To Make-Whole … or Not

Fifth Circuit Holds that Disallowance of Claim Pursuant to the Bankruptcy Code Does Not Render Such Claim Impaired and Casts Doubt on Creditors’ Ability to Recover Make-Whole Amounts or Post-Petition Interest at the Default Contract Rate

On January 17, 2019, a three-judge panel of the United States Court of Appeals for the Fifth Circuit reversed, in part, and vacated, in part, a bankruptcy court decision in In re Ultra Petroleum Corp., Case No. 17-20793 (5th Cir. Jan. 17, 2019) (“Ultra II”). The bankruptcy court had held that certain creditors (the “OpCo Creditors”) of a solvent debtor were deemed unimpaired by the Ultra chapter 11 plan and, therefore, entitled to the full $201 million make-whole (the “Make-Whole Amount”) and post-petition interest at the default contract rate in the aggregate amount of $186 million. In re Ultra Petroleum Corp., 575 B.R. 361, 370–71 (Bankr. S.D. Tex. 2017) (“Ultra I”). The Fifth Circuit remanded the case back to the bankruptcy court to consider whether it was the Bankruptcy Code that impaired the creditors’ rights, and not the Ultra chapter 11 plan.

In particular, the Ultra II opinion:

• Holds that “[Bankruptcy] Code impairment is not the same thing as plan impairment” and, therefore, the bankruptcy court erred when holding that a plan impairs a creditor if the plan “refuses to pay an amount the Bankruptcy Code independently disallows.”
• Suggests that make-whole amounts will generally be considered unmatured interest in the Fifth Circuit. Thus, unless the solvent debtor exception applies, the Debtors can avoid paying the Make-Whole Amount without impairing the OpCo Creditors’ Claims.
• States that while OpCo Creditors have no legal right to collect post-petition interest at the default contract rate, the bankruptcy court may award interest (i) pursuant to the post-judgment interest statute (28 U.S.C. § 1961) at the applicable judgment rate or (ii) at a rate supported by the equities of the case.

The bankruptcy court will reconsider these issues in accordance with the Fifth Circuit’s opinion. Ultra II, however, may have substantial implications beyond this case. The opinion suggests that make-whole provisions may only be enforceable in extremely narrow circumstances. If that ultimately proves to be true, the holding could impact decisions made by future debtors regarding venue, decisions of market participants in connection with financings, as well as the drafting of make-whole provisions in future debt agreements.

• The Ultra II opinion does not include an explicit declaration that make-whole provisions are always unmatured interest, subject to disallowance under ssection 502(b) however, it comes very close. The opinion includes very little analysis of the bankruptcy court’s contrary determination, and related multi-page discussion, that the Make-Whole Amount is an enforceable liquidated damages obligation under New York state law. See Ultra I, at 368–72. In addition, the Ultra II court suggests that a make-whole provision may be both a liquidated damages clause and unmatured interest, subject to disallowance under ssection 502(b) See Ultra II, at 22 (“Others have concluded make-whole provisions are better viewed as liquidated damages, rather than unmatured interest. But those categories are not mutually exclusive.”) (citations omitted).
• To the extent the bankruptcy court adopts similar treatment, which appears likely in light of the Ultra II court’s strongly worded opinion, the ability of creditors to enforce a make-whole provision inside the Fifth Circuit could be limited to cases involving a solvent debtor and/or an oversecured creditor. Even with a solvent debtor, however, enforcement is far from guaranteed given the Ultra II court’s stated doubt that the solvent debtor exception applies under the BBankruptcy Code Indeed, the Ultra II court explicitly stated that it expects the bankruptcy court to consider whether a creditor’s ability to seek dismissal of a bad-faith filing under the BBankruptcy Codeimpacts the continued application of the solvent debtor exception. Ultra II, p. 24 (“We trust the bankruptcy court on remand also will consider what effect (if any) § 1112(b) has on the solvent-debtor exception (if any exists).”).
• The inability to enforce make-whole provisions in most circumstances will likely result in various changes in behavior by future debtors, creditors and lenders. For example, potential debtors seeking to avoid make-whole obligations will be more likely to commence cases in the Fifth Circuit. On the other hand, creditors seeking to enforce make-wholes may insist on filing in a different circuit. Such dynamics will certainly affect the negotiation of pre-planned and pre-packaged plans.
• Additionally, lenders and borrowers may begin revising the currently accepted forms of make-whole provisions (e.g., including alternatives to yield maintenance formulas so the terms appear less like the economic equivalent of interest). Lenders may also seek terms that provide increased opportunities/abilities to trigger an event of default before a potential debtor seeks bankruptcy protection.
• The ability of creditors to recover post-petition interest at rates above the...