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...
