Fifth Circuit Rules on the "Solvent-Debtor Exception" and Make-Whole Premiums

On October 14, 2022, the U.S. Court of Appeals for the Fifth Circuit issued a long-awaited ruling on whether Ultra Petroleum Corp. ("UPC") must pay a $201 million make-whole premium to noteholders under its confirmed chapter 11 plan and whether the noteholders and certain other unsecured creditors are entitled to postpetition interest on their claims pursuant to the "solvent-debtor exception." In affirming the bankruptcy court's 2020 ruling, a divided three-judge panel of the Fifth Circuit held that the Bankruptcy Code disallows the make-whole premium "as the economic equivalent of unmatured interest," but held that "because Congress has not clearly abrogated the solvent-debtor exception," it applied to this case. Given UPC's solvency, the Fifth Circuit majority also ruled that UPC is obligated to pay postpetition interest to its noteholders and certain other unsecured creditors at the agreed-upon contractual default rate to render their claims unimpaired by UPC's plan. See Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138 (5th Cir. 2022) (affirming In re Ultra Petroleum Corp., 624 B.R. 178 (Bankr. S.D. Tex. 2020)), reh'g denied, No. 21-20008 (5th Cir. Nov. 15, 2022).

Ultra Petroleum

UPC issued approximately $1.5 billion in unsecured notes from 2008 to 2010. The master note purchase agreement (the "MNPA"), which was governed by New York law, provided that UPC had the right to prepay the notes at 100% of the principal plus a make-whole amount. The make-whole amount was calculated by subtracting the accelerated principal from the discounted value of the future principal and interest payments. Events of default under the agreement included a bankruptcy filing by UPC. In that event, failure to pay the outstanding principal, any accrued interest, and the make-whole amount immediately also triggered the obligation to pay interest at a default rate specified in the MNPA.

UPC also had an approximately $1 billion unsecured revolving credit facility (the "RCF") that provided for the payment of post-default interest.

UPC filed for chapter 11 protection in April 2016. Improving business conditions during the course of the case allowed UPC to seek confirmation of a chapter 11 plan that provided for the payment in cash of all unsecured claims in full. The plan designated the noteholder claims and the RCF creditor claims as unimpaired but did not provide for the payment of the make-whole amount. Nor did the plan provide for the payment of postpetition interest at the default rate on the make-whole amount, the principal amount under the notes, or the principal amount under the RCF. UPC contested the noteholders' right to receive the make-whole amount. The parties agreed that postpetition interest should be paid on the noteholder and RCF creditor claims, but disagreed on the appropriate rate. The plan distributed new common stock in the reorganized entity to UPC's existing shareholders.

The bankruptcy court initially decided that, under New York law, the make-whole amount was an enforceable liquidated damages provision, rather than an unenforceable penalty. The court also held that UPC's chapter 11 plan impaired the noteholders' claims because the plan failed to provide for the payment of the make-whole amount and postpetition default-rate interest. The court rejected UPC's position that, because the make-whole amount represented "unmatured interest" and was not allowable under section 502(b)(2) of the Bankruptcy Code, the plan left the rights of the noteholders under the Bankruptcy Code unaltered, and the claims were therefore unimpaired under section 1124(1) of the Bankruptcy Code.

The ruling was appealed to the Fifth Circuit, which ultimately remanded the case to the bankruptcy court to determine: (i) whether the make-whole premium should be disallowed under section 502(b)(2) as unmatured interest; and (ii) whether UPC was required to pay postpetition interest to the noteholders and the RCF creditors under the solvent-debtor exception and, if so, at what rate.

On remand, the bankruptcy court held that the make-whole premium was not "interest" because it did not compensate the noteholders for UPC's use or forbearance of the noteholders' money but, instead, "compensate[d] the [noteholders for the cost of reinvesting in a less favorable market." It further explained that, in an unfavorable market, UPC's decision not to use the noteholders' money would cause them to suffer damages, which the make-whole premium liquidated. The court also wrote that "[t]he Make-Whole Amount is not unmatured interest simply because it could equal zero when reinvestment rates are high." Moreover, the make-whole premium did not accrue over time but, rather, "[was] a one-time charge which fixe[d] the [noteholders'] damages when it [was] triggered." 

Because the make-whole premium was not interest, the court wrote, "it is also not unmatured interest" or its "economic equivalent." The court defined this as "the economic substance of unmatured interest," such as unamortized original issue discount on bonds. Instead, the bankruptcy court ruled that the make-whole premium was an enforceable liquidated damages clause under New York law, and accordingly, "it forms part of the [noteholders'] allowed claims."

Next, the bankruptcy court held that, because UPC was solvent, it was obligated to pay postpetition interest to the noteholders and the RCF creditors. It wrote that, according to the legislative history, "Congress gave no indication that it intended to erode the solvent debtor exception" when it enacted the Bankruptcy Code. Moreover, "[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.

According to the bankruptcy court, standing alone, neither section 105(a) of the Bankruptcy Code (giving the bankruptcy court broad equitable power), nor 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." 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)."

Finally, the bankruptcy court held that the default contract rate was the appropriate rate of interest rather than the federal judgment rate. Limiting the noteholder and RCF creditor class to interest at the federal judgment rate (then 0.54%), it noted, 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."

UPC appealed the bankruptcy court's ruling directly to the Fifth Circuit.

The Fifth Circuit's Ruling

A divided three-judge panel of the Fifth Circuit affirmed.

Writing for the majority, U.S. Circuit Court Judge Jennifer Walker Elrod explained that "[b]ecause the Make-Whole Amount here is the 'economic equivalent' of a lender's 'unmatured interest,' the [Bankruptcy] Code—per our circuit's precedent—disallows it." Ultra, 51 F.4th at 146 (citing 11 U.S.C. § 501(b)(2); In re Pengo Indus., Inc., 962 F.2d 543, 546 (5th Cir. 1992)).

The Fifth Circuit majority concluded that, regardless of the label applied to the payment, the make-whole amount was unmatured interest or its "economic equivalent" because "it compensates [the noteholders] for the future use of their money, albeit use that will never actually occur because of [UPC's] default." In so ruling, the majority rejected the noteholders' argument that the make-whole amount matured upon UPC's default when it filed for bankruptcy. Judge Elrod agreed with the bankruptcy court that the acceleration clause "was an ipso facto clause that is not to be considered in assessing whether the payment it triggered had matured." Id. at 147.

The Fifth Circuit majority also rejected as "untenable" the noteholders' argument that the make-whole amount was not the economic equivalent of unmatured interest but, rather, "liquidated damages," as some courts have held. "Liquidated damages certainly can compensate for anticipated transaction costs that are not unmatured interest," Judge Elrod wrote, "[b]ut the Make-Whole Amount … is both liquidated damages and the 'economic equivalent of unmatured interest'—indeed, that is its whole point." Id. at 149.

Next, the Fifth Circuit majority agreed with the bankruptcy court that the solvent-debtor exception, which was derived from English law and recognized under the former Bankruptcy Act, survived the enactment of the Bankruptcy Code in 1978. Nothing in the Bankruptcy Code, Judge Elrod explained, manifests clear Congressional intent to abrogate a legal principle that was universally recognized in cases involving solvent debtors before the Bankruptcy Code was enacted.

According to the majority, "Congress has not explicitly addressed claims for unmatured interest owed by solvent debtors" and "the text of § 502(b)(2) hardly constitutes an unambiguous—let alone explicit—change in bankruptcy practice." Id. at 156.

The Fifth Circuit majority held that "the solvent-debtor exception is alive and well" and that UPC is obligated to pay the make-whole amount "even though … it is indeed otherwise disallowed unmatured interest."

The majority rejected UPC's alternative argument that the make-whole amount should be disallowed as an unenforceable penalty under New York law. According to Judge Elrod, the make-whole amount constitutes enforceable liquidated damages under New York contract law—and the solvent-debtor exception continues to apply—because the make-whole amount is not "plainly or grossly disproportionate to the probable loss" incurred by the noteholders as a result of default. Id. at 157 (citation omitted).

Finally, the Fifth Circuit majority ruled that the appropriate rate of postpetition interest is the default contract rate rather than the federal judgment rate. Logic dictates, the majority explained, that unimpaired creditors cannot be treated less favorably under a chapter 11 plan than impaired creditors, who are entitled to "not less than" what they would have received in a chapter 7 liquidation under section 1129(a)(7)'s best interests test, which, in a solvent-debtor case, includes interest at "the legal rate" under section 726(a)(5). The majority acknowledged that most courts have construed "the legal rate" to mean the federal judgment rate. However, Judge Elrod explained, "the legal rate" specified in section 726(a)(5) "only sets a floor—not a ceiling—for what an impaired (and by implication, unimpaired) creditor is to receive in a cram-down scenario," and the "fair and equitable" test in section 1129(b) permits the payment of interest at a higher rate in an appropriate case.

"Creditors are entitled to what they bargained for," the Fifth Circuit majority concluded, "and the Code does not preclude the contractual interest rate." Id. at 160.

In a dissenting opinion, Circuit Judge Andrew S. Oldham agreed with the majority that the

make-whole amount "is unmatured interest in disguise," but argued that it should be disallowed because the solvent-debtor exception did not survive enactment of the Bankruptcy Code. According to the dissent, it is "unmistakably clear that" section 502(b)(2) is "incompatible with the pre-existing solvent-debtor exception." Id. Judge Oldham explained that, unlike section 502(b)(2), the former Bankruptcy Act did not preclude unmatured interest, and the majority misconstrued the relevant statutory provisions in concluding otherwise. He wrote that "[n]either the solvent-debtor exception's historical pedigree nor its policy underpinnings—no matter how compelling—can overcome Congress's clear, and clearer-than-ever, command on this point." Id. at 164.


The circuit courts of appeals have come to different conclusions over the allowance of make-whole premiums in bankruptcy. The Third Circuit allowed a make-whole premium in Delaware Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016). The Second Circuit disallowed one in BOKF NA v. Momentive Performance Materials Inc. (In re MPM Silicones LLC), 874 F.3d 787 (2d Cir. 2017), cert. denied sub nom BOKF N.A. v. Momentive Performance Materials Inc., 138 S. Ct. 2653 (2018), but only because the make-whole never became due under the relevant terms of the notes. In Ultra Petroleum, the bankruptcy court noted that MPM is distinguishable because the Second Circuit "was not presented with the question of whether a make-whole is unmatured interest."

On November 9, 2022—less than one month after the Fifth Circuit's ruling in Ultra Petroleum—the U.S. Bankruptcy Court for the District of Delaware held that a make-whole premium owed by reorganized debtor Hertz Global for redeeming $1.24 billion in unsecured notes prior to their stated maturity must be disallowed as unmatured interest. Mindful of the disagreement among various circuit courts on this issue, the bankruptcy court immediately certified the decision for a direct appeal to the Third Circuit, which will now have an opportunity to weigh in on the matter. The court also certified for direct appeal its denial of a motion to reconsider its previous decision awarding postpetition interest to unsecured noteholders of the solvent chapter 11 debtor at the federal judgment rate rather than the contract rate. See In re Hertz Corp., Adv. Proc. No. 21-50995 (Bankr. D. Del. Nov. 9, 2022).

According to a leading commentator, prior to the Fifth Circuit's ruling in Ultra Petroleum and the bankruptcy court's decision in Hertz, a majority of lower courts had concluded that a make-whole premium is not unmatured interest, but "more akin to a charge or a fee, or to liquidated damages, than to interest not yet due." Collier on Bankruptcy ¶ 502.03 (16th ed. 2022) (citing cases). Whether these recent rulings portend a shift in the landscape on this issue remains to be seen.

The Fifth Circuit majority's conclusion in Ultra Petroleum that the solvent-debtor exception survived the enactment of the Bankruptcy Code and demands payment of postpetition interest at the contract rate is a significant development, but not unprecedented. Once-rare solvent-debtor bankruptcy cases have become more common in recent years, and the obligation to pay postpetition interest under a chapter 11 plan to render unsecured creditors' claims unimpaired (such that they are therefore deemed to accept the plan) can carry a hefty price tag. Most other recent court rulings involving solvent debtors—including the Ninth Circuit's decision (discussed here and elsewhere in this edition of the Business Restructuring Review) in In re PG&E Corp., 46 F.4th 1047 (9th Cir. 2022) (holding that the solvent-debtor exception requires payment of postpetition interest, presumptively at the contract rate, but remanding the case for determination of the rate), reh'g en banc denied, No. 21-16043 (9th Cir. Oct. 5, 2022), stayed pending petition for cert., No. 21-16043 (9th Cir. Oct. 27, 2022)—have likewise affirmed that the solvent-debtor exception is alive and well. However, it bears noting that the Ninth Circuit's decision, like the Fifth's, was accompanied by a vigorous dissent. Moreover, the Ninth Circuit's ruling has been stayed pending the disposition of a petition seeking Supreme Court review of the decision.

The conclusion of the Fifth and Ninth Circuits that postpetition interest must be paid at the contract rate, rather than the federal judgment rate, in a solvent-debtor case represents a potentially expensive approach to an issue that has divided courts. Before the Fifth and Ninth Circuit's recent decisions, many lower courts had ruled to the contrary. See, e.g., In re RGN-Grp. Holdings, LLC, 2022 WL 494154, at *6 (Bankr. D. Del. Feb. 17, 2022) (federal judgment rate); In re Hertz Corp., 637 B.R. 781, 801 (Bankr. D. Del. 2021) (same), reconsideration denied and direct appeal certified, Adv. Proc. No. 21-50995 (Bankr. D. Del. Nov. 9, 2022); In re Mullins, 633 B.R. 1, 16 (Bankr. D. Mass. 2021) (same); In re Cuker Interactive, LLC, 622 B.R. 67, 71 (Bankr. S.D. Cal. 2020) (same). As noted, on November 9, 2022, the Hertz bankruptcy court certified a direct appeal of its ruling on the issue to the Third Circuit.

On November 15, 2022, the Fifth Circuit denied UPC's motion for an en banc rehearing of the court's decision in Ultra Petroleum

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