Two recent decisions from circuit courts of appeal – the Fifth and Ninth – have addressed a question that does not arise often: in a solvent-debtor chapter 11 case, is the debtor required to pay post-petition interest (commonly referred to as “pendency interest”) to unsecured creditors in order to render such claims unimpaired? And, if so, what is the applicable rate of interest to use? Additionally, a subsequent decision from the Second Circuit, while not ultimately reaching the issue, favorably cited the recent Fifth and Ninth Circuit decisions.
I. History of Case Law on Post-Petition Interest in Solvent Debtor Cases
Most modern case law recognizes that unsecured creditors of solvent debtors are entitled to post-petition interest on their claims if they are to be deemed unimpaired.
In cases where interest on an unsecured claim is required, the applicable bankruptcy code language, and court decisions interpreting it, are less than clear on what rate of interest should apply. Section 726(a)(5) of the Bankruptcy Code refers to interest at “the legal rate,” which, unfortunately, is not particularly helpful. The courts that addressed this issue, concluded that the “legal rate” of interest means one of the following: (i) the contract rate; or (ii) the federal judgment rate set forth in 28 U.S.C. § 1961.
II. The Ninth Circuit’s Decision in PG&E Corp.
In In re PG&E Corp., 46 F.4th 1047 (9th Cir. 2022), reh’g denied, No. 21-16043 (9th Cir. Oct. 5, 2022), stayed pending petition for cert., No. 21-16043 (9th Cir. Oct. 27, 2022), the Ninth Circuit ruled that a solvent debtor’s chapter 11 plan must pay pendency interest to unsecured creditors to render their claims unimpaired. In so doing, the court opined: “pursuant to the solvent-debtor exception, unsecured creditors possess an ‘equitable right’ to postpetition interest [under section 1124(1) of the Bankruptcy Code] when a debtor is solvent.”
With respect to the issue of the applicable rate of interest to be paid to such creditors, the Ninth Circuit, in reversing the lower court, held that there is a presumption that the pendency interest to be paid to unsecured creditors should be based on the contractual or default rate, and not the federal judgment rate, absent contrary and compelling equitable considerations.
In reaching its holding, the Ninth Circuit first addressed whether its prior decision in In re Cardelucci, 285 F.3d 1231 (9th Cir. 2002) was controlling in the case before it. Both the bankruptcy and district courts below held that Cardelucci established a broad rule that all unsecured claims in a solvent-debtor bankruptcy are entitled only to post-petition interest at the federal judgment rate, regardless of impairment status.
The Ninth Circuit in PG&E rejected this holding, reasoning that “Cardelucci merely held that the phrase ‘interest at the legal rate’ in § 726(a)(5) refers to the federal judgment rate as defined by 28 U.S.C. § 1961(a).” Section “726(a)(5) only applies to impaired chapter 11 claims via the best-interests test. Cardelucci therefore does not tell us what rate of postpetition interest must be paid on plaintiffs’ unimpaired claims.” PG&E Corp., 46 F.4th at 1056. The Ninth Circuit continued:
Cardelucci interpreted language from a specific statutory provision—§ 726(a)(5)—that does not apply to unimpaired claims. Rather, as discussed above, § 726(a)(5) only applies to chapter 11 cases through the best-interests test, § 1129(a)(7), which itself only applies to impaired creditors. Though our opinion in Cardelucci did not say so, the creditors in that case were impaired. Indeed, the creditors in Cardelucci had to be impaired for § 726(a)(5) to apply in the first place. Moreover, the parties in Cardelucci agreed that the amount of interest owed hinged solely on the interpretation of § 726(a)(5). Thus, the fact that Cardelucci did not reference the creditors' impaired status—or limit the scope of its holding to impaired claims—is not surprising. But Cardelucci provides no textual basis for applying § 726(a)(5) to unimpaired claims, nor could it for the reasons explained above.
We therefore decline to read Cardelucci as establishing the broad rule that PG&E advocates. Cardelucci merely held that the phrase “interest at the legal rate” in § 726(a)(5) refers to the federal judgment rate. But this holding does not answer what rate of interest is required where § 726(a)(5) does not apply—including for unimpaired claims. The bankruptcy and district courts erred in concluding that Cardelucci settles the issue before us.
PG&E Corp., 46 F.4th at 1056–57 (internal citations omitted).
The court concluded by holding “that the equitable solvent-debtor exception—and its core principle that creditors should be made whole when the bankruptcy estate is sufficient—persists under the Code. Accordingly, under the Code, unsecured creditors of a solvent debtor retain an equitable right to postpetition interest pursuant to their contracts, subject to any other equities in a given case. A failure to compensate creditors according to this equitable right as part of a bankruptcy plan results in impairment.” Id.at 1061.
III. The Fifth Circuit’s Decision in Ultra Petroleum Corp.
A little over one month later, the Fifth Circuit issued a ruling in Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138 (5th Cir. 2022), reh’g denied, No. 21-20008 (5th Cir. Nov. 15, 2022), addressing the same issue. Just as the Ninth Circuit did in PG&E, the Fifth Circuit concluded that, in a solvent debtor case, “[c]reditors are entitled to what they bargained for,” meaning that creditors in that case with claims based on contracts, were entitled to pendency interest at the default contract rate.
In so doing, the court considered the interplay between section 1129(a)(7) and section 726(a)(5) of the Bankruptcy Code. Section 1129(a)(7) provides that a bankruptcy court can “cram down” a plan on impaired creditors, over their objection, if they “will receive or retain under the plan ... not less than the amount that [they] would so receive or retain if the debtor were liquidated under chapter 7.” 11 U.S.CC. § 1129(a)(7)(A)(ii). In turn, section 726(a) governs what the creditors would get if the debtor were liquidated in a chapter 7 case. Section 726(a) provides a waterfall for the distribution of a debtor’s assets in a chapter 7 liquidation. Before a solvent debtor’s equity holders get any of the estate’s leftovers, section 726(a)(5) says that creditors are to be paid interest on their claims “at the legal rate” from the petition date.
In Ultra Petroleum, the debtor relied on the words “legal rate” to support its argument. The “legal rate,” according to the debtors, must be the federal judgment rate. In support of its argumenta, the debtors relied on aforementioned 2002 Ninth Circuit decision in Cardelucci.
The Fifth Circuit rejected application of Cardelucci, holding:
We do not quarrel with the Cardelucci court’s sensible reasoning, but neither must we decide the matter. The precise referent of “the legal rate” is not dispositive here. Why? Because Ultra overlooks the logically prior textual fact that “the legal rate” only sets a floor—not a ceiling—for what an impaired (and by implication, unimpaired) creditor is to receive in a cram-down scenario. Specifically, the Code provides that objecting, impaired creditors must receive “not less than” what they would receive in a Chapter 7 liquidation—including “interest at the legal rate” per § 726(a)(5)—in order for the plan to be “crammed down” on them.
So, even if “the legal rate” is the Federal Judgment Rate, the Code does not preclude unimpaired creditors from receiving default-rate post-petition interest in excess of the Federal Judgment Rate in solvent-debtor Chapter 11 cases. Recall that under § 1124(1), unimpaired creditors' “legal, equitable, and contractual rights” must remain “unaltered.” And as a matter of equity, creditors are entitled to contractually specified rates of interest “on” their claims when a solvent debtor is fully capable of paying up. As the bankruptcy court rightly noted below, “[t]his equitable right is the root of the solvent-debtor exception.” And as we have explained, the solvent-debtor exception survived the Bankruptcy Code’s enactment.
Ultra Petroleum Corp., 51 F.4th at 158–59 (emphasis in original) (internal citations omitted).
The Fifth Circuit went on: “The requirements of § 1129(b) for plan confirmation buttress our conclusion. That section states that the bankruptcy court shall only confirm a plan if it is ‘fair and equitable’—a test long understood to mean the ‘absolute priority rule.’” Id. “Unsecured creditors vying against each other for shares of a ‘limited pot of assets’ have no equitable rights vis-à-vis each other to contractual rates of interest on their claims: they must be treated equally; but ‘[w]hen the struggle is between creditors and equity holders, as opposed to creditors and creditors, [creditors’] equitable right [to contractual post-petition interest rates] is critical.’ And per the absolute priority rule, creditors’ rights prevail.” Id. (internal citations omitted).
These two decisions are a departure from a number of lower court decisions forming the majority rule that the federal judgment rate, rather than the contract rate, is the applicable rate of interest in solvent debtor cases. See, e.g., In re RGN-Grp. Holdings, LLC, 2022 WL 494154, *6 (Bankr. D. Del. Feb. 17, 2022) (holding that was creditor was entitled to interest on its allowed unsecured claim at the federal judgment rate rather than the contract rate); In re The Hertz Corp., 637 B.R. 781 (Bankr. D. Del. 2021), reconsideration denied and direct appeal certified, Adv. Pro. No. 21-50995 (MFW) (Bankr. D. Del. Nov. 21, 2022) (same); In re Cuker Interactive, LLC, 622 B.R. 67, 69 (Bankr. S.D. Cal. 2020) (holding that because construing the solvent debtor-exception to require the payment of contract-rate interest might be problematic in cases with a significant number of creditors where several interest rates might apply, leading to an administrative morass and different treatment of creditors in the same class, pendency interest must be paid at the federal judgment rate); In re Mullins, 633 B.R. 1, 16 (Bankr. D. Mass. 2021) (to satisfy the “best interests” test, which incorporates section 726(a)(5)’s dictate that interest be paid at “the legal rate” in a case involving sufficient assets, pendency interest must be paid at the federal judgment rate); see also In re Energy Future Holdings Corp., 540 B.R. 109, 118 (Bankr. D. Del. 2015) (“[T]he plain meaning of section 1129(b)(2) does not require payment to unsecured creditors of post-petition interest when a junior class is receiving a distribution for a plan to be fair and equitable. Rather, the Court has the discretion to exercise its equitable power to require, among other things, the payment of post-petition interest, which may be at the contract rate or such other rate as the Court deems appropriate. Finally, the plan in this case need not provide for the payment in cash on the effective date of post-petition interest at the contract rate for the PIK Noteholders to be unimpaired. Indeed, the plan need not provide for any payment of interest, even at the Federal judgement rate. But in order for the PIK Noteholders to be unimpaired the plan must provide that the Court may award post-petition interest at an appropriate rate if it determines to do so under its equitable power.”).
With these recent decisions from the Fifth and Ninth Circuits, all five of the circuit courts of appeal to have addressed the issue are in agreement that the contract rate is the applicable rate of interest in solvent debtor cases. See, e.g., Gencarelli v. UPS Cap. Bus. Credit, 501 F.3d 1, 7 (1st Cir. 2007) (“This is a solvent debtor case and, as such, the equities strongly favor holding the debtor to his contractual obligations ....”); In re Dow Corning Corp., 456 F.3d 668, 680 (6th Cir. 2006) (“[T]here is a presumption that default interest should be paid to unsecured claim holders in a solvent debtor case.”); In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 207 (3d Cir. 2003) (holding that failure to pay post-petition interest on claim “could not qualify for nonimpairment under § 1124(1) because the failure to pay postpetition interest does not leave unaltered the contractual or legal rights of the claim.”).
Following the decisions from the Fifth and Ninth Circuits, the indenture trustee in Hertz asked the court to reconsider its 2021 decision which held that the solvent debtor exception did not survive the enactment of the bankruptcy code. The court denied the motion for reconsideration stating: “[the Fifth and Ninth Circuits] did not rely on any argument that was not considered by the Court in its [decision last year].” Furthermore, the court noted that the dissenters in both of those opinions concluded “that the solvent-debtor exception did not survive the passage of the Bankruptcy Code and that section 502(b)(2) expressly disallowed any claim for unmatured interest.” See In re The Hertz Corp., Adv. Pro. No. 21-50995 (MFW) [ECF No. 71] (Bankr. D. Del. Nov. 21, 2022).
The court then certified a direct appeal to the Court of Appeals for the Third Circuit.
IV. The Second Circuit’s Decision in LATAM Airlines
In In re LATAM Airlines Grp. S.A., 2022 WL 17660057 (2d Cir. December 14, 2022), the U.S. Court of Appeals for the Second Circuit favorably discussed portions of the Ultra Petroleum and PG&E decisions, stating: “We find these authorities persuasive. We therefore join the Third, Fifth, and Ninth Circuits and hold that a claim is impaired under Section 1124(1) only when the plan of reorganization, rather than the Code, alters the creditor's legal, equitable, or contractual rights.” Id.at *5. Ultimately, however, the court did not address the extent to which the “solvent debtor” exception survived the enactment of the Bankruptcy Code because the court deferred to and affirmed the bankruptcy court’s determination that the debtor was insolvent.
As a result of these three recent decisions, lower courts throughout the country may soon start departing from the majority rule and adopt the reasoning of these circuit courts of appeal. The pending decision from the Third Circuit in Hertz will also play an important part in how this issue plays out in the future.