Third Circuit Finds ‘Make Whole Premiums’ Constitute Unmatured Interest That Must Be Paid By Solvent Debtor
A three-judge panel for the Third Circuit affirmed in part and reversed in part Delaware Bankruptcy Judge Mary F. Walrath’s decisions denying the Debtor, Hertz’s, noteholders’ post-petition claims for interest at the contract rate and make-whole premiums. Writing for the majority, Judge Thomas L. Ambro found that the noteholders had a right to contractual post-petition interest and make-whole premiums as a result of Hertz being “solvent.” Unless overturned on appeal, Hertz must now pay its noteholders more than $270 million in premiums and post-petition interest. The decision follows similar rulings from the Fifth Circuit in Ultra Petroleum and the Ninth Circuit in PG&E, supporting the pre-Bankruptcy Code “solvent-debtor exception” to the general prohibition on unmatured interest.
In the Bankruptcy Court in Delaware, Judge Walrath found in favor of Hertz on the interest rate issue and determined that as an unimpaired class of creditors to a solvent debtor, they were entitled to the post-petition legal rate of interest pursuant to Sections 1129 (a)(7)(A)(ii) and 726(a)(5) of the Bankruptcy Code. She also found that the “economic substance” of the make-whole was interest, and therefore would be disallowed per Section 502(b)(2).
Judge Ambro’s majority opinion, which was joined by Judge Cheryl A. Krause (in a three-judge panel), focused on whether the Bankruptcy Code gave debtors “leverage to deny their unsecured noteholders more than a quarter billion dollars of interest they promised to pay pre-bankruptcy” while “giving lower priority equity holders four times that amount” under their Chapter 11 plan. The Court here felt that although the make-whole claims would be disallowed as the “economic equivalent” of interest under section 502(b)(2) of the Bankruptcy Code in an insolvent case, the absolute priority rule required debtors to pay contractual post-petition interest and make whole claims in full before making distributions to equity holders in a solvent case.
Judge Ambro noted that if Hertz was allowed to “cancel more than a quarter billion dollars” of obligations owed to the noteholders and distribute a “massive gift” to shareholders, that would “impermissibly ‘depart’” from the Bankruptcy Code’s “basic priority rules,” citing the U.S. Supreme Court’s 2017 Jevic decision. Judge Ambro also cited the opinions issued in Ultra and PG&E as support for this conclusion. The Fifth Circuit required the debtors to pay make-whole premiums and contract-rate post-petition interest (including default interest) in order to be classified as unimpaired, and the Ninth Circuit ruled that unimpaired creditors were entitled to post-petition interest at the contractual or default state law rate. Despite the fact that Judge Ambro disagreed with Judge Walrath on the “solvent debtor” exception, he agreed that the 2022/2024 early redemption premium was not triggered because the notes matured by their terms when Hertz filed bankruptcy. Although the ruling allows Hertz to redeem the notes without a fee well before their stated maturity, Judge Ambro suggests that this result is “not absurd” and the “commercially sophisticated” noteholders agreed to the terms that “compel” the result.
Judge Ambro also affirmed the bankruptcy court’s determination that the 2026/2028 notes redemption premiums are subject to disallowance under section 502(b)(2). The majority opinion traces the “two common” make whole analyses and concludes that the make-whole claims are unmatured interest under “both” of the “definitional” and economic equivalency tests. Nevertheless, Judge Ambro invoked the absolute priority rule to conclude that the debtors must pay the 2026/2028 premiums despite section 502(b)(2) and post-petition interest at the contract rate. Prior to Jevic, Judge Ambro explains, the Third Circuit “saw the absolute priority rule as a procedural protection that applied only when § 1129(b) is invoked,” but in Jevic the Supreme Court extended the absolute priority rule to apply “everywhere.” Consequently, Judge Ambro concluded that the Bankruptcy Code “entitles every creditor—not just the dissenting impaired creditors who can invoke § 1129(b)—to treatment consistent with absolute priority absent a clear statement to the contrary.” The majority says this result flows from Jevic’s “condemnation of ‘backdoor means’ to defeat the absolute priority rule.” The Court refused to leave a “back door wide open” in solvent debtor cases that would allow plan proponents to “force creditors to accept a ‘priority-violating’ distribution.”
Judge Ambro concludes that full payment of post-petition interest at contract rates is the appropriate remedy to satisfy the absolute priority rule, even though the rule only “imposes” post-petition interest at an “equitable rate.” Although the appellate court would ordinarily remand the matter to the bankruptcy court to evaluate equitable considerations and set the post-petition interest rate, Judge Ambro felt that it would be “profoundly unfair to scrimp” after junior equity holders already received more substantial distributions “more than three years ago.”
In the dissent, Judge David J. Porter aligned himself with the dissenting opinions in the Ultra and PG&E cases, which recognized that the Bankruptcy Code “plainly disallows” claims for unmatured interest—including post-petition interest and make whole premiums—despite the fact Hertz was solvent. Judge Porter rejects the majority’s reliance on Jevic because Section 502(b)(2) “expressly disempowers” courts from allowing claims for post-petition interest and make whole premiums.
Caveat: As the Third Circuit made clear, payment of the contract rate of interest is not guaranteed, as equitable considerations may weigh against awarding an unsecured creditor its contract rate of interest.
To discuss the issues raised here or any other issues involving creditors’ rights and bankruptcy, please contact Leslie Beth Baskin, Esquire at 215-241-8926 or at lbaskin@sgrvlaw.com.