The court found that make-whole fees owing to unsecured creditors are the “functional equivalent of unmatured interest,” as make-whole fees are typically among a “suite of fees” payable by debtors to their lenders as a standard loan condition.
In Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.),―F.4th―(3d. Cir. 2024), the Third Circuit Court of Appeals held that a solvent debtor must pay unsecured noteholders’ post-petition interest at the contract rate, plus additional make-whole fees.
Background
The Hertz Corporation filed for Chapter 11 bankruptcy protection in the District of Delaware in May 2020. Hertz proposed a Chapter 11 plan that, among other things, purported to (1) pay all of Hertz’s creditors in full, leaving these creditors “unimpaired” and (2) return more than $1 billion to equity holders, to be paid in a combination of new equity and cash.
Certain unsecured noteholders filed an adversary proceeding challenging the plan’s characterization of what it meant to be “unimpaired.” To actually be unimpaired, the noteholders argued, Hertz’s plan should have paid them:
- Post-petition interest at the contract rate provided for under the notes―instead of at the lower federal judgment rate included in Hertz’s plan; and
- The make-whole fees due under the notes―instead of disallowing the make-whole fees, as set forth in Hertz’s plan.
The bankruptcy court dismissed the noteholders’ claims. A direct appeal to the Third Circuit followed.
The Third Circuit’s Ruling
The Third Circuit Court of Appeals addressed two issues: (1) whether make-whole fees constitute “unmatured interest,” which is typically disallowed by Bankruptcy Code Section 502(b)(2); and (2) where a debtor is solvent (as Hertz was), whether the debtor must pay unimpaired creditors interest accruing post-petition at the contract rate plus any make-whole fees.
The court found that make-whole fees owing to unsecured creditors are the “functional equivalent of unmatured interest,” as make-whole fees are typically among a “suite of fees” payable by debtors to their lenders as a standard loan condition. As unmatured interest, make-whole fees fall under the scope of Section 502(b)(2) and, as a general rule, are disallowed in insolvent debtor cases. However, because Hertz was indisputably solvent, an exception to the general rule applies. That exception, known as the “solvent debtor exception” requires solvent debtors to pay “unimpaired” creditors post-petition interest.
Given that Hertz was solvent, the court analyzed whether Hertz must pay the noteholders all post-petition interest owing under the notes at the contract rate, plus the make-whole fees. The court started its analysis of this question by examining the absolute priority rule, which dictates the priority of payments between debt and equity in the bankruptcy waterfall. Under the absolute priority rule, all creditors must be paid in full before equity holders can receive any return. The court determined that, for the noteholders to be truly “unimpaired” under Hertz’s plan, the noteholders must receive the full amount of post-petition interest calculated pursuant to the terms of the notes (and not the federal judgment rate) plus the make-whole fees provided for under the notes. Here, Hertz’s plan violated the absolute priority rule by providing equity holders significant value while significantly reducing the interest owing to the noteholders and entirely cancelling the make-whole fees that the noteholders otherwise were entitled to under their contracts. The court specifically stated that “[a] creditor is impaired if its treatment violates the absolute priority rule because every creditor has a right to treatment consistent with that principle” and condemned any “backdoor means” to defeat this rule.
Conclusion
The Hertz decision adds to a growing body of case law favoring unsecured noteholders and reinforcing the principle that solvent debtors cannot attempt to leverage the Bankruptcy Code to avoid paying creditors what those creditors bargained for. Through this decision, the Third Circuit joins the Fifth and Ninth Circuit Courts of Appeal in their recognition of the solvent debtor exception, potentially indicating a more national trend on this issue.
The decision also emphasizes the importance of the absolute priority rule and what it truly means for a creditor to be “unimpaired” under a plan. Creditors should carefully analyze the solvency of the debtor and whether equity holders are proposed to receive any value before all creditors are to be paid in full in any proposed plan.
For More Information
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