The opinion is Wells Fargo Bank, Indenture Trustee v. The Hertz Corp. (In re The Hertz Corp), Adv. P. No. 21-50995, Delaware Bankruptcy Court (issued December 22, 2021, Doc. 28).
The question is whether (and at what rate) post-petition interest can be recovered on pre-petition unsecured claims, when debtor is solvent, under the “solvent debtor exception.” The answers pit equitable arguments against statutory provisions and even looks back to caselaw under the Bankruptcy Act of 1898.
Basic Rule & Exception
Post-petition interest on unsecured claims is not allowed! That’s the basic rule established by § 502(b)(2) of the Bankruptcy Code, like this:
- the bankruptcy court “shall allow such claim . . . except to the extent that . . . (2) such claim is for unmatured interest.”
However, the “solvent debtor exception” to the basic rule allows post-petition interest on unsecured claims when the debtor is solvent.
Q & A
Questions and answers under the “solvent debtor exception,” according to the Hertz opinion, are as follows.
First question: When does post-petition interest accrue on unsecured claims?
Answer: Only when debtor is solvent.
Second question: At what rate does interest accrue on unsecured claims when debtor is solvent? Such rate could be either:
- the rate contracted between the parties (these rates are often very high); or
- the federal judgment rate (this rate has been very low in recent times).
Answer: post-petition interest accrues, against a solvent debtor, only at the federal judgment rate.
Equitable Arguments v. Statutory Provisions
–By Unsecured Creditors (Equitable Arguments)
Unsecured creditors in the case contend they are entitled to receive post-petition interest at their contract rates against a solvent debtor—as a matter of equity.
Such exception is based on the idea that, when a debtor is solvent, unsecured creditors should receive their full contract rights before owners receive a dime. [Note: this is the same idea animating the absolute priority rule.]
In Hertz, Debtors are not only solvent, they are awash in cash:
- All allowed claims are being paid in full; and
- More than $1.5 billion is being returned to Debtors’ owners.
Therefore, equitable considerations require that unsecured claims receive post-petition interest at their contract rates, before any funds are returned to Debtor’s owners.
–By Debtors (Statutory Provisions)
Debtors argue that equitable principles cannot override the following express provisions of the Bankruptcy Code:
- § 502(b)(2) disallows post-petition interest on unsecured claims, without regard to a debtor’s solvency;
- § 726(a)(5) requires payment of post-petition interest on unsecured claims when debtor is solvent, but the rate of interest accrual is set at “the legal rate” (i.e., the federal judgment rate)—not the contract rate; and
- § 726(a)(5) is incorporated into Chapter 11 by § 1129(a)(7).
Arguments From Bankruptcy Act Cases
–By Unsecured Creditors
A Hertz oddity is this: the confirmed plan identifies certain unsecured creditors as “unimpaired.” So, these unsecured creditors make a two-step argument relating to (i) an impaired v. unimpaired distinction, and (ii) case law under the Bankruptcy Act of 1898.
- The solvent debtor exception began under the Bankruptcy Act;
- The Bankruptcy Code adopts the “solvent debtor exception” for unsecured claims in § 726(a)(5)—providing that post-petition interest accrues on unsecured claims at “the legal rate” (i.e., the federal judgment rate), when debtor is solvent; and
- § 726(a)(5) is incorporated into Chapter 11 by § 1129(a)(7)—but only as to unsecured claims that are impaired.
Second Step—Case Law.
Unsecured claims in Hertz are being treated as unimpaired, and Chapter 11 of the Bankruptcy Code is silent on post-petition interest for unimpaired claims in a solvent case.
Therefore, the “solvent debtor exception” articulated by the U.S. Supreme Court, under the Bankruptcy Act, controls. That’s because the exception arose under the Bankruptcy Act and survives today because the Bankruptcy Code did not repudiate it.
Debtors contend that none of the Supreme Court cases cited by unsecured creditors support the creditors’ contention. That’s because:
- all such cases deal with rights of secured creditors (not unsecured creditors) to post-petition interest; and
- secured creditors have an entirely different analysis based on different statutes (i.e., § 506(b) & § 1129(b)(2)(A)).
The Bankruptcy Court agrees with Debtors that Bankruptcy Act opinions do not control.
However, unsecured creditors are entitled to post-petition interest when the debtor is solvent: it’s just that their interest accrues only at the “legal rate” (i.e., federal judgment rate), not the contract rate.
- a bankruptcy court cannot use equitable principles to modify express language of the Bankruptcy Code;
- § 502(b)(2) expressly disallows claims of unsecured creditors for unmatured interest; and
- When a debtor is solvent, the Bankruptcy Code does not waive the application of § 502(b)(2).
Bankruptcy court opinions to the contrary do exist, such as:
- In re Ultra Petroleum Corp., 624 B.R. 178 (Bankr. S.D. Tex. 2020), holds that unsecured creditors are entitled to post-petition interest at the contract rates, notwithstanding disallowance by § 502(b); and
- In re Energy Future Holdings Corp., 540 B.R. 109 (Bankr. D. Del. 2015), says that bankruptcy courts have broad equitable discretion to determine what post-petition interest, if any, unimpaired creditors are entitled to receive.
Such contrary opinions are unpersuasive, says the Hertz Court. The “solvent debtor exception” survives from the Bankruptcy Act into the Bankruptcy Code only by codification:
- by § 506(b) for over-secured creditors; and
- by § 502(b), § 726(a)(5) and § 1129(a)(7) for unsecured creditors.
Such contrary opinions are also opposed to Third Circuit precedent. In In re PPI Enterprises, Inc., 324 F.3d 197 (3rd Cir. 2003), for example, the amount of a landlord’s claim is capped by § 502(b), even though the debtor is solvent and its owners are entitled to a distribution in that Chapter 11 case.
Additionally, the Hertz opinion spills considerable electronic ink in declaring that a 1984 amendment to § 1129(a)(7) does not change the analysis. That’s because Congress geared the amendment to address a plan voting issue—not an interest rate issue.
The Hertz opinion discussed above offers a rationale for limiting the “solvent debtor exception” to the “legal rate” of interest.
It will be interesting to see whether the opinion gets a following.
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