Unimpaired Unsecured Creditors in Solvent-Debtor Chapter 11 Case Entitled to Postpetition Interest, Presumably at Contract or Default Rate

Perhaps given the relative rarity of solvent-debtor cases during the nearly 45 years since the Bankruptcy Code was enacted, a handful of recent high-profile court rulings 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. This question was recently addressed by two federal circuit courts of appeals. In In re PG&E Corp., 46 F.4th 1047 (9th Cir. 2022) ("Pacific Gas"), reh'g denied, No. 21-16043 (9th Cir. Oct. 5, 2022), stayed pending petition for cert., No. 21-16043 (9th Cir. Oct. 27, 2022), a divided panel of the U.S. Court of Appeals for the Ninth Circuit ruled that a solvent debtor's chapter 11 plan must pay pendency interest to unsecured creditors to render their claims unimpaired.

"We clarify today," the Ninth Circuit majority wrote, "that pursuant to the solvent-debtor exception, unsecured creditors possess an 'equitable right' to postpetition interest [under section 1124(1) of the Bankruptcy Code] when a debtor is solvent." The Ninth Circuit reversed a ruling below directing that pendency interest be paid to unsecured creditors only at the federal judgment rate, acknowledging the presumption that unimpaired creditors in a solvent chapter 11 case should receive pendency interest at the contractual or default rate absent contrary and compelling equitable considerations. However, finding that it lacked adequate evidence to balance the equities, the court of appeals remanded the case to the bankruptcy court for a determination of the appropriate interest rate (or rates).

On October 27, 2022, the Ninth Circuit issued an order staying the mandate on its ruling pending the filing of a petition for U.S. Supreme Court review. "If a timely petition for certiorari is filed, the mandate will issue immediately upon notice to this court that the Supreme Court has denied the petition," the order provides. "If certiorari is granted, the stay of the mandate will continue until the Supreme Court's final disposition."

Shortly after the Ninth Circuit handed down its decision in Pacific Gas, the Fifth Circuit issued a long-awaited ruling in Ultra Petroleum Corp. v. Ad Hoc Comm. of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F.4th 138 (5th Cir. 2022) ("Ultra II"), reh'g denied, No. 21-20008 (5th Cir. Nov. 15, 2022). Like the Ninth Circuit, a divided Fifth Circuit panel concluded that "the solvent-debtor exception is alive and well." The Fifth Circuit majority accordingly held that a solvent chapter 11 debtor was obligated to pay a make-whole premium to unimpaired noteholders amount "even though … it is indeed otherwise disallowed unmatured interest." It also ruled that, because "[c]reditors are entitled to what they bargained for," the noteholders and certain other creditors were entitled to pendency interest at the default contract rate. A more detailed discussion of Ultra II appears elsewhere in this edition of the Business Restructuring Review.

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. Fifth priority in a chapter 7 liquidation 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 in chapter 7 are 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 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 creditors is impaired under a plan unless the plan: (i) "leaves unaltered the legal, equitable, and contractual rights" to which each creditor in the class is entitled; or (ii) 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) apply 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).

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 "cram-down" 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, by incorporating the minimum benchmark of the result of a chapter 7 liquidation, the bests interests of creditors test of section 1129(a)(7) requires that a chapter 11 debtor that can pay its creditors in full pay impaired unsecured creditors pendency interest on their allowed claims "at the legal rate" to confirm a plan. See 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

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 also items that have been deemed the equivalent of interest, such as original issue discount. Id. This means that, except where the Bankruptcy Code provides for an exception (or potentially allows for an exception, as described below), any claim for postpetition interest will be disallowed.

The bar on recovery by creditors of interest accruing after a bankruptcy filing predates the enactment of the Bankruptcy Code and is derived from English law. 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 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).

The Solvent-Debtor Exception

English law contained notable exceptions to the unmatured-interest 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 I"). In such cases, the post-bankruptcy interest was viewed as "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 arguably 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").

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." 

Whether the solvent-debtor exception survived enactment of the Bankruptcy Code in 1978 is disputed. A handful of rulings from the federal circuit courts (including the Ninth Circuit's decisions in Cardelucci and Pacific Gas, as discussed below, as well as the Fifth Circuit's rulings in Ultra I and Ultra II (discussed elsewhere in this edition) have held or suggested that the exception survived. See, e.g., Ultra II, 51 F.4th at 156 ("We thus hold that the solvent-debtor exception is alive and well. The 1978 Code's disallowance of unmatured interest did not abrogate the exception with 'unmistakable' clarity."); Ultra I, 943 F.3d at 765–66 ("Our review of the record reveals no reason why the solvent debtor exception could not apply"); 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' claims for fees, costs and charges, section 502(b) does not disallow unreasonable prepayment penalties in a solvent-debtor case (so long as they are 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)); In re Cardelucci, 285 F.3d 1231, 1234 (9th Cir. 2002) (because the chapter 11 debtor was solvent, an unsecured creditor was entitled to payment of pendency interest at the federal judgment rate prior to any distribution of remaining assets to the debtor).

Recent lower court rulings have generally recognized the continued vitality of the exception, but some courts disagree over to what extent it continues in force, including its statutory source of authority, and how it should be applied. Notable decisions include:

·    In re LATAM Airlines Grp. S.A., 2022 WL 2206829, *23 (Bankr. S.D.N.Y. June 18, 2022) (finding that the solvent-debtor exception survived the enactment of the Bankruptcy Code through section 1129(a)(7), not section 1124(1), and noting that the alternative outcomes—awarding no pendency interest or awarding pendency interest at the contract rate—"are simply untenable and illogical" because "the former would offend basic tenants of fairness and the purposes of the Bankruptcy Code by essentially allowing impaired creditors to be treated better than unimpaired creditors via an overly strict reading of section 1129(a)(7) that is contrary to Congressional intent"), corrected, 2022 WL 2541298 (Bankr. S.D.N.Y. July 7, 2022), motion to certify appeal denied, 2022 WL 2962948 (Bankr. S.D.N.Y. July 26, 2022), aff'd, 2022 WL 3910718, *6 n.2 (S.D.N.Y. Aug. 31, 2022) (noting that it was unnecessary to resolve the debate over whether the solvent-debtor exception survived the enactment of the Bankruptcy Code because the bankruptcy court's finding that the debtor was insolvent was not clearly erroneous).

·    In re RGN-Grp. Holdings, LLC, 2022 WL 494154, *6 (Bankr. D. Del. Feb. 17, 2022) (agreeing with the rationale articulated In re The Hertz Corp., 637 B.R. 781 (Bankr. D. Del. 2021), reconsideration denied and direct appeal certified, Adv. Pro. No. 21-50995 (MFW) (Bankr. D. Del. Nov. 9, 2022), where the court ruled that the solvent-debtor exception survived the enactment of the Bankruptcy Code only to a limited extent, and concluding that a landlord was entitled to interest on its allowed unsecured claim at the federal judgment rate rather than the contract rate).

·    In re Moore & Moore Trucking, LLC, 2022 WL 120189, *10 (Bankr. E.D. La. Jan. 12, 2022) (ruling that the solvent-debtor exception remains in force but cannot prevent a solvent debtor from extending the maturity date of a prepetition promissory note under a chapter 11 plan).

·    Hertz, 637 B.R. at 800 (noting that "the solvent debtor exception survived passage of the Bankruptcy Code only to a limited extent" and applies only in section 506(b) as to oversecured creditors and to impaired classes of unsecured creditors in a chapter 11 case pursuant to sections 1129(a)(7) and 726(a)(5); when Congress amended the Bankruptcy Code in 1984 to limit the scope of section 1129(a)(7) to impaired classes (which was not previously the case), "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").

·    In re Mullins, 633 B.R. 1, 10-11 (Bankr. D. Mass. 2021) (reasoning 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" and explaining that the legislative history of the provision does not suggest that "Congress intended to abrogate the solvent debtor exception").

·    In re Ultra Petroleum Corp., 624 B.R. 178, 198 (Bankr. S.D. Tex. 2020) ("UPC") (on remand from Ultra I, ruling 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 and noting that "[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"), aff'd, 51 F.4th 138 (5th Cir. 2022), reh'g denied, No. 21-20008 (5th Cir. Nov. 15, 2022).

·    In re Cuker Interactive, LLC, 622 B.R. 67, 69 (Bankr. S.D. Cal. 2020) (in accordance with Ninth Circuit precedent, a solvent debtor must pay pendency interest to general unsecured creditors "at the legal rate").

·    In re PG&E Corp., 610 B.R. 308, 312–13 (Bankr. N.D. Cal. 2019) (based on the Ninth Circuit's precedent in Cardelucci, "unsecured creditors of a solvent debtor will be paid the Federal Interest Rate whether their prepetition contracts call for higher or lower rates, or applicable state law judgment rates are higher, or there are no other applicable rates to consider. Nor is that rule limited to impaired claims"), aff'd, 2021 WL 2007145 (N.D. Cal. May 20, 2021), rev'd and remanded, 46 F.4th 1047 (9th Cir. 2022).

Appropriate Rate of Interest on Unsecured Claims in a Solvent-Debtor Case

In cases where interest on an unsecured claim is required, the statutory language and court decisions on the rate of interest payable are 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. Courts disagree on the appropriate rate. Before the Fifth and Ninth Circuit rulings in Ultra II (discussed elsewhere in this edition) and PG&E (discussed below) concluding that the contract rate is (at least presumptively) the appropriate rate of interest in a solvent-debtor case, the Ninth Circuit had previously held in Cardelucci that the federal judgment rate was the appropriate rate of interest. See Cardelucci, 285 F.3d at 1234. 

Many lower courts agreed with this approach. See, e.g., RGN-Group, 2022 WL 494154, at *6 (federal judgment rate); Hertz, 637 B.R. at 801 (federal judgment rate); Cuker, 622 B.R. at 71 (quoting UPC, 624 B.R. at 195) (because construing the solvent debtor-exception to require the payment of contract-rate interest might be problematic in cases with a significant number of creditors where several interest rates might apply, leading to an administrative morass and different treatment of creditors in the same class, pendency interest must be paid at the federal judgment rate); Mullins, 633 B.R. at 16 (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); see also In re Energy Future Holdings Corp., 540 B.R. 109, 118 (Bankr. D. Del. 2015) ("[T]he plain meaning of section 1129(b)(2) does not require payment to unsecured creditors of post-petition interest when a junior class is receiving a distribution for a plan to be fair and equitable. Rather, the Court has the discretion to exercise its equitable power to require, among other things, the payment of post-petition interest, which may be at the contract rate or such other rate as the Court deems appropriate. Finally, the plan in this case need not provide for the payment in cash on the effective date of post-petition interest at the contract rate for the PIK Noteholders to be unimpaired. Indeed, the plan need not provide for any payment of interest, even at the Federal judgement rate. But in order for the PIK Noteholders to be unimpaired the plan must provide that the Court may award post-petition interest at an appropriate rate if it determines to do so under its equitable power.").

The Ninth Circuit considered the solvent-debtor exception and the appropriate rate of pendency interest in Pacific Gas.

Pacific Gas

PG&E Corp. and its Pacific Gas & Electric Co. utility subsidiary (collectively, "PG&E") filed for chapter 11 protection in the Northern District of California in January 2019. With listed assets of $71.4 billion and debts of $51.7 billion, PG&E was solvent on a balance sheet basis at the time it filed for bankruptcy to the tune of approximately $20 billion. The filing was precipitated by potential liabilities exceeding $30 billion arising from the alleged role of PG&E's equipment in sparking the largest and most deadly wildfires in California history.

PG&E's chapter 11 plan proposed to pay the claims of non-wildfire unsecured creditors in full together with pendency interest at the federal judgment rate (then 2.59%). The plan provided that the non-wildfire claim unsecured creditor class was unimpaired and that the class was therefore deemed to accept the plan. Certain unsecured creditors (collectively, the "plaintiffs") objected, arguing that they should be entitled to pendency interest at the significantly higher rates specified either in their contracts or under state law, which would increase total interest payments by as much as $200 million. According to the plaintiffs, because PG&E was solvent, they were entitled to interest at the contractual or default state law rates, failing which their claims would be impaired.

The bankruptcy court held that, in accordance with Cardelucci, all unsecured creditors of a solvent chapter 11 debtor—whether or not impaired—are entitled to pendency interest, but at the federal judgment rate. In the alternative, the court ruled, even if Cardelucci did not control, the Bankruptcy Code itself limits unsecured creditors of a solvent debtor to interest at the federal judgment rate, and the plaintiffs' claims were therefore unimpaired by the plan (as distinguished from the statute).

The bankruptcy court later confirmed PG&E's chapter 11 plan. The plaintiffs appealed the confirmation order and the pendency interest order, but the district court affirmed for the same reasons articulated by the bankruptcy court. The plaintiffs appealed to the Ninth Circuit.

The Ninth Circuit's Ruling

A divided three-judge panel of the Ninth Circuit reversed the ruling and remanded the case below for additional determinations. 

Writing for the majority, U.S. Circuit Court Judge Carlos F. Lucero (sitting by designation from the Tenth Circuit) noted that the rate of pendency interest payable to unimpaired unsecured creditors in a solvent-debtor case was a matter of first impression among the federal circuit courts of appeals.

According to the majority, the lower courts erred in holding that, as unimpaired creditors, the plaintiffs were entitled to pendency interest, but only at the federal judgment rate. Under the solvent-debtor exception, Judge Lucero wrote, the plaintiffs "possess an equitable right to receive postpetition interest at the contractual or default state law rate, subject to any other equitable considerations, before PG&E collects surplus value from the bankruptcy estate." Pacific Gas, 46 F.4th at 1053. Cardelucci, the majority explained, "does not hold otherwise," and the lower courts erred in concluding that the decision settled the issue.

Judge Lucero explained that the litigants in Cardelucci agreed that unsecured creditors in a chapter 11 case (whose claims were impaired under a plan, although the court does not state as much) were entitled to pendency interest because the debtor was solvent, but disputed the rate of interest. Although, under the circumstances, the Cardelucci court made no distinction between unimpaired and impaired claims (and "did not refer to impairment status at all"), the court held merely that the phrase "interest at the legal rate" in section 726(a)(5) means the federal judgment rate. According to the majority in Pacific Gas, because section 726(a)(5) applies only to impaired claims in chapter 11 via the best interests test, "Cardelucci therefore does not tell us what rate of postpetition interest must be paid on plaintiffs' unimpaired claims." Id. at 1056.

The majority rejected PG&E's argument that the solvent-debtor exception was abrogated by the enactment of the Bankruptcy Code. According to PG&E, the combination of section 502(b)(2)—the general rule prohibiting postpetition interest on unsecured claims—and section 726(a)(5) (an exception to the unmatured interest prohibition applying only to impaired creditors in a solvent debtor chapter 11 case)—"reflects Congressional intent to establish a uniform rate of postpetition interest for all unsecured claims when a debtor is solvent."


 "To the contrary," Judge Lucero wrote, for the plaintiffs' claims to be unimpaired, "the Code required PG&E's plan to leave 'unaltered' all of plaintiffs' 'legal, equitable, and contractual rights,'—§ 1124(1)—including their equitable right to receive the bargained-for postpetition interest under the solvent-debtor exception." Id.

According to the majority, the solvent-debtor exception derived from English law was well established in cases under the Bankruptcy Act and "[n]o Code provisions—alone or together—unambiguously displace the long-established solvent debtor exception or preclude supposedly unimpaired creditors from asserting an equitable right to contractual postpetition interest." Id. at 1058. Echoing the courts in Mullins, UPC, and Energy Future, Judge Lucero explained that section 502(b)(2) can plausibly be read to prohibit postpetition interest as "part of" a claim, but not interest "on" a claim, which may be required to render the claim unimpaired. Nor does section 726(a)(5) abrogate the equitable solvent-debtor exception because it applies only to impaired chapter 11 creditors via the best interests test. According to the majority, if lawmakers had intended "to limit all unsecured, chapter 11 creditors to interest at the federal judgment rate, it could have done so directly," yet did not.

In addition, the majority noted, the removal of section 1124(3) from the Bankruptcy Code in 1994 to foreclose, as interpreted by the vast majority of courts, the designation of unsecured claims paid in their "allowed amount" without postpetition interest as unimpaired by a chapter 11 plan "confirm[s] that creditors of a solvent debtor who are designated as unimpaired must receive postpetition interest on their claim[s]—notwithstanding § 502(b)(2), or the fact that no Code provision expressly entitles such creditors to unaccrued interest." Pacific Gas, 46 F.4th at 1060. According to Judge Lucero, absent creditors' retention of "equitable rights" required by section 1124(1) to render their claims unimpaired, "creditors whose claims were paid in full and designated as unimpaired would not be entitled to any postpetition interest—the exact result Congress sought to preclude by repealing § 1124(3).") Id. (citing Energy Future, 540 B.R. at 123, where the court explained that unimpaired creditors' equitable right to interest "resolves a conflict between" section 502(b)(2) and the repeal of section 1124(3)).

This interpretation of the relevant Bankruptcy Code provisions, the majority stated, is supported by the plain meaning of the text and "equitable principles that persist under the modern bankruptcy regime." By contrast, it wrote, PG&E's reading of the Bankruptcy Code would permit it to "end-run [creditors'] statutory rights while reaping a windfall of hundreds of millions of dollars." Id.

Turning to the appropriate rate of interest, the majority noted that "absent compelling equitable considerations," a bankruptcy court should defer to the presumption that creditors in a solvent chapter 11 case should receive contractual or default-rate postpetition interest. However, because the "record before us is limited" (e.g., there was no evidence of the extent to which PG&E was solvent and could therefore pay pendency interest at any rate), the majority remanded this issue to the bankruptcy court. It accordingly reversed the district court's ruling and remanded the question of the appropriate interest rate below.


In a lengthy dissent, Circuit Judge Sandra Ikuta adopted a strict textualist approach, reasoning that: (i) pursuant to section 502(b)(2), "a claim stops accruing interest at the time the petition in bankruptcy is filed," and any claim for postpetition interest must be disallowed unless such a claim is expressly authorized somewhere else in the Bankruptcy Code; and (ii) the Bankruptcy Code does not explicitly authorize or require payment of postpetition interest to unimpaired creditors.

According to Judge Ikuta, Congress knew how to draft the kind of statutory language that would create an exception to section 502(b)(2)'s prohibition of postpetition interest on unimpaired claims as well as impaired claims (via the best interests test and section 726(a)(5)), but elected not to do so. She wrote that "the sole function of the courts is to enforce [the Code's plain language] according to its terms … even if that 'may produce inequitable results for trustees and creditors.'" Id. at 1075 (citations omitted). Moreover, Judge Ikuta noted, "even if policy considerations were relevant, Congress could have chosen to give impaired creditors greater protections than unimpaired creditors, because impaired creditors (such as classes of wildfire victims here) may not receive payment of their claims in full." Id.


The recent surge in solvent-debtor chapter 11 cases may be an aberration. Whether or not that is the case, we now have a wealth of judicial guidance at the bankruptcy and appellate level addressing the exception itself as well as the appropriate rate of pendency interest on unsecured claims.

Pacific Gas is consistent with the vast majority of decisions (including the Fifth Circuit's recent ruling in Ultra II) regarding the continued vitality of the solvent-debtor exception in cases under the Bankruptcy Code. Courts differ over the source of authority for the exception, but they generally agree that it survived the enactment of the Bankruptcy Code. 

Both Pacific Gas and Ultra II are notable in rejecting the federal judgment rate as the appropriate rate of interest that must be paid to unsecured creditors to render their claims unimpaired by a chapter 11 plan. Based on these rulings, plan proponents in other chapter 11 cases must consider the impact—strategic and financial—of designating unsecured claims as unimpaired.

On October 5, 2022, the Ninth Circuit denied PG&E's petition for a rehearing en banc of the case. However, on October 27, 2022, the Ninth Circuit issued an order staying the mandate on its ruling pending the filing of a petition for U.S. Supreme Court review.

Jones Day represented certain utility company shareholders owning a substantial portion of the outstanding common equity of PG&E in a series of regulatory proceedings before the California Public Utilities Commission.


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