In a holding that is significant for fixed-rate lending markets, the US Court of Appeals for the Fifth Circuit recently ruled that certain make-whole provisions constitute “unmatured interest” and are thus not within unsecured creditors’ allowed claims. The decision could effectively eliminate make-whole rights from bondholders in most Chapter 11 cases filed in the Fifth Circuit.
A three-judge panel of the US Court of Appeals for the Fifth Circuit issued an important “make-whole” decision in In re Ultra Petroleum on January 17. The court of appeals held that a make-whole provision cast in the industry-standard “T+50” formula and triggered by the acceleration-upon-bankruptcy provision in a standard note purchase agreement is “unmatured interest” within the meaning of 11 USC § 502(b)(2), and thus not within an unsecured creditor’s allowed claim.
Ultra is the first court of appeals decision squarely so to hold, and the holding has enormous significance for fixed-rate lending markets. If the ruling stands, it will likely have the effect of eliminating make-whole rights from bondholders in most Chapter 11 cases commenced in the Fifth Circuit, thus giving debtors considerable incentive to file cases therein.
The case was heard on direct appeal from a decision of Bankruptcy Judge Marvin Isgur in the US Bankruptcy Court for the Southern District of Texas. The court of appeals vacated in part, reversed in part, and remanded in part to Judge Isgur for further proceedings.
The appeal arose from confirmation of a reorganization plan under two unusual circumstances. First, the appellee noteholders held claims in an unimpaired class, and second, as of confirmation, and as all parties agreed, the principal obligor was solvent. Judge Isgur decided the case on Section 1124 grounds, and the Fifth Circuit ruled on that basis as well. It held that although Section 1124(1) of the Bankruptcy Code refers only to “claims” (and not allowed claims), the provision requires only that a plan leave unaltered the allowed claims of a creditor class. In determining allowance, a plan may provide for the adjustment of claims as required by Section 502(b), including subsection (b)(2). In so ruling, the court adopted a distinction that had been adopted in another context by the US Court of Appeals for the Third Circuit in Solow v. PPI Enterprises, 324 F.3d 197 (3d Cir. 2003): Section 1124 only prohibits “plan” impairment, and application of the allowance limitations in Section 502 is merely “code” impairment. In so holding, the Fifth Circuit rejected the rationale of the bankruptcy court’s decision—that all claim alteration is necessarily “plan” impairment—because pursuant to Section 1141(d) of the Bankruptcy Code, only a confirmed plan can alter the rights of a claimant under applicable law.
Reaching a question that had not been decided below, the Fifth Circuit went on to rule that a standard make-whole provision in a note purchase agreement constitutes “unmatured interest” pursuant to Section 502(b)(2) that is not part of an unsecured creditor’s allowed claim or its “claim” for Section 1124 purposes. The court ruled that a make-whole payment was the “economic equivalent” of interest and that it was unmatured—even though payable under an automatic acceleration-upon-bankruptcy provision—reasoning that maturity must be considered without reference to any ipso facto clause.
The Ultra dispute remains live, however. The court of appeals remanded the case to the bankruptcy court to consider whether the “solvent debtor” rule had survived enactment of the 1978 Bankruptcy Code and would require payment of the make-whole premium under the separate theory that a solvent debtor must honor its contracts. However, the court of appeals expressed “doubt” that the rule does survive. In this respect the opinion appears to be at odds with decisions in other circuits. While a favorable ruling on the solvent debtor rule might effectively reverse the effect of the decision for Ultra’s noteholders, it likely would leave in place the core Section 502(b)(2) holding.
The court of appeals also remanded to determine the rate of post-petition interest payable. Acknowledging that post-petition interest must be paid on an unimpaired, unsecured claim in a solvent debtor case, the court vacated the bankruptcy court’s ruling that the appropriate rate of interest should be the contract rate. The court then remanded for determination of the appropriate rate, expressing the view that the federal judgment rate is the only statutory rate that could apply, but that equity might dictate a different rate.
Morgan Lewis represents appellee noteholders in the matter.
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