied on the plain language of the agreement, which stated that in the event of default-such as American's bankruptcy filing-"the unpaid principal amount of the [notes] then outstanding, together with accrued but unpaid interest thereon and all other amounts due thereunder, but for the avoidance of doubt without make-whole amount, shall immediately and without further act become due and payable." (Emphasis added.)

The court submitted simply, "If the parties wished for the make-whole amount to be due in these circumstances, they could have bargained for such a provision. Instead, the parties bargained for the exact opposite result, with the Indentures stating clearly, explicitly and unambiguously that the make-whole amount is not due in the event of payment following acceleration."

Recent precedent backed the conclusion. In 2007, the same court held similarly in a case involving Solutia Inc., in which a borrower filed for Chapter 11. The judge pointed out that the loan language clearly called for accelerated payment of the note in the event of bankruptcy, but was silent as to a make-whole fee.

In that case, the court rebuffed any attempt to "read into agreements between sophisticated parties provisions that are not there." And in 2010, in HSBC Bank USA, N.A. v. Calpine Corp., the district court declined to compel a borrower to pay make-whole costs where the overt language of the contract did not provide for the payment of premiums in case of accelerated payment.