Hertz Bankruptcy Court Weighs In On Make-Whole Premiums, Solvent-Debtor Exception, And Pendency Interest

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Perhaps surprisingly given the rarity of such cases, a handful of high-profile court rulings recently have addressed whether a solvent chapter 11 debtor is obligated to pay postpetition, ...
United States Insolvency/Bankruptcy/Re-Structuring
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Perhaps surprisingly given the rarity of such cases, a handful of high-profile court rulings recently have addressed whether a solvent chapter 11 debtor is obligated to pay postpetition, pre-effective date interest ("pendency interest") to unsecured creditors to render their claims "unimpaired" under a chapter 11 plan and, if so, at what rate. Some of these cases have also involved the enforceability of noteholder claims for "make-whole" premiums triggered by the debtors' redemption of their notes prior to maturity and whether such claims must be disallowed as the "economic equivalent" of unmatured interest. All of these issues were recently examined by the bankruptcy court that presided over the chapter 11 cases of auto rental giant The Hertz Company and its affiliates.

In In re The Hertz Corp., 2021 WL 6068390 (Bankr. D. Del. Dec. 22, 2021), the U.S. Bankruptcy Court for the District of Delaware dismissed in part claims asserted by unsecured noteholders for make-whole premiums and pendency interest. In so ruling, the court held that: (i) a make-whole premium was due under the terms of one, but not the other, of two note indentures; (ii) the court would not discount the possibility that the make-whole premiums could be disallowed as the economic equivalent of unmatured interest, but it lacked sufficient evidence to make that determination; (iii) even if make-whole premium claims were disallowed as unmatured interest, such claims would be impaired by the Bankruptcy Code, rather than by the debtors' chapter 11 plan; (iv) the pre-Bankruptcy Code "solvent debtor" exception obligating a solvent debtor to pay interest on unsecured claims only partially survived enactment of the Bankruptcy Code; and (v) the appropriate rate of pendency interest under the "solvent debtor" exception is the federal judgment rate rather than the contract rate.

Hertz is far from the end of the story on many of these issues. Appeals involving some of them are currently pending before two circuit courts of appeals, which are expected to issue decisions in the near future.

The Bankruptcy Code's Priority Scheme

The Bankruptcy Code sets forth certain priority rules governing distributions to creditors in both chapter 7 and chapter 11 cases. Secured claims enjoy the highest priority under the Bankruptcy Code. See generally 11 U.S.C. § 506. The Bankruptcy Code then recognizes certain priority unsecured claims, including claims for administrative expenses, wages, and certain taxes. See id. § 507(a). General unsecured claims come next in the priority scheme, followed by any subordinated claims and the interests of equity holders.

In a chapter 7 case, the order of priority for the distribution of unencumbered assets is determined by section 726 of the Bankruptcy Code. The order of distribution ranges from payments on claims in the order of priority specified in section 507(a), which have the highest priority, to payment of any residual assets after satisfaction of all claims to the debtor, which has the lowest priority. The second to lowest priority in a chapter 7 case is given to "interest at the legal rate from the date of the filing of the petition" on any claim with a higher liquidation priority, including unsecured claims. See id. § 726(a)(5).

Distributions are to be made pro rata to parties of equal priority within each of the six categories specified in section 726. If claimants in a higher category of distribution do not receive full payment of their claims, no distributions can be made to parties in lower categories.

In a chapter 11 case, the chapter 11 plan determines the treatment of secured and unsecured claims (as well as equity interests), subject to the requirements of the Bankruptcy Code.

Impairment of Claims Under a Chapter 11 Plan

Creditor claims and equity interests must be placed into classes in a chapter 11 plan and treated in accordance with the Bankruptcy Code's plan confirmation requirements. Such classes of claims or interests may be either "impaired" or "unimpaired" by a chapter 11 plan. The distinction is important because, among other things, only impaired classes have the ability to vote to accept or reject a plan. Under section 1126(f) of the Bankruptcy Code, unimpaired classes of creditors and shareholders are conclusively presumed to have accepted a plan.

Section 1124 provides that a class of claims is impaired under a plan unless the plan: (1) "leaves unaltered the legal, equitable, and contractual rights" to which each creditor in the class is entitled; or (2) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates each creditor in the class for resulting losses.

Section 1124 originally included a third option, then section 1124(3), for rendering a claim unimpaired—by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that, in light of this third option, and because sections 726(a)(5) and 1129(a)(7) of the Bankruptcy Code (described below) are applicable in a chapter 11 case only to impaired creditors, a solvent debtor's chapter 11 plan that paid unsecured claims in full in cash, but without postpetition interest, did not impair the claims. The perceived unfairness of New Valley led Congress to remove this option from section 1124 of the Bankruptcy Code in 1994. Since then, most courts considering the issue have held that, if an unsecured claim is paid in full in cash with postpetition interest at an appropriate rate, the claim is unimpaired under section 1124. See, e.g., In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 205–07 (3d Cir. 2003) ("PPI").

Cram-Down Confirmation Requirements

If a creditor class does not agree to impairment of the claims in the class under the plan and votes to reject it, the plan can be confirmed only under certain specified conditions. Among these conditions are requirements that: (i) each creditor in the class receive at least as much under the plan as it would receive in a chapter 7 liquidation (11 U.S.C. § 1129(a)(7)) (commonly referred to as the "best interests" test); and (ii) the plan be "fair and equitable" (Id. § 1129(b)(1)).

Therefore, in the case of a chapter 11 debtor that can pay its creditors in full, the best interests test in section 1129(a)(7) would require that any impaired unsecured creditors be paid pendency interest on their allowed claims "at the legal rate." Id. § 726(a)(5).

The best interests test, however, applies only to impaired classes of claims or interests. This was not always the case. When the Bankruptcy Code was enacted in 1978, the provision applied to all classes—impaired or not. Congress amended section 1129(a)(7) in 1984 so that it now applies only to impaired classes. See Bankruptcy Amendments and Federal Judgeship Act of 1984, 98 Stat. 333, Pub. L. 98-353 (1984) § 512(a)(7); In re Wonder Corp. of Am., 70 B.R. 1018, 1024 (Bankr. D. Conn. 1987) ("[T]he 1984 Amendments also modified § 1129(a)(7) so that its provisions now only apply to 'each impaired class of claims or interests' rather than to 'each class of claims or interests.'").

Section 1129(b)(2)(B) of the Bankruptcy Code provides that a plan is "fair and equitable" with respect to a dissenting impaired class of unsecured claims if the creditors in the class receive or retain property of a value equal to the allowed amount of their claims or, failing that, if no creditor or equity holder of lesser priority receives any distribution under the plan. This is known as the "absolute priority rule."

Disallowance of Claims for Unmatured Interest and the Solvent Debtor Exception

Section 502(b)(2) of the Bankruptcy Code provides that a claim for interest that is "unmatured" as of the petition date shall be disallowed. See generally Collier on Bankruptcy ("Collier") ¶ 502.03 (16th ed. 2022) ("fixing the cutoff point for the accrual of interest as of the date of the filing of the petition is a rule of convenience providing for equity in distribution"). Charges that have been deemed to fall into this category include not only ordinary interest on a debt, but items that have been deemed the equivalent of interest, such as original issue discount. Id. This means that, unless there is an exception stated elsewhere in the Bankruptcy Code (see below), any claim for postpetition interest will be disallowed.

The bar on recovery by creditors of interest accruing after a bankruptcy filing pre-dates the enactment of the Bankruptcy Code and is derived from English law. See Nicholas v. U.S., 384 U.S. 678, 682 (1966) (explaining that "[i]t is a well-settled principle of American bankruptcy law that in cases of ordinary bankruptcy, the accumulation of interest on claims against a bankruptcy estate is suspended as of the date the petition in bankruptcy is filed[, which rule is] grounded in historical considerations of equity and administrative convenience"); Sexton v. Dreyfus, 219 U.S. 339, 344 (1911) (recognizing that the rule that interest ceases to accrue on unsecured debt upon commencement of bankruptcy proceedings is a fundamental principle of English bankruptcy law, which is the basis of the U.S. system). Section 63 of the Bankruptcy Act of 1898, as amended by the Chandler Act of 1938, expressly disallowed unmatured interest as part of a claim. Bankruptcy Act of 1938, ch. 575, § 63, 52 Stat. 840 (repealed 1978).

English law included notable exceptions to the rule. One of those was the "solvent debtor" exception, which provided that interest would continue to accrue on a debt after a bankruptcy filing if the creditor's contract expressly provided for it, and would be payable if the bankruptcy estate contained sufficient assets to do so after satisfying other debts. See In re Ultra Petroleum Corp., 913 F.3d 533, 543-44 (5th Cir.) (citing treatises and cases), opinion withdrawn and superseded on reh'g, 943 F.3d 758 (5th Cir. 2019) ("Ultra"). In such cases, the post-bankruptcy interest was deemed part of the underlying debt obligation, as distinguished from interest "on" a creditor's claim. Id.

The fundamental principle barring creditors from recovering postpetition interest on their claims was incorporated into U.S. bankruptcy law—as were some of the exceptions, but only in part.

In pre-Bankruptcy Code cases where the debtor possessed adequate assets to pay all claims in full with interest—meaning that the payment of interest to one creditor did not impact the recovery of other creditors—principles of equity dictated that creditors be paid interest to which they were otherwise entitled, most commonly at the rate determined by their contracts with the debtor. See Am. Iron & Steel Mfg. Co. v. Seaboard Air Line Ry., 233 U.S. 261, 266–67 (1914) (concluding "in the rare instances where the assets ultimately proved sufficient for the purpose, that creditors were entitled to interest accruing after adjudication"); Debentureholders Protective Comm. of Cont'l Inv. Corp. v. Cont'l Inv. Corp., 679 F.2d 264, 269 (1st Cir. 1982) (in refusing to confirm a plan under chapter X of the Bankruptcy Act because it did not pay postpetition interest on unsecured claims, noting that "[w]here the debtor is solvent, the bankruptcy rule is that where there is a contractual provision, valid under state law, providing for interest on unpaid [installments] of interest, the bankruptcy court will enforce the contractual provision with respect to both [installments] due before and [installments] due after the petition was filed"); Ruskin v. Griffiths, 269 F.2d 827, 832 (2d Cir. 1959) ("where there is no showing that the creditor entitled to the increased interest caused any unjust delay in the proceedings, it seems to us the opposite of equity to allow the debtor to escape the expressly bargained-for" contractual interest provision); Sword Line, Inc. v. Indus. Comm'r of N.Y., 212 F.2d 865, 870 (2d Cir. 1954) (explaining that "interest ceases upon bankruptcy in the general and usual instances noted … unless the bankruptcy bar proves eventually nonexistent by reason of the actual solvency of the debtor"); Johnson v. Norris, 190 F. 459, 466 (5th Cir. 1911) (determining that debtors "should pay their debts in full, principal and interest to the time of payment whenever the assets of their estates are sufficient").

Moreover, even though section 502(b)(2) of the Bankruptcy Code provides that a claim for unmatured interest shall be disallowed, there are specific exceptions to the rule included elsewhere in the Bankruptcy Code. For example, section 506(b) of the Bankruptcy Code provides that an oversecured creditor is entitled to interest on its allowed secured claim.

In addition, as noted above, in a chapter 7 case, the distribution scheme set forth in section 726 of the Bankruptcy Code designates as fifth in priority of payment postpetition interest on an unsecured claim at "the legal rate."

In cases where interest on a claim is permitted, the rate of interest payable is unclear. As noted, section 726(a)(5) refers to interest at "the legal rate," which could mean the contract rate, the post-judgment rate, the federal statutory rate specified in 28 U.S.C. § 1961, or some other rate.

Whether the solvent debtor exception survived enactment of the Bankruptcy Code in 1978 is disputed. A handful of rulings from the federal circuit courts have suggested that the exception survived. See, e.g., Ultra, 943 F.3d at 765–66 ("Our review of the record reveals no reason why the solvent debtor exception could not apply. As other circuits have recognized, 'absent compelling equitable considerations, when a debtor is solvent, it is the role of the bankruptcy court to enforce the creditors' contractual rights.' … That might be the case here. … But 'mindful that we are a court of review, not of first view,' we will not make the choice ourselves or weigh the equities on our own.") (citations omitted); Gencarelli v. UPS Capital Bus. Credit, 501 F.3d 1, 7 (1st Cir. 2007) (holding that, in contrast to section 506(b)'s reasonableness limitation on oversecured creditors' secured claims for fees, costs, and charges, section 502(b) does not disallow unreasonable prepayment penalties in a solvent debtor case (as long as allowable under state law), and noting that "[t]his is a solvent debtor case and, as such, the equities strongly favor holding the debtor to his contractual obligations as long as those obligations are legally enforceable under applicable non-bankruptcy law"); Official Comm. of Unsecured Creditors v. Dow Corning Corp. (In re Dow Corning Corp.), 456 F.3d 668, 678 (6th Cir. 2006) (noting that "[t]he legislative history of the Bankruptcy Code makes clear that equitable considerations operate differently when the debtor is solvent: '[C]ourts have held that where an estate is solvent, in order for a plan to be fair and equitable, unsecured and undersecured creditors' claims must be paid in full, including postpetition interest, before equity holders may participate in any recovery'" (quoting 140 Cong. Rec. H10,752–01, H10,768 (1994) (statement of Rep. Brooks, Chairman of the House Committee on the Judiciary and co-author of the Bankruptcy Reform Act of 1994)).

Recent Court Rulings

There have been a handful of recent court rulings addressing the continued vitality of the solvent debtor exception.

In In re Ultra Petroleum Corp., 624 B.R. 178 (Bankr. S.D. Tex. 2020) ("UPC"), leave to appeal granted, No. 21-20008 (5th Cir. Jan. 5, 2020), the bankruptcy court ruled that, based on the legislative history, "Congress gave no indication that it intended to erode the solvent debtor exception" when it enacted the Bankruptcy Code. Id. at 198. Moreover, it noted, "[e]quitable considerations" continue to support it, including the policy against allowing a windfall at the expense of creditors to any debtor that can afford to pay all of its debts. Id.

According to the court, this conclusion is also supported by post-Bankruptcy Code court rulings involving solvent debtors as well as the 1994 removal from the Bankruptcy Code of section 1124(3). In short, the court wrote, there is a "monolithic mountain of authority, developed over nearly three hundred years in both English and American courts, holding that a solvent debtor must make its creditors whole." Id. at 200 (citations omitted).

The court explained that, standing alone, neither section 105(a) of the Bankruptcy Code (giving the bankruptcy court broad equitable power), section 1129(a)(7) (the best interests test), nor section 1129(b)(1) (requiring a cram-down chapter 11 plan to be fair and equitable with respect to dissenting impaired classes of creditors) is a statutory source for the solvent debtor exception. Instead, the court wrote, "piecing these Bankruptcy Code provisions together," the solvent debtor exception flows through section 1124(1), which provides that, to render a class of claims unimpaired, a plan must leave unaltered the claimants' "legal, equitable, and contractual rights." Id. at 202. According to the court, "[b]ecause an unimpaired creditor has equitable rights to be treated no less favorably than an impaired creditor and to be paid in full before the debtor realizes a recovery, a plan denying post-petition interest in a solvent debtor case alters the equitable rights of an unimpaired creditor under § 1124(1)." Id. at 203.

Finally, the bankruptcy court held that the default contract rate is the appropriate rate of pendency interest rather than the federal judgment rate. The court explained that the noteholders' right to pendency interest was based on "two key equitable rights"—the right to receive no less favorable treatment than impaired creditors and the right to have their contractual rights fully enforced. Id. at 204. According to the court, if the noteholder class were paid interest at the federal judgment rate, it would be worse off than if it were impaired under the debtors' plan because "even though the [noteholders] would receive identical interest as a hypothetical impaired class, as an unimpaired class the Claimants were deprived of the right to vote for or against the plan." Id. In addition, the court noted, limiting the noteholder class to pendency interest at the federal judgment rate would contravene the purpose of the solvent debtor exception, which dictates that when a debtor is solvent, "a bankruptcy court's role is merely to enforce the contractual rights of the parties." Id.

In In re Cuker Interactive, LLC, 622 B.R. 67 (Bankr. S.D. Cal. 2020), the court held that, in accordance with Ninth Circuit precedent, a solvent debtor must pay pendency interest to general unsecured creditors "at the legal rate." Id. at 69 (citing In re Cardelucci, 285 F.3d 1231 (9th Cir. 2002) (applying the federal judgment rate in cases where creditors were impaired); In re PG&E Corp., 610 B.R. 308 (Bankr. N.D. Cal. 2019) ("PG&E") (pendency interest must be paid at the federal judgment rate to render unsecured claims unimpaired), aff'd sub nom. Official Committee of Unsecured Creditors v. PG&E Corp., No. 20-04570 (HSG) (N.D. Cal. May 21, 2021), appeal filed, No. 21-16043 (9th Cir. June 17, 2021); In re Beguelin, 220 B.R. 94 (B.A.P. 9th Cir. 1998) (same)).

On the basis of that precedent, the court ruled that, in accordance with the solvent debtor exception, the bankruptcy court's role in a case involving a solvent debtor was "'merely to enforce the contractual rights of the parties.'" Cuker, 622 B.R. at 71 (quoting UPC, 624 B.R. at 195). However, the Cuker court explained, construing the solvent debtor exception to require the payment of contract-rate interest might be problematic in cases with a significant number of creditors because several interest rates might apply, leading to an administrative morass and different treatment of creditors in the same class. For this reason, the court held that pendency interest must be paid at the federal judgment rate.

In In re Mullins, 633 B.R. 1 (Bankr. D. Mass. 2021), the court reasoned that lawmakers' use of the phrase "fair and equitable" in sections 1129(b)(1) and 1129(b)(2) "was intended to codify at least a century of bankruptcy jurisprudence … and grounded the solvent debtor exception as it related to impaired creditors in that provision." Id. at 10. It also explained that the legislative history of the provision does not suggest that "Congress intended to abrogate the solvent debtor exception." Id. at 11.

Construing section 1129(b) as not abrogating the solvent debtor exception, the court noted, does not conflict with section 502(b)(2). It explained that, although section 502(b)(2) unambiguously provides that pendency interest cannot be included as part of an allowed claim, "there is a significant distinction between whether postpetition interest can be part of an allowed claim and whether there are circumstances under which the debtor may be required to pay postpetition interest on an allowed claim." Id. at 15.

The court emphasized that it was not adopting a "free-floating solvent debtor exception and a balancing of the equities test." Id. at 10 n.8. Rather, it wrote, "well-developed jurisprudence and the evidentiary record in this and in future cases will dictate the course of the 'solvent debtor exception' in these rare cases—unless a future statutory amendment or other controlling appellate authority mandates a different approach." Id. Moreover, because the court concluded that the statutory provisions codifying the absolute priority rule and the best interests test required the payment of pendency interest in this case, the court also declined to decide "whether the solvent debtor exception is founded more generally in an 'equitable right' inherent in insolvency proceedings under the Code rather than in § 1129(b) or any other specific provisions of the Code." Id. at 16 n.12.

Addressing the appropriate rate of pendency interest, the court agreed with the majority of other courts, finding that, 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.


Citing disruption to their car rental business caused by the COVID-19 pandemic, the Hertz Corporation and its affiliates (collectively, "debtors") filed for chapter 11 protection on May 22, 2020, in the District of Delaware. After an auction process, the bankruptcy court confirmed a chapter 11 plan for the debtors on June 10, 2021.

The plan provided for the payment of unsecured creditors in full, including the holders of two series of senior unsecured notes issued by the debtors prepetition ("22/24 Notes" and "26/28 Notes" and, collectively, "Senior Notes"), together with pendency interest at the federal judgment rate, as well as a distribution to shareholders of cash and new warrants or subscription rights. In accordance with the terms of the relevant indentures, the Senior Notes were accelerated upon the debtors' bankruptcy filing. In addition, redemption of the notes prior to the stated maturity date under certain specified conditions triggered the debtors' obligation to pay the noteholders a redemption or make-whole premium designed to compensate the noteholders for the loss of future interest payments if the debt was paid off before maturity. The plan, however, did not provide for the payment of make-whole premiums to the holders of the Senior Notes or certain other unsecured noteholders.

The plan confirmation order preserved the rights of unsecured noteholders to assert entitlement to make-whole premiums and additional interest as necessary to render their claims unimpaired. The plan went effective on June 30, 2021.

On July 1, 2021, the indenture trustee ("Senior Note Trustee") for the 22/24 Notes and the 26/28 Notes filed a complaint seeking a declaratory judgment that, in addition to the principal and prepetition interest paid to the Senior Noteholders on the effective date of the plan (in excess of $2.7 billion), the debtors were obligated to pay approximately $272 million, consisting of: (i) make-whole premiums due under the Senior Notes totaling approximately $147 million; and (ii) pendency interest at the contract default rate in excess of the federal judgment rate (approximately $125 million). The debtors filed a motion to dismiss the complaint.

The Bankruptcy Court's Ruling

Entitlement to Make-Whole Premium. Addressing the Senior Noteholders' claims for the payment of make-whole premiums, U.S. Bankruptcy Judge Mary Walrath concluded that the Senior Note Trustee stated a plausible claim that make-whole premiums were due under the indentures because the redemption of the Senior Notes was at the debtors' option, rather than involuntary—i.e., a consequence of acceleration of the Senior Notes triggered by a bankruptcy filing that the debtors were forced to make due to the pandemic. She rejected the debtors' argument that redemption of the Senior Notes was involuntary because: (i) they filed for bankruptcy in good faith (i.e., not in a strategic effort to avoid paying the make-whole premiums); and (ii) any alternative to redemption, including reinstatement of the Senior Notes, was hypothetical at best.

The decision to file for chapter 11, Judge Walrath wrote, "was perhaps the best option for the Debtors in light of the drastic effects on their business caused by the pandemic, but it was not the only option." Hertz, 2021 WL 6068390, at *5. She further noted that although the debtors "chose" to conduct an auction for a plan sponsor and ultimately selected the highest and best offer, "that too was not the Debtors' only option." According to Judge Walrath, "[a]t numerous junctures in any bankruptcy case, a debtor in possession has multiple paths from which to choose," and "[e]ven though the Debtors acted in good faith and in the fulfillment of their fiduciary duties, the Court concludes that their actions were voluntary." Id.

Even so, due to the different language contained in the indentures, Judge Walrath found that the debtors' motion to dismiss the Senior Note Trustee's claims for make-whole premiums should be granted with respect to the 22/24 Notes. Under the relevant language of the 22/24 Notes indenture, the Senior Note Trustee failed to state a claim that a make-whole premium was due because the make-whole was due only if the 22/24 Notes were redeemed "prior to maturity" rather than prior to their originally scheduled maturity, which was a separately defined term under the 22/24 Notes Indenture. Since Hertz's bankruptcy filing accelerated the 22/24 Notes, their maturity was brought forward, and any subsequent redemption did not trigger the make-whole obligation. Id. at *6. By contrast, the 26/28 Notes indenture did not specify that any optional redemption must be "prior to maturity," and the Senior Note Trustee stated a claim that a premium would be due "because [the notes] were redeemed before the initial period stated" in the relevant indenture section. Id. at *7.

Disallowance of Make-Whole Premium as Unmatured Interest. Next, Judge Walrath considered whether, even if due under the terms of the indentures, the make-whole premiums should be disallowed under section 502(b)(2) as the "economic equivalent" of unmatured interest, an issue that has been disputed by the courts. Compare UPC, 624 B.R. at 188-95 (concluding that a make-whole premium was liquidated damages rather than unmatured interest and should not be disallowed under section 502(b)(2)), withIn re MPM Silicones LLC, 2014 WL 4436335, at *17-18 (Bankr. S.D.N.Y. Sept. 9, 2014) (ruling that noteholders' claim to a make-whole premium based on the debtor's breach of a no-call provision was unmatured interest disallowed under section 502(b)(2)), aff'd in part and rev'd in part on other grounds, 874 F.3d 787 (2d Cir. 2017). See generally Collier at ¶ 502.03[3](a) (collecting cases).

Judge Walrath declined to decide the issue. The judge noted that, based on relevant case law and other authority, she was "not prepared to conclude, as a legal matter, that make-wholes cannot be disallowed as unmatured interest," but determined that more evidence of the economic substance of the make-whole premiums was necessary. Nevertheless, Judge Walrath suggested in dicta that the Senior Note Trustee might be unable to present evidence that the make-whole premiums were "not, in fact, the economic equivalent of unmatured interest due under those Senior Notes." Hertz, 2021 WL 6068390, at *9.

Impairment and the Solvent-Debtor Exception. Judge Walrath then examined whether, even if the make-whole premiums were the economic equivalent of unmatured interest, the claims of the Senior Noteholders, in accordance with the solvent-debtor exception, would be impaired under the debtors' plan if the noteholders were not paid the premiums. Initially, citing Ultra, PPI, and PG&E, she explained that "any modification of the Noteholders' claim to unmatured interest or to the [make-whole] premium (if it is the economic equivalent of unmatured interest) is an impairment of the Noteholders' contract claims by operation of section 502(b)(2) of the Bankruptcy Code, not the Debtors' Plan." Hertz, 2021 WL 6068390, at *11. As a consequence, Judge Walrath ruled, the Senior Noteholders' claims "are not impaired within the meaning of section 1124(1)." Id.

Judge Walrath noted that, "in essence," the Bankruptcy Code "is silent on what treatment unimpaired creditors must receive in a solvent chapter 11 debtor case." Id. According to their express terms, she explained, "sections 1129(a)(7) and 726(a)(5) provide what treatment impaired creditors are entitled to receive, not what treatment unimpaired claims are entitled to receive in a solvent chapter 11 debtor case."

The judge rejected the argument that, by repealing section 1124(3), lawmakers intended that unimpaired creditors must be paid their contract rate of interest in a solvent debtor chapter 11 case. Congress, she explained, could have so provided by either: (i) amending section 1124(3) to require that unimpaired creditors receive their contract rate of interest, in addition to payment in full of their allowed claims; or (ii) amending section 502(b)(2) to provide that unmatured interest is disallowed "except in the case of a solvent debtor." Yet it did neither.

She characterized the district court's ruling in UPC on this point as "not persuasive." She explained that the UPC court impermissibly relied on equitable principles to modify the express language of the section 502(b)(2) of the Bankruptcy Code when it ruled that the solvent debtor exception survives and that unimpaired creditors were entitled to contract-rate pendency interest "because they were entitled to have their equitable rights fully enforced under section 1124(1)." "When a debtor is solvent," Judge Walrath wrote, "the Bankruptcy Code does not waive the application of section 502(b)(2)." Id. at *15.

In addition, Judge Walrath characterized as "problematic" the bankruptcy court's decision in In re Energy Future Holdings Corp., 540 B.R. 109 (Bankr. D. Del. 2015), where the court ruled that a bankruptcy court has the equitable power to award the contract rate "or such other rate as the Court deems appropriate." Hertz, 2021 WL 6068390, at *15. In particular, she explained: (i) the Energy Future court relied on the "fair and equitable" test of section 1129(b), "which by its express terms does not apply to unimpaired creditors"; (ii) "it provides no guidance to debtors or creditors as to precisely how unimpaired creditors must be treated and thus will result in endless litigation"; and (iii) it "runs counter to recent Supreme Court jurisprudence (and Congressional amendments) that have sought to curb the bankruptcy court's exercise of equitable discretion." Id.

Judge Walrath wrote that "after consideration of the cases cited by the parties, the express language of the Bankruptcy Code, and its Legislative History, the Court is convinced that the solvent debtor exception survived passage of the Bankruptcy Code only to a limited extent." Id. She explained that the Bankruptcy Code expressly codified the solvent debtor exception in section 506(b) as to oversecured creditors and in sections 1129(a)(7) and 726(a)(5) as to unsecured creditors. Judge Walrath further noted that: (i) although sections 1129(a)(7) and 726(a)(5) currently apply only to unsecured creditors impaired by a chapter 11 plan, they applied to all unsecured creditors—impaired and unimpaired—when the Bankruptcy Code was originally enacted; and (ii) when Congress amended the Bankruptcy Code in 1984 to limit the scope of section 1129(a)(7) to impaired classes, "it was motivated by the desire to require voting only by impaired creditors, rather than by a desire to assure that unimpaired creditors get their contract rate of interest." Id. at *16.

Judge Walrath also determined that neither the Bankruptcy Code nor its legislative history expressly states that unimpaired creditors are entitled to their contract rate of interest "or even to more than impaired creditors in the case of a solvent debtor." Id. Instead, she wrote, the legislative history "provides strong evidence Congress intended that unimpaired creditors in a solvent chapter 11 debtor case should receive post-petition interest only in accordance with sections 1129(a)(7) and 726(a)(5)." Id. Moreover, Judge Walrath reasoned, the legislative history to the repeal of section 1124(3) suggests that lawmakers believed that there is no legitimate reason in a solvent debtor chapter 11 case to distinguish between impaired and unimpaired unsecured creditors who are receiving full payment of their claims in cash under a plan. As a consequence, she ruled, "both should receive the same treatment: payment of their allowed claim plus post-petition interest at the federal judgment rate in accordance with section 726(a)(5)." Id.

Judge Walrath accordingly held that the Senior Note Trustee failed to state a plausible claim that the debtors were obligated to pay pendency interest on the Senior Notes at the rates specified in the indentures rather than at the federal judgment rate.


The entitlement of noteholders to make-whole premiums in chapter 11 cases has been the subject of a considerable amount of litigation. At least for the moment, Hertz has not added significantly to the discussion, principally because the court, based on the inadequate evidence before it, declined to decide whether the make-whole premiums in the case before it were the economic equivalent of unmatured interest that must be disallowed in bankruptcy. In addition, the court's conclusions regarding impairment of claims pursuant to the Bankruptcy Code versus impairment pursuant to the plan are consistent with other recent decisions.

The aspects of the ruling concerning the solvent debtor exception and the appropriate rate of pendency interest are more significant. The holding reinforces the well-established statutory and equitable principle that debtors with the means to pay all of their creditors in full should be obligated to do so. Hertz adds to the mix by concluding that the solvent-debtor exception only partially survived enactment of the Bankruptcy Code because it applies only to impaired classes of creditors. By contrast, the courts in Mullins and UPC agreed that the solvent debtor exception survived the enactment of the Bankruptcy Code in its entirety, but they notably disagreed over the statutory basis for its continued application. The Hertz court found their rationale to be unconvincing, ruling that a solvent chapter 11 debtor is obligated to pay pendency interest to impaired classes of unsecured creditors at the federal judgment rate. As noted, two circuits may soon add to the growing body of case law on these issues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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