The opinion is significant for a number of reasons, not least of which is that the Bankruptcy Court held that a make-whole premium is not a claim for unmatured interest as the Court of Appeals had intimated.
On October 27, in In re Ultra Petroleum Corp., No. 16-32202, slip op. (Bankr. S.D. Tex. Oct. 26, 2020), the Bankruptcy Court for the Southern District of Texas held that unsecured noteholders were entitled to payment of a make-whole premium and post-petition interest at the contractual default rate under a confirmed plan of reorganization that purported to pay the noteholders in full.
The plan provided that noteholders would be paid post-petition interest at the federal judgment rate and did not provide for any payment of make-whole amounts. Certain groups of unsecured noteholders objected to confirmation, asserting the right to be paid make-whole amounts and interest at the contractual default rate.
The Bankruptcy Court held that the make-whole amount owing under the applicable note purchase agreement was a permissible liquidated damages provision under New York law, and not a penalty or the payment of “unmatured interest,” which is prohibited by Section 502(b)(2) of the Bankruptcy Code.
The Bankruptcy Court also held that in the rare circumstance where a debtor is solvent, that the so-called solvent debtor exception applies and that the debtor is required to pay post-petition interest. The Chapter 11 cases of Ultra Petroleum Corp. and affiliates (the “debtors”) was unique because, due to post-petition increases in commodity prices, the debtors were solvent when they confirmed their plan. The court further held that, to avoid the debtor receiving a windfall, the proper rate of interest is the contractually agreed upon rate, which was the default rate.
Accordingly, in order for the unsecured noteholders to be unimpaired and paid in full under the plan, the debtors are required to pay the make-whole claim and post-petition contractual interest.
The Bankruptcy Court’ opinion came after an initial ruling by the court was brought on direct appeal to the Fifth Circuit Court of Appeals. The Fifth Circuit held that a creditor’s claim is not impaired where a plan fails to pay claim amounts that are disallowed under the Bankruptcy Code, such as amounts for unmatured interest under Section 502(b)(2) of the Bankruptcy Code. The Court of Appeals remanded the matter to the Bankruptcy Court to determine whether the unsecured noteholder’s make-whole claim was a claim for unmatured interest and whether the solvent debtor exception to the payment of post-petition interest applied after the adoption of the Bankruptcy Code in 1978.
On remand, the Bankruptcy Court held that the make-whole was not an impermissible penalty and not a claim for unmatured interest that would be disallowed under the Bankruptcy Code. Instead, the Bankruptcy Court held that the make-whole was a permissible claim for liquidated damages. The court reasoned that the make-whole claim was a one-time payment for “breach of a promise to use money,” and did not compensate noteholders for the use of money over time like interest.
The Bankruptcy Court also held that the solvent debtor exception to the nonpayment of post-petition interest has been widely recognized before and after the adoption of the Bankruptcy Code. The court found that the exception is rooted in the principle that creditors must be paid in full before any value may be retained by equity holders. Congress did not “silently abandon that fundamental equitable principle” when the Bankruptcy Code was enacted, the court said. Moreover, the Bankruptcy Court reasoned, a solvent debtor would receive a windfall if it is permitted to pay the lower federal judgment rate while retaining value to its equity holders.
The opinion is significant for a number of reasons, not least of which is that the Bankruptcy Court held that a make-whole premium is not a claim for unmatured interest as the Court of Appeals had intimated. Make-whole and prepayment premiums may be viewed as compensating noteholders and lenders for the interest they would have earned in the future but for payment prior to maturity. Accordingly, such claims have been challenged in bankruptcy as unmatured interest not allowed under section 502(b)(2) of the Bankruptcy Code. In fact, in its initial opinion, the Fifth Circuit stated in dicta that a make-whole premium was the “economic equivalent of ‘interest.’” The Fifth Circuit withdrew that opinion and issued a revised opinion finding that analysis of whether a make-whole premium constitutes “unmatured interest” is a fact-specific determination that should be made in the first instance by the Bankruptcy Court. While the opinion has very limited precedential value, the Bankruptcy Court’s opinion is good news for noteholders and lenders seeking to enforce prepayment and make-whole provisions in bankruptcy.
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