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In Brief: Fifth Circuit Vacates Ruling that Make-Whole Premium Is Disallowed Unmatured Interest but Holds Firm on Bankruptcy Code v. Chapter 11 Plan Impairment

In the July/August 2019 issue of the Business Restructuring Review, we discussed a landmark decision by the U.S. Court of Appeals for the Fifth Circuit in In re Ultra Petroleum Corp., 913 F.3d 533 (5th Cir. 2019) ("Ultra I"). The Fifth Circuit ruled that: (i) a "make-whole" premium owed on unsecured notes constituted "unmatured interest" disallowed by section 502(b)(2) of the Bankruptcy Code; and (ii) because the Bankruptcy Code, rather than the debtor's chapter 11 plan itself, disallowed the noteholders' claim for a make-whole premium and postpetition interest at the contractual default rate, the noteholders' claims were not "impaired" for purposes of confirming the plan. The ruling represented a landmark decision on the allowance of such premiums in chapter 11, over which there has been considerable litigation in recent years, including at the circuit court level. However, because recent litigation over such premiums has generally sidestepped the issue of whether a make-whole premium is unmatured interest that must be disallowed under section 502(b)(2), the Fifth Circuit's decision departed from the norm.

In In re Ultra Petroleum Corp., 2019 WL 6318074 (5th Cir. Nov. 26, 2019) ("Ultra II"), the Fifth Circuit agreed to rehear the case and vacated its decision in Ultra I. In Ultra II, the court of appeals reaffirmed its previous ruling regarding impairment but remanded the case below to determine whether the noteholders' claims for a make-whole premium might be allowed under the pre-Bankruptcy Code "solvent-debtor exception" to the general rule disallowing claims for unmatured interest.

Ultra I

In ruling on the question of impairment in Ultra I, the Fifth Circuit followed the rationale of the only other court of appeals that has considered the question, every reported decision by lower courts (other than the bankruptcy court below), and leading commentators. See In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 205–07 (3d Cir. 2003) (ruling that a landlord's future rent claim capped under section 502(b)(6) of the Bankruptcy Code was not impaired under a chapter 11 plan because the Bankruptcy Code, not the plan, capped the claim); In re Am. Solar King Corp., 90 B.R. 808, 819 (Bankr. W.D. Tex. 1988) ("Impairment results from what the plan does, not what the [bankruptcy] statute does."); accord In re Tree of Life Church, 522 B.R. 849, 861–62 (Bankr. D.S.C. 2015); In re RAMZ Real Estate Co., 510 B.R. 712, 717 (Bankr. S.D.N.Y. 2014); In re K Lunde, LLC, 513 B.R. 587, 595–96 (Bankr. D. Colo. 2014); see generally Collier on Bankruptcy ¶ 1124.03[6] (16th ed. 2019).

Despite ruling that the noteholders' claim for a make-whole premium was disallowed as unmatured interest under section 502(b)(2), the Fifth Circuit acknowledged that, because the debtor was solvent, the claim might still be allowed under the pre-Bankruptcy Code "solvent-debtor exception" derived from English law. According to the Fifth Circuit, the bankruptcy court's resolution of the Bankruptcy Code versus chapter 11 plan impairment question prevented it from considering whether "Congress chose not to codify the solvent-debtor rule as an absolute exception to § 502(b)(2)" or whether lawmakers' silence on that score in 1978 should be presumed as an indication that certain long-established bankruptcy principles should remain undisturbed. The Fifth Circuit accordingly remanded the case below to make that determination.

The Ultra I court also remanded the case to the bankruptcy court for additional findings regarding the appropriate rate of postpetition interest on the notes, which contractually bore interest at a default rate due to the debtor's failure to pay the amount outstanding upon acceleration (including the make-whole premium). The Fifth Circuit determined that it could not answer that question without additional findings because: (i) the only provision of the Bankruptcy Code that speaks to the appropriate interest rate payable on a claim—section 726—did not apply in this case; and (ii) the pre-Bankruptcy Code practice of allowing postpetition interest in solvent cases provided no guidance on this issue because "the modern concept of post-petition interest on a claim [as distinguished from as part of a claim] had no analogy under pre-Code law."

In January 2019, the appellees, an ad hoc committee of unsecured creditors and the noteholders, jointly petitioned the Fifth Circuit for a rehearing en banc of the Ultra I ruling. In addition to seeking reconsideration of the impairment issue, the appellees argued that the court unnecessarily held that the make-whole premium was disallowed under section 502(b)(2) "in conflict with several prior Fifth Circuit decisions, the Second Circuit, and lower federal and New York state court decisions." Rehearing was warranted, they wrote, "to secure uniformity of this Court's decisions and to avoid substantial disruption in the financial markets and bankruptcies nationwide."

Ultra II

The Fifth Circuit granted the petition and vacated its ruling in Ultra I. However, in Ultra II, the court doubled down on its decision to reverse the bankruptcy court's impairment ruling in keeping with "the monolithic mountain of authority holding the Code—not the reorganization plan—defines and limits the claim in these circumstances." According to the Fifth Circuit, the plain text of the provision of the Bankruptcy Code defining "impairment" in this context—section 1124(1)—"requires that 'the plan' do the altering." Therefore, the court wrote, "a creditor is impaired under § 1124(1) only if 'the plan' itself alters a claimant's 'legal, equitable, [or] contractual rights.'" In so ruling, the Fifth Circuit rejected the noteholders' arguments to the contrary for substantially the same reasons articulated in its prior decision.

However, whereas the Fifth Circuit previously held that the Bankruptcy Code disallows a claim for a make-whole premium as unmatured interest, it declined to reiterate that portion of its decision. According to the Fifth Circuit, the bankruptcy court is "best able" to make that determination as well as a determination regarding the appropriate rate of postpetition interest on the noteholders' claims. The Fifth Circuit also directed the bankruptcy court to consider whether the solvent-debtor exception continues to apply under the Bankruptcy Code.

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