‘Unimpairment’ Under Chapter 11: More Than Just a Non-Word

March 28, 2022

It begins with an awkward mouthful. Outside a bankruptcy brief, is “unimpairment” even a word? (No, per Merriam-Webster.) Inside Chapter 11, it’s much more: a trend.

Want to refinance your bonds cheaply? Are you an otherwise sound and solvent business, forced into bankruptcy by a massive fire (PG&E), persistent low commodity pricing (Ultra Petroleum), or a pandemic (Hertz, whose airport rental business was shuttered in 2020 by COVID-19)?

Or would you just prefer to boost your stock value by lowering your coupon?

Chapter 11 allows debtors to reorganize without paying debts in full, through a form of creditor democracy backstopped by rules allowing disappointed creditors to object to plans that unfairly confer value on junior stakeholders.

For many years, Section 1124 was a sleepy corner of this chapter. It allows the debtor to force its plan upon a creditor class without a vote, provided that the claims of the class are “unaltered” by the plan.

In a new trend, debtors are arguing they can deem “unimpaired” bondholders whose interest rates were cut to the bone on the filing date, and whose prepayment premiums are eliminated in the plan. The argument stitches together three Code sections[1] to whittle down the “allowed” claim of this group and then cut off the portion that is disallowed.[2]

Circuit decisions in Ultra Petroleum and PG&E are expected soon. Suppose the trend prevails—what next? What’s to stop any debtor whose business can survive the bankruptcy process from using chapter 11 to refinance at lower rates?

Some trend advocates have pointed to a court’s “bad faith” dismissal power under Section 1112, but that standard is, to put it politely, vague. And if the circuit courts bless unimpairment, it is hard to see how a debtor using Section 1124 to strip down the interest rates on its debt differs from a taxpayer exploiting a loophole in that other code.

Debtors will argue that it can’t be “bad faith” to exploit a legal right. Creditors may wonder what became of their coupon.

[1] Sections 1124(1) (referring to whether a claim is altered by the plan), 502(b)(2) (excluding unmatured interest from the “allowed claim”), and 726(a)(5) (directing payment of interest at the “legal rate” as a part of the distribution waterfall in Chapter 7 cases).

[2] Morgan Lewis represents bondholders who argue that this argument offends the statute and common sense.