In contrast to the Ninth Circuit majority, the dissenting judge contended that unimpaired, unsecured creditors are not entitled to payment of post-petition interest at all, a position that was not advanced by any party to the appeal.
PG&E filed for chapter 11 in 2019 to proactively address potential liabilities related to a series of wildfires in Northern California. Unlike most chapter 11 debtors, PG&E was solvent at all relevant times. Its proposed, and ultimately confirmed, chapter 11 reorganization plan provided that certain general unsecured creditors would be paid the full principal amount of their claims plus post-petition interest at the federal judgment rate of 2.59% under 28 U.S.C. § 1961(a). The plan thus classified these claims as “unimpaired.” Section 1124(1) of the Bankruptcy Code provides that a class of claims is “unimpaired” if the plan “leaves unaltered the legal, equitable, and contractual rights to which such claim … entitles the holder of such claim[.]”
An ad hoc group of general unsecured trade claimants (the “Ad Hoc Committee”) objected to the plan, arguing that their claims could not rightfully be deemed “unimpaired.” Some members of the Ad Hoc Committee had contracts with PG&E that contained bargained-for interest rates on unpaid obligations, while others believed that they should be entitled to interest at the 10% default rate set by California law. The Ad Hoc Committee claimed that by paying them the lower federal judgment rate, PG&E’s plan “impaired” them by depriving them of roughly $200 million that they would have received pursuant to interest rates in their contracts, or, in the absence of such terms, the California default rate.
The Bankruptcy and District Court Decisions
The Bankruptcy Court overruled the Ad Hoc Committee’s objection based on its reading of the so-called “best interests” test set forth in section 1129(a)(7) of the Bankruptcy Code. The District Court affirmed on the same grounds.
The “best interests” test provides that to confirm a plan over the objection of an impaired objecting creditor, the debtor most prove that the plan will provide that creditor with at least the same recovery that it would receive in a chapter 7 liquidation. Recoveries in a chapter 7 case are governed by section 726 of the Bankruptcy Code, which provides that creditors of a solvent debtor must receive post-petition interest at “the legal rate.” The Ninth Circuit had previously interpreted “legal rate” to refer to the federal judgment rate. See In re Cardelucci, 285 F.3d 1231 (9th Cir. 2002).
Although section 1129(a)(7) applies, on its face, only to impaired creditor classes, the Bankruptcy Court found no basis to hold that “unimpaired” creditors of a solvent debtor should be entitled to post-petition interest at a greater rate than impaired creditors. In other words, the Bankruptcy Court interpreted the best interests test to create a uniform rule that all unsecured creditors of a solvent debtor are entitled to post-petition interest at the federal judgment rate regardless of whether they are “impaired” or “unimpaired.”
The Ninth Circuit’s Decision
On appeal, the Ninth Circuit reversed the decisions below. The Ninth Circuit explained that the default rule on post-petition interest, which was developed by common law judges and later codified in section 502(b)(2) of the Bankruptcy Code, is that interest ceases to accrue once a debtor has filed for bankruptcy. The rationale is that in most cases, “the debtor cannot pay all its creditors, and therefore payment of interest accruing after filing would … result in disparate treatment of creditors.” As those concerns do not exist when a debtor has sufficient assets to pay its creditors in full, common law courts developed an exception, which held that when a debtor is solvent, “the task for the bankruptcy court is simply to enforce creditors’ rights according to the tenor of the contracts that created those rights” by either granting the creditor interest at the rate set forth in its contract with the debtor or, absent such a provision, at the default state law rate. The Ninth Circuit found that this so-called “solvent debtor exception,” though never codified in any U.S. statute, was applied with regularity under the Bankruptcy Act of 1898 (a predecessor to the current Bankruptcy Code). The question on appeal was thus whether the exception survived passage of the Bankruptcy Code.
The answer, in the Ninth Circuit’s view, starts from the Supreme Court’s proposition that the Bankruptcy Code should not be read “to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.” The Ninth Circuit rejected the notion that section 1129(a)(7) is a clear indication that Congress intended to displace the solvent debtor exception for unimpaired creditors because section 1129(a)(7) applies, by its plain text, only to “impaired” creditors. The Bankruptcy Code builds in important procedural protections for impaired creditor classes that are not available to unimpaired creditor classes—e.g., impaired creditors have the right to vote to accept or reject a plan, whereas unimpaired creditors are simply deemed to accept it, and a debtor can only confirm a plan against the objection of an impaired creditor class by satisfying section 1129(b)’s stringent “cram-down” requirements. The Ninth Circuit opined that in light of these important distinctions, there is no basis to conclude that Congress intended the limitations on post-petition interest for impaired creditors set forth in sections 1129(a)(7) and 726 to likewise limit post-petition interest for unimpaired creditors.
The Ninth Circuit also examined other Bankruptcy Code provisions and the legal landscape against which they were drafted and found that they suggest that Congress did not intend to displace the solvent debtor exception for unimpaired creditors but in fact wanted to preserve it. Surveying pre-Code case law on the solvent debtor exception, the Ninth Circuit concluded that when the Bankruptcy Code was ratified in 1978, it was “well-established” that creditors of a solvent debtor had an “equitable right” to post-petition interest at the contract or default state law rate. Against that backdrop, Congress drafted section 1124(1) of the Bankruptcy Code to provide that a creditor is not “unimpaired” by a chapter 11 plan unless the plan “leaves unaltered the legal, equitable, and contractual rights to which such claim … entitles the holder of such claim.” In view of that history, the Ninth Circuit had no trouble holding that the solvent debtor exception survived passage of the Bankruptcy Code and that the “equitable right” it creates cannot be altered when a chapter 11 plan treats creditors as “unimpaired.”
Notwithstanding the Ninth Circuit’s unambiguous conclusion that “creditors of a solvent debtor … enjoy an equitable right to contractual or state law default post-petition interest,” it left open the possibility for bankruptcy courts to fashion exceptions to that rule. The Court “acknowledge[d] the possibility that cases could arise where payment of contractual or default interest could impair the ability of other similarly situated creditors to be paid in full, or where other ‘compelling equitable considerations’ could counsel in favor of payment of post-petition interest at a different rate.” The Court noted that any such exceptions should be limited and that “in most solvent-debtor cases involving unimpaired creditors,” bankruptcy courts should simply “enforce creditors’ rights according to the tenor of the contracts that created those rights.”
Judge Ikuta dissented from the majority opinion, opining that the Bankruptcy Code does not entitle unimpaired creditors to any post-petition interest at all, and that because “the Code is clear,” the solvent debtor exception and other pre-Code common law no longer apply. Judge Ikuta asserted that section 502(b)(2) of the Bankruptcy Code, which disallows unsecured creditors’ claims for unmatured interest, means that those creditors are not entitled to any interest after a debtor files for bankruptcy, and that “a claim is unimpaired so long as the proposed plan gives the creditor the same legal or contractual right to payment, or right to an equitable remedy, that the creditor had as of the date the petition was filed.” Citing to certain instances where the Bankruptcy Code explicitly awards post-petition interest (such as section 726(a)(5)), Judge Ikuta reasoned that the lack of an explicit provision in the Bankruptcy Code awarding post-petition interest to unimpaired creditors is indicative of Congress’s intent not to provide unimpaired creditors with a right to post-petition interest on their claims.
The Ninth Circuit’s decision is unlikely to be the final word on this issue. The Fifth Circuit is expected to rule on the same question in the near future on an appeal from a decision issued by the U.S. Bankruptcy Court for the Southern District of Texas in Ultra Petroleum. If the Fifth Circuit’s decision creates a circuit split, there could be a strong push for the Supreme Court to grant certiorari and decide the issue once and for all.
In the interim, though, the Ninth Circuit’s decision can be read to provide support for unimpaired creditors of solvent debtors asserting claims not only for post-petition interest, but also for other bargained-for contractual rights. For instance, some courts have suggested that make-whole amounts provided for in certain bond indentures might be viewed as the economic equivalent of unmatured interest that, but-for the “solvent debtor exception,” would be disallowed pursuant to section 502(b)(2). See, e.g., In re Ultra Petroleum Corp., 943 F.3d 758 (5th Cir. 2019). The Ninth Circuit’s assertion that unimpaired creditors of solvent debtors should get the “tenor of the[ir] contracts” can be read to suggest that such creditors should be entitled to payment of contractual make-wholes even if make-wholes are properly characterized as the economic equivalent of unmatured interest.
1 Compare In re Ultra Petroleum Corp., 624 B.R. 178, 203-04 (Bankr. S.D. Tex. 2020) (unimpaired creditors are entitled to post-petition interest at the contract rate), with In re The Hertz Corp., 637 B.R. 781, 800–01 (Bankr. D. Del. 2021) (unimpaired creditors are only entitled to post-petition interest at the federal judgment rate).