The common law solvent debtor exception, in short, means that a solvent debtor must generally pay post-petition interest accruing during bankruptcy at the contractual or state law rates before collecting surplus value from the bankruptcy estate. Several recent bankruptcy court rulings have analyzed the solvent debtor exception, and some have called the solvent debtor exception into question.1 On August 29, 2022, the United States Court of Appeals for the Ninth Circuit, in a divided opinion, became the first circuit court to address the question that has resulted in differing conclusions among bankruptcy courts: what rate of post-petition interest must a solvent debtor pay to creditors whose claims are designated as unimpaired under a plan pursuant to § 1124(1) of the Bankruptcy Code?
In reversing the ruling of U.S. Bankruptcy Judge Dennis Montali of the Northern District of California, the Ninth Circuit held that (i) while there may be exceptions based on the equities of each case, unimpaired creditors of a solvent debtor enjoy an equitable right to contractual or state law default post-petition interest before allocation of surplus value from a bankruptcy estate; and (ii) contrary to the holdings of some bankruptcy courts, passage of the bankruptcy code did not abrogate the solvent-debtor exception.
The Pacific Gas & Electric Company (PG&E) filed for chapter 11 on January 29, 2019. At the time of filing, PG&E's assets exceeded its liabilities by approximately $20 billion, making it, by all accounts, a solvent debtor. PG&E's chapter 11 plan, however, classified the claims of the ad hoc committee of holders of trade claims (the "Ad Hoc Committee") as general unsecured claims and provided that the creditors would be paid in full plus post-petition interest at the federal judgment rate of 2.59% under 28 U.S.C. § 1961(a). The plan also classified the creditors' claims as unimpaired, meaning that they were deemed automatically to accept the plan and had no power to vote against it or argue that their treatment was not "fair and equitable" under 11 U.S.C. § 1129(b)(1).
The Ad Hoc Committee, and other similarly situated creditors, objected to confirmation of the PG&E plan and argued that PG&E had to honor its contractual obligations before its shareholders reaped a surplus from the bankruptcy estate. Prior to PG&E's bankruptcy filing, the Ad Hoc Committee claimants, and similarly situated creditors, possessed a contractual right to interest on debts not paid—either at rates stipulated by their contracts or the California default rate of 10%. The Ad Hoc Committee asserted that by paying their claims at the federal judgment rate, the plan denied them roughly $200 million that they would have been paid pursuant to the interest rates in their contracts, or in the absence of such terms, the California state default rate.
The bankruptcy court disagreed, and relying on precedent in In re Cardelucci, 285 F.3d 1231 (9th Cir. 2002), held that unsecured creditors of a solvent-debtor, regardless of impairment status, are entitled only to post-petition interest at the federal judgment rate. The District Court affirmed the bankruptcy court's ruling. The Ninth Circuit, however, reversed the decision and remanded to the bankruptcy court to determine the appropriate interest rate for the unimpaired creditors.
The Ninth Circuit's Ruling
In a 2–1 decision of the panel that heard the case, the Ninth Circuit disagreed with the bankruptcy court's conclusion that in a solvent debtor bankruptcy case unsecured claims are entitled only to post-petition interest at the federal judgment rate, regardless of impairment status. The Ninth Circuit made the critical distinction between claims that are impaired and claims that are unimpaired (such as the claims of the appellants) under a plan of reorganization. The majority held that the Ninth Circuit's previous decision in Cardelucci was not binding on a case involving unimpaired claims of a solvent debtor. The majority reasoned that Cardelucci merely was interpreting the meaning of words "interest at the legal rate" in section 726(a)(5) of the Bankruptcy Code. The majority decision focused on the fact that section 726(a)(5) would be relevant for determining whether a plan satisfies the "best interest of creditors" test in section 1129(a)(7)(A)(ii), which looks to whether impaired claims will receive as much under a plan as they would in a hypothetical chapter 7 of the debtor. The Court concluded that, because unimpaired classes of claims are not subject to 1129(a)(7)(A)(ii), Cardelucci was not binding on what rate of post-petition interest must be paid on the Ad Hoc Committee's unimpaired claims. Under the Ninth Circuit's ruling, debtors in a similar situation will now be faced with a choice: "compensate creditors in full, pursuant to the solvent-debtor exception or designate them as impaired claimants entitled to the full scope of the [Bankruptcy] Code's substantive and procedural protections."2
Although the majority was clear throughout the opinion that its holding turned on the fact that the Ad Hoc Committee's claims were unimpaired, it left open the possibility that the contractual rate could apply to holders of impaired claims. Specifically, in a footnote, the majority observed that impaired claims would be subject to the cramdown provisions of Section 1129(b)(1) of the Bankruptcy Code, which the Sixth Circuit, in Dow Corning, held would require that impaired creditors in a solvent case must receive interest at the contractual rate before equity could receive a recovery. The majority elected not to opine on that point, noting that: "[w]e express no opinion on this issue, but merely point out that PG&E's designation of plaintiffs as unimpaired precluded them from potentially making this argument to the bankruptcy court."3
The majority also disagreed with the bankruptcy court's alternative holding that the bankruptcy code limited the Ad Hoc Committee to post-petition interest at the federal judgment rate. The panel held that the Bankruptcy Code did not abrogate the solvent debtor exception, which was an equitable principle that pre-dated the adoption of the Bankruptcy Code. Rather, the Bankruptcy Code's text, history, and structure compelled the conclusion that creditors, like the Ad Hoc Committee, continue to possess an equitable right to bargained for post-petition interest when a debtor is solvent. Accordingly, the majority held that failure to "compensate creditors according to this equitable right as part of a bankruptcy plan results in impairment" under section 1124(1) of the Bankruptcy Code.4
While the majority strongly suggested that the bankruptcy court should have applied the contractual or state default interest rate, the Ninth Circuit remanded to the bankruptcy court for a final determination of the correct interest rate. The majority's conclusion that the solvent debtor exception was an equitable principle mandated that there needed to be a finding on the rate to be applied based upon the equities of the case. The majority, however, made clear that:
We are confident that in most solvent-debtor cases involving unimpaired creditors, the equitable role of the bankruptcy court will be "simply to enforce creditors' rights according to the tenor of the contracts that created those rights." However, we acknowledge 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 postpetition interest at a different rate.5
The dissenting judge on the panel took an even more restrictive position than either of the lower courts and concluded that the solvent debtor exception did not survive the enactment of the Bankruptcy Code. In the view of the dissent, if Congress had intended the exception to survive, it could have included the exception in the Bankruptcy Code, but by not doing so, there is no basis for the payment of post-petition interest in any chapter 11 case, regardless of whether the debtor is solvent.
- The solvent debtor exception is alive and well in the Ninth Circuit (at least in the view of the majority of the three-judge panel).
- The Ninth Circuit will now be among the creditor friendly venues for unimpaired claim holders of solvent debtors, although solvent debtors are quite rare. It is possible that down the road, there could be a circuit court split if or when other circuit courts decide this issue.
- This ruling could impact the negotiating dynamics of plans of reorganization involving solvent debtors, as solvent debtors and their creditors will weigh the benefits and drawbacks of being deemed unimpaired against voting on the debtor's plan.
- The holding emphasized that the solvent debtor exception does not provide courts with unlimited discretion to redistribute rights, nor does it automatically mean that creditors would be paid at their contractual rate of interest. Instead, the majority was clear the contractual rate would be the starting point, subject to future courts being able to impose a different rate, taking into account the impact on similarly situated creditors or post-petition interest being paid at a different rate based on equitable considerations.
Special thanks to Josh Friedman who co-authored this publication.
1. Compare In re Ultra Petroleum Corp., 624 B.R. 178, 203–04 (Bankr. S.D. Texas 2020) (holding that unimpaired creditors must receive postpetition interest at the contract rate), with In re Energy Future Holdings Corp., 540 B.R. 109, 124 (Bankr. D. Del. 2015) (holding that unimpaired creditors are entitled to interest "under equitable principles" at a rate "the Court deems appropriate"), and In re The Hertz Corp., 637 B.R. 781, 800–01 (Bankr. D. Del. 2021) (holding that unimpaired creditors need only receive interest at the federal judgment rate).
3. Id. at *11, n. 8.
4. Id. at *11.
5. Id. at 14 (citations omitted).
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