The allowance of postpetition interest in solvent debtor chapter 11 cases has become an important issue in recent years for corporate issuers, bondholders and other creditors. This post will examine a recent decision in the Hertz case by Judge Mary Walrath of the U.S. Bankruptcy Court for the District of Delaware on the rate of interest payable to unsecured creditors who are entitled under the Bankruptcy Code to full payment of their claims under a plan of reorganization. (Judge Walrath also addressed other topics in her decision pertaining to the allowance of make-whole premiums, which were examined in an earlier post.)
The Hertz Corporation filed for protection under chapter 11 of the U.S. Bankruptcy Code in May 2020, its business decimated by the Covid-19 pandemic. In little more than a year, however, it had recovered so successfully that it was able to propose a plan of reorganization that purported to pay unsecured creditors in full.
Hertz claimed that under its plan, the holders of its over $2.7 billion of unsecured bonds were “unimpaired.” Hertz’s plan proposed to pay the bondholders the full principal amount of the bonds, and interest accrued during the course of the chapter 11 case at the federal judgment rate rather than the significantly higher rate set forth under the terms of the bonds and the indentures.
The bondholders disputed that their claims were unimpaired because, among other things, the plan did not provide for payment at the contract rate under the indentures. They also argued that a pre-Bankruptcy Code equitable doctrine commonly known as the “solvent debtor exception” entitled them to full payment of interest.
The two sides agreed to let the plan proceed to confirmation and have Judge Walrath determine afterwards what the bondholders were entitled to receive. Post-confirmation, Hertz moved to dismiss the bondholders’ claims for postpetition interest at the contract rate under the indentures.
Judge Walrath’s Analysis
In her decision on Hertz’s motion to dismiss the claims, Judge Walrath looked at the Bankruptcy Code to resolve whether the contract rate or the federal judgment rate would apply on any allowed postpetition interest.
Non-Impairment – Under the Bankruptcy Code, creditors’ claims are unimpaired if “the plan . . . leaves unaltered the legal, equitable and contractual rights” of the holder of such claim. Unimpaired creditors do not have a right under the Bankruptcy Code to vote to accept or reject a proposed plan, but are instead deemed to accept. The bondholders asserted that their treatment as unimpaired creditors under the plan entitled them to all of their rights under the indentures, including the payment of both the make-whole premiums and interest at the contract rate.
Judge Walrath disagreed. In most chapter 11 cases, section 502(b) of the Bankruptcy Code expressly disallows claims for “unmatured interest,” i.e, interest which had not yet accrued as of the commencement of the case. She cited a Third Circuit decision, PPI Enterprises, that held that a creditor’s claim was not impaired if the claim was limited or disallowed not by the plan itself, but rather by the Bankruptcy Code as a matter of law. Since section 502(b) disallows claims for unmatured interest, the failure under the plan to provide for payment of future unpaid interest would not constitute impairment.
Solvent Debtor Exception – The bondholders cited a number of pre-Bankruptcy Code cases which held that where a debtor is solvent, creditors are entitled to contract rate interest on their claims and other contractual rights before any value should go to shareholders.
The bondholders pointed to a recent decision by Judge Marvin Isgur in the Southern District of Texas who, faced with similar issues in the case of Ultra Petroleum Corp., ruled that the solvent debtor exception remained good law and effectively overrode section 502(b)’s disallowance of unmatured interest with respect to solvent debtors and required the payment of interest at the contract rate.
Judge Walrath acknowledged the solvent debtor exception, but interpreted it more narrowly than Judge Isgur. She pointed to section 726(a)(5) of the Bankruptcy Code, which provides for payment of interest “at the legal rate” in solvent debtor chapter 7 liquidation cases, and section 1129(a)(7) of the Bankruptcy Code, which mandates that impaired creditors be treated as well under a chapter 11 plan as they would under a hypothetical chapter 7 case.
Judge Walrath determined that the weight of caselaw authority viewed “the legal rate” under section 726(a)(5) as the federal judgment rate rather than contract rate interest. Reasoning further that Congress could not have intended for unimpaired creditors to be treated worse than impaired creditors, she held that the solvent debtor exception required payment of accrued and unpaid interest on the bonds at the federal judgment rate.
Judge Walrath recognized the solvent debtor exception to the disallowance of unmatured interest under section 502(b), but only to the extent of requiring payment of accrued postpetition interest at the federal judgment rate.
Value fluctuations stemming from the pandemic disruption and the subsequent rapid recovery, and ongoing economic volatility and uncertainty means that more solvent debtor cases can be expected moving forward into 2022. Given the influence of the Delaware Bankruptcy Court in large chapter 11 cases, Judge Walrath’s analysis in Hertz will inform the calculations of debtors and bondholders during plan negotiations in such cases.