Article courtesy of Margaret G. Parker-Yavuz (Akin Gump) and Chanwon (Pio) Yoon (Akin Gump)
Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.), 2021 Bankr. LEXIS 3491 (Bankr. D. Del. Dec. 22, 2021)
The Hertz debtors filed a motion to dismiss unsecured notes indenture trustees’ complaint seeking to recover make-whole premium and/or post-petition interest at the contract default rate in excess of the federal judgment rate. The U.S. Bankruptcy Court for the District of Delaware granted the debtors’ motion to dismiss the post-petition interest claim, and granted in part and denied in part the debtors’ motion to dismiss the make-whole premium claim.
On May 22, 2020, the Hertz Corporation and its affiliates (the “Debtors”) filed voluntary petitions under chapter 11 of the Bankruptcy Code. The Debtors filed a plan of reorganization that provided for creditors to receive payment in full in cash on the plan’s effective date plus post-petition interest to the effective date at the federal judgment rate or in the amount necessary to render them unimpaired. The plan was confirmed on June 10, 2021 in an order that preserved the rights of the Debtors’ unsecured noteholders to assert entitlement to a make-whole premium and additional interest and other claims as necessary to render their claims unimpaired. The plan became effective on June 30, 2021.
On July 1, 2021, Well Fargo Bank, N.A. (“Wells Fargo”), as indenture trustee for certain unsecured notes issued by the Debtors pre-petition, filed a complaint seeking a declaratory judgment that, in addition to the principal and pre-petition interest at the federal judgment rate paid to the noteholders on the plan’s effective date (totaling over $2.7 billion), the Debtors must pay (1) approximately $147 million in make-whole premium and (2) approximately $125 million in post-petition interest at the contract default rate (in excess of the federal judgment rate). U.S. Bank, N.A. (“US Bank”), as indenture trustee for another series of unsecured notes, intervened as a plaintiff seeking relief on the post-petition interest claim. The Debtors filed a motion to dismiss both counts for failure to state a claim.
Note that, with respect to both the make-whole premium count and the post-petition interest count, the Court was deciding a motion to dismiss. In order to survive a motion to dismiss, a complaint must have sufficient factual content to state a claim that is plausible on its face. The Court’s ruling in this case therefore was not a ruling on the merits of make-whole or a decision on whether a make-whole premium is unmatured interest under section 502(b)(2) of the Bankruptcy Code; those issues are still to be decided by the Court.
Make-Whole Premium Claim
With respect to their motion to dismiss the make-whole premium count, the Debtors asserted that (a) no redemption premium was payable under the express language of the indentures because the indenture acceleration provisions did not provide for the payment of redemption premium and (b) even if the indentures did require payment of a redemption premium, the premium would be unmatured interest and must be disallowed under the Bankruptcy Code.
In considering the Debtors’ first argument relating to the language of the indentures, the Court looked to In re Energy Future Holdings Corp., 842 F.3d 247 (3d. Cir. 2016) (“EFH”), in which the Third Circuit concluded that the issue of whether a redemption premium was due depended not on the terms of the acceleration clause, but on the terms of the redemption provision. Applying EFH, the Court rejected the Debtors’ argument and concluded that the applicable contractual provision for determining whether redemption premium is due is the redemption provision in the indentures.
After concluding that Wells Fargo alleged sufficient facts to establish a facially plausible claim that the redemption of the notes was at the Debtors’ “option” given that the Debtors voluntarily filed the plan of reorganization, the Court determined that two series of the notes (the “2022/2024 Notes”) were not entitled to a redemption premium because the applicable redemption provision provided for redemption “prior to maturity thereof” and did not use the term “Stated Maturity” which was a defined term in the indenture meaning the date the notes were originally due. Since the redemption provision did not use the defined term “Stated Maturity”, the Court concluded that it was intended to refer to the common meaning of “maturity”, which includes maturity upon acceleration caused by a bankruptcy filing. The Court concluded that “maturity” occurred at the time of the bankruptcy filing when the notes were accelerated, and since the notes were not redeemed prior to that time, there was no redemption premium due on the 2022/2024 Notes under the language of the indenture.
In the case of the other series of notes (the “2026/2028 Notes”), the indenture contained an additional redemption clause allowing the issuer to redeem those notes at any time prior to a specified date (rather than “prior to maturity”) with the redemption premium. Since the 2026/2028 Notes were redeemed prior to the relevant date specified in that clause, the Court found that Wells Fargo had stated a plausible claim that, under the express terms of the indenture, a premium would be due on the 2026/2028 Notes.
The Court next addressed the Debtors’ second argument that, even if redemption premium is due under the indenture, it must be disallowed as unmatured interest under section 502(b)(2) of the Bankruptcy Code. The Court noted that the term “unmatured interest” is not defined in the Bankruptcy Code and pointed out that, in deciding whether a charge is unmatured interest, courts look to the economic substance of the transaction to determine what counts as interest. The Court noted that although the Third Circuit in EFH characterized a redemption premium as the “contractual substitute for interest lost on Notes redeemed before their expected due date,” it was not addressing the issue of whether it could be characterized as such to be disallowed under section 502(b)(2) of the Bankruptcy Code. The Court further noted that while the Fifth Circuit in In re Ultra Petroleum Corp., 943 F.3d 758 (5th Cir. 2019) (“Ultra”) suggested that some make-whole premiums may be the equivalent of unmatured interest, it did not decide whether the ones in that case were, and instead remanded to the bankruptcy court to determine the issue. The Court concluded that the question of whether the redemption premium is the economic equivalent of unmatured interest is not a legal question, but is instead a factual question – i.e., whether the redemption premium is the economic equivalent of unmatured interest. Since in this case the redemption premium under the indenture is tied to the Treasury rate and is not simply the present value of the unmatured interest, the Court found that Wells Fargo may be able to show that the redemption premium is not the economic equivalent of unmatured interest and therefore stated a plausible claim for relief.
Post-Petition Interest Claim
In the second count of their complaint, Wells Fargo and US Bank (the “Indenture Trustees”) sought a declaratory judgment that the noteholders are entitled to post-petition interest on their claims, from the petition date to the date they were paid in full, at the contract rate (which was significantly higher than the federal judgment rate). Wells Fargo also asserted that, to the extent the Court concludes that the make-whole redemption premium is unmatured interest, the noteholders are still entitled to it under the express terms of the indentures. The Indenture Trustees argued that the noteholders were treated as unimpaired under the Debtors’ plan and therefore their claims for post-petition interest and/or redemption premium must be paid in accordance with the indentures. In making this argument, the Indenture Trustees relied on section 1124(1) of the Bankruptcy Code, which provides that a class of claims or interests is impaired under a plan unless the plan leaves the legal, equitable and contractual rights to such claims or interest unaltered. The Debtors, on the other hand, argued that the noteholders’ claims were not impaired within the meaning of section 1124(1) because any modification of the noteholders’ claim for unmatured interest (or redemption premium, to the extent it is found to be the economic equivalent of unmatured interest) is an impairment resulting from the operation of section 502(b)(2) of the Bankruptcy Code, rather than the Debtors’ plan. The Court agreed with the Debtors, citing Third Circuit precedent and Ultra.
The Indenture Trustees further argued that the noteholders were entitled to the contract rate of interest under the “solvent debtor exception.” This equitable doctrine, which arose under the Bankruptcy Act (prior to the enactment of the Bankruptcy Code), provided that creditors were entitled to their full contract rights if a debtor was solvent. The Indenture Trustees asserted that the solvent debtor exception was incorporated into the Bankruptcy Code and applies in this case because the Debtors were “awash in cash, paid all creditors in full, and provided a substantial return on investment to equity.” Disagreeing with a comment of the Ultra court on the solvent debtor exception and citing Third Circuit precedent, the Court noted that “a bankruptcy court cannot use equitable principles to modify express language of the Code”, and being unimpaired does not mandate that the noteholders should receive the contract rate of interest in contravention of section 502(b)(2). After examining the case law cited by the parties, the express language of the Bankruptcy Code and its legislative history, the Court concluded that the solvent debtor exception survived the passage of the Bankruptcy Code only to a limited extent as codified in sections 506(b), 1129(a)(7) and 726(a)(5). The Court found that, regardless of whether the noteholders were treated as impaired or unimpaired, given that the debtor was solvent they would have received the same treatment – payment in full in cash of their allowed claim plus post-petition interest in accordance with sections 1129(a)(7) and 726(a)(5) at the federal judgment rate. The Court explained that treating both unimpaired and impaired unsecured creditors similarly in a solvent chapter 11 case “promotes several important policies of the Bankruptcy Code” as it prevents a debtor from paying preferred creditors more than others simply by classifying them as unimpaired. The Court concluded that the Indenture Trustees failed to state a plausible claim that the Debtors must pay post-petition interest on the notes at the rates specified in the indenture rather than at the federal judgment rate and granted the Debtors’ motion to dismiss the second count of the complaint.