Ninth Circuit Holds that Unimpaired Creditors of Solvent Debtor Are Entitled to Postpetition Interest
In re PG&E Corp., No. 21-16043, 2022 WL 3712478 (9th Cir. Aug. 29, 2022)
Article Courtesy of David Simonds of Hogan Lovells
In In re PG&E Corp., a panel of the United States Court of Appeals for the Ninth Circuit (the “Ninth Circuit”) held, by a 2-1 majority, that the long-standing “solvent debtor” exception survived the enactment of the Bankruptcy Code. Accordingly, creditors of a solvent debtor, in order to be “unimpaired,” are entitled to receive postpetition interest at the contractual or applicable state law rate (as opposed to the federal judgment rate), subject to any other equitable considerations, before the solvent debtor or shareholders may collect or retain surplus value from the bankruptcy estate.
As important background, a creditor’s rights with respect to a chapter 11 plan turn, in part, on whether such creditor’s claim is treated as “unimpaired” or “impaired.” A creditor whose claim is treated as “unimpaired” is not entitled to vote on a chapter 11 plan and is deemed to have consented to the plan. In contrast, a creditor whose claim is treated as “impaired” is entitled to vote on the chapter 11 plan and also to other protections, including that its treatment be “fair and equitable” if the class in which its claim is classified has rejected the plan. In addition, an impaired creditor that votes against a chapter 11 plan must receive no less value under that plan that it would have received in a hypothetical chapter 7 liquidation (the “best interests of creditors” test). In order for a creditor’s claim to be “unimpaired,” section 1124(1) of the Bankruptcy Code requires that the plan leave unaltered the creditor’s “legal, equitable and contractual rights.”
PG&E Corporation and Pacific Gas & Electric Company (collectively, “PG&E”) filed for chapter 11 reorganization in January 2019 in response to catastrophic wildfires that occurred in Northern California during the preceding years. Following the fires, PG&E faced tens of billions of dollars in potential liabilities to fire victims, in addition to the tens of billions of dollars the company owed pursuant to its outstanding debt and other contractual obligations. However, PG&E was solvent at the time of filing, with assets reported to exceed liabilities by $20 billion, and PG&E has never argued that it was insolvent. (NB: A company is not required to be “insolvent” in order to commence a chapter 11 case.)
In June 2020, PG&E confirmed a chapter 11 plan of reorganization that, among other things, treated the appellants, an ad hoc group of trade creditors (the “AHC”), as “unimpaired” and provided for postpetition interest to be paid on their claims, and those of other unsecured creditors, at the federal judgment rate of 2.59% per annum. The AHC and Plaintiffs and other unsecured creditors objected to the amount of postpetition interest provided under the plan. They argued that, because PG&E was solvent, they must receive interest at the contractual or default state law rates (some of which ran as high as 10% per annum) to be considered unimpaired. Both the bankruptcy court, in a ruling prior to confirmation, and the district court, on appeal, disagreed, concluding that In re Cardelucci, 285 F.3d 1231 (9th Cir. 2002) (“Cardelucci”), and the text of the Bankruptcy Code limited plaintiffs to recovery of postpetition interest at the much lower federal judgment rate. The Ninth Circuit reversed the bankruptcy and district courts.
First, the Ninth Circuit held that its prior decision in Cardelucci did not control. Cardelucci was a case involving a creditor whose claim was impaired. Section 726(a) of the Bankruptcy Code establishes the priority of distributions in a chapter 7 liquidation. Section 726(a)(5) requires creditors of a solvent debtor to receive postpetition interest at “the legal rate” (which Cardelucci held was the federal judgment rate). Section 726 of the Bankruptcy Code does not apply in a chapter 11 case except through the best interests of creditors test. Therefore, while Cardelucci established that, pursuant to the best interests of creditors test, a dissenting, impaired creditor of a solvent chapter 11 debtor must receive postpetition interest on its claim at the federal judgment rate, it says nothing about whether an unimpaired creditor must receive postpetition interest on its claim and, if so, at what rate.
Second, the Ninth Circuit held that the enactment of the Bankruptcy Code did not abrogate the common law “solvent debtor” exception, a rule providing that creditors have an equitable right, absent countervailing equities, to receive postpetition interest at the contractual or state default interest rate before allocation of surplus value to the debtor’s shareholders. While the Bankruptcy Code’s prohibition on payment of unmatured interest (section 502(b)(2)) cut off a “contractual” right to postpetition interest, and the absence of any provision in the Bankruptcy Code expressly providing for payment of postpetition interest to unimpaired creditors meant there was no “legal” right to such interest, as PG&E was solvent, plaintiffs’ claims retained an “equitable” right to receive postpetition interest. Accordingly, the Ninth Circuit overturned the alternative holding of the bankruptcy and district courts that the Bankruptcy Code limited payment of postpetition interest to the federal judgment rate. The Ninth Circuit reversed and remanded to the bankruptcy court to determine the appropriate rate of interest.
Citing decisions from other circuits, the Ninth Circuit held that the solvent debtor exception, while equitable in nature, does not give bankruptcy judges “free-floating discretion to redistribute rights in accordance with [their] personal views of justice and fairness.” Rather, “absent compelling equitable considerations, when a debtor is solvent, it is the role of the bankruptcy court to enforce the creditors’ contractual rights.” The Ninth Circuit concluded by stating that “[w]e are confident that in most solvent-debtor cases involving unimpaired creditors, the equitable role of the bankruptcy court will be simply to enforce creditors’ rights according to the tenor of the contracts that created those rights.” Given the lack of any indication that payment of contractual or default interest could impair the ability of other similarly situated creditors, the Ninth Circuit found no “compelling equitable considerations” that would defeat the presumption that the AHC was entitled to contractual or default postpetition interest.
The dissenting judge took a position more limiting than those of the lower courts, which PG&E had not even argued below, that the solvent debtor exception had not only been abrogated by the enactment of the Bankruptcy Code, but the failure of Congress to include the exception in the Bankruptcy Code meant that there was never a right to payment of postpetition interest in any chapter 11 case, whether or not the debtor is solvent.
On September 12, 2022, PG&E filed a petition for an en banc rehearing by the Ninth Circuit, arguing, for the first time, that the panel should adopt the reasoning of the dissent and absolutely bar payment of postpetition to unimpaired creditors in both solvent and insolvent debtor cases. PG&E’s petition is currently pending.
 Although not at issue in the PG&E appeal, a separate subsection of the Bankruptcy Code, section 1124(2), permits a plan of reorganization to reinstate a prepetition debt, and leave a creditor “unimpaired” by : (1) leaving unaltered the lender’s legal, equitable and contractual rights, (2) curing any prepetition defaults (other than ipso facto defaults), (3) reinstating maturity and terms of the original obligation and (4) compensating the lender for (a) any damages incurred as a result of reasonable reliance on the acceleration of the obligation and (b) any actual pecuniary loss arising from the failure to perform a nonmonetary obligation.
 The Ninth Circuit left open the question of the rate an impaired creditor of a solvent debtor would be entitled to receive under section 1129(b)(1) in a cramdown scenario.