In the latest development in the Ultra make-whole saga, on November 26, 2019 the United States Court of Appeals for the Fifth Circuit granted the Noteholder’s Motion for Reconsideration or Rehearing En Banc, reconsidered its January 17, 2019 decision (the “Original Fifth Circuit Opinion”) and issued a substitute opinion (the “New Fifth Circuit Opinion”). Our prior updates on the Ultra make-whole decisions for the ACIC Private Notes newsletter are located here and here. Among other things, the New Fifth Circuit Opinion vacates the portion of the Original Fifth Circuit Opinion that held that make-whole was unmatured interest under Section 502(b)(2) of the Bankruptcy Code and, therefore, not a permissible component of a claim in bankruptcy.
By way of background, in the underlying bankruptcy case, the Ultra Debtors classified the noteholders as unimpaired creditors under Section 1124(1) of the Bankruptcy Code yet, at the same time, objected to the noteholders’ claims for make-whole and post-petition interest. The Debtors challenged the noteholders’ entitlement to make-whole and post-petition interest on a number of grounds, including arguing that (1) make-whole was unmatured interest under Section 502(b)(2) of the Bankruptcy Code, (2) the payment of the make-whole and post-petition interest at the contract default rate (rather than the much lower federal judgment rate) was “double counting”, and (3) the noteholders’ classification as unimpaired creditors under the plan of reorganization did not entitle them to make-whole and post-petition interest if such amounts were otherwise disallowed by the Bankruptcy Code.
Judge Isgur of the US Bankruptcy Court for the Southern District of Texas rejected the Debtors’ arguments and awarded the noteholders make-whole and post-petition interest, holding that (1) creditors classified as unimpaired are entitled to all of their legal, contractual and equitable rights without limitation by the Bankruptcy Code and (2) make-whole was an enforceable liquidated damages claim. In so holding, Judge Isgur did not have to decide the question of whether make-whole was unmatured interest under Section 502(b)(2) of the Bankruptcy Code or whether the pre-Bankruptcy Code rule that solvent debtors are obliged to honor all contractual obligations survived the enactment of the Bankruptcy Code.
The Bankruptcy Court decision was appealed directly to the United States Court of Appeals for the Fifth Circuit. In summary, the Original Fifth Circuit Decision held that:
(1) since Section 1124(1) of the Bankruptcy Code refers to impairment by the plan, a claim is not impaired under Section 1124 if a statute (e.g. Section 502(b)(2)), not the plan, is doing the impairing;
(2) impairment is evaluated after the claim disallowance provisions of Section 502(b) are applied (i.e., if the full amount of the claim, net of disallowed interest, is paid, there is no impairment);
(3) notwithstanding the fact that the Bankruptcy Court had not addressed the unmatured interest question, make-whole was unmatured interest and disallowed under Section 502(b)(2) of the Bankruptcy Code since (i) it was the economic equivalent of interest, (ii) it was unmatured as of the petition date, and (iii) other court decisions to the contrary were not persuasive; and
(4) noteholders did not have a legal right to the post-petition interest, distinguishing between post-petition interest as part of a claim and post-petition interest on a claim and since the Note Purchase Agreement did not provide for the contract default rate to apply to bankruptcy judgements, the noteholders did not have a contractual right to post-petition interest on a claim.
The Original Fifth Circuit Opinion remanded certain issues to the Bankruptcy Court for consideration, including whether the solvent debtor rule survived the enactment of the Bankruptcy Code and, if so, whether it could be grounds for awarding make-whole and post-petition interest. At the same time, in dicta, the Fifth Circuit expressed its doubts about whether the solvent debtor rule had survived.
Immediately following the Original Fifth Circuit Opinion, the noteholders filed a motion for reconsideration by the panel or rehearing by the full court. In addition to arguing that the substance of the Court’s unimpairment decision was incorrect, the noteholders argued that the issue of whether make-whole was unmatured interest should not have been decided by the Fifth Circuit in the first instance, but rather considered by the Bankruptcy Court on remand. After a lengthy deliberation, the panel granted the motion and substituted the New Fifth Circuit Opinion for the Original Fifth Circuit Opinion. The New Fifth Circuit Opinion still holds that creditors can be properly classified as unimpaired under Section 1124 of the Bankruptcy Code and have their claims limited by the provisions of the Bankruptcy Code, including Section 502(b)(2). This portion of the decision has implications beyond the issue of allowance of make-whole and post-petition interest. However, instead of deciding whether make-whole is unmatured interest for purposes of Section 502(b)(2), as the Original Fifth Circuit Opinion did, the New Fifth Circuit Opinion remands this issue to the Bankruptcy Court. The Fifth Circuit also remanded to the Bankruptcy Court the question of whether the solvent debtor rule survived the enactment of the Bankruptcy Code. However, in the New Fifth Circuit Opinion, the Court replaces its prior skeptical statement with a positive statement that “[o]ur review of the record reveals no reason why the solvent-debtor exception could not apply.”
The Ultra journey is not over. In the coming months the Bankruptcy Court will hear the arguments on whether make-whole is unmatured interest under Section 502(b)(2). Hopefully the Bankruptcy Court will follow the majority of courts that have rejected this argument, and upheld make-whole as an enforceable liquidated damage clause. Separately, the Bankruptcy Court could uphold its prior award of make-whole and post-petition interest based on the authority of the solvent debtor rule.
Renée Dailey, Chip Fisher and Kate Lindsay