Third Circuit Rules Noteholders Were Improperly Denied Make-Whole Payments and Interest By Solvent Debtor - Bankruptcy, Restructuring & Creditors’ Rights Client Alert
A recent decision by the Third Circuit in the Chapter 11 case of Hertz Global (“Hertz”) held that make-whole payments and interest were enforceable against a solvent Chapter 11 debtor, overturning a decision by the Bankruptcy Court that held that such payments constituted “unmatured interest”, payment of which is generally prohibited under Section 502(b)(2) of the Bankruptcy Code.
Make-whole payments, or prepayment premiums, are common features in loans and corporate bonds, and require a borrower or issuer to compensate or make lenders “whole” for the loss of expected interest and fees when a loan is prepaid or redeemed prior to its maturity. Such premiums typically are in the form of a lump-sum payment comprised of the net present value of the interest payments that a lender would forgo upon a prepayment or redemption.
Circuit courts have differed in their views as to the enforceability of make-whole provisions in the bankruptcy context. For example, the Second Circuit has focused on whether (i) the make-whole provision was contingent on prepayment and (ii) whether the debtor’s prepayment was voluntary or involuntary.[1] The Fifth Circuit has ruled that make-whole premiums are generally liquidated damages and the “economic equivalent” of unmatured interest that is subject to disallowance under the Bankruptcy Code, unless the “solvent debtor exception” applies.[2] Where the solvent debtor exception applies, both the Fifth and the Ninth Circuits have held post-petition interest must be paid at the contract rate rather than the federal judgment rate.[3] Finally, the Third Circuit has approached the enforceability of make-whole provisions by assessing whether a redemption (either pre or post loan maturity) is mandatory or optional. In Energy Future, the applicable make-whole provision provided for the payment of a premium to noteholders if the debtors redeemed or refinanced the debt at any time prior to the maturity date. The applicable indenture also included an acceleration provision that provided that all outstanding notes would become due and payable upon a bankruptcy filing. Both lower courts held the debtor did not need to make the make-whole payments because the acceleration provision took effect upon the bankruptcy filing and the automatic stay prohibited the noteholders from rescinding the acceleration. The Third Circuit reversed the lower court decisions and concluded the redemption provision remained applicable even in a post-bankruptcy acceleration context. The Third Circuit found no conflict between the redemption and acceleration provisions and concluded the Chapter 11 bankruptcy filing could not be used as a means to reduce the debtor’s debt obligations.[4]
Hertz filed for Chapter 11 protection in the spring of 2020 due to the significant decline in car rental services following COVID-19. Similar to Ultra Petroleum, market conditions ultimately rendered Hertz solvent at the time of its plan confirmation, which plan (i) included the payment of over $1.1 billion to shareholders and (ii) purported to “unimpair” creditors. Thus, as a matter of bankruptcy law, creditors were presumed to accept the plan and did not vote on the plan. In connection with multiple legal issues relating to plan confirmation, the Bankruptcy Court concluded (i) as unimpaired creditors, noteholders were entitled to receive interest at the federal judgment rate (as opposed to the applicable contract rate) and (ii) the make whole payments included impermissible post-petition interest that violated Section 502(b)(2) of the Bankruptcy Code.[5] Recognizing there was a Circuit split on the issue, the Bankruptcy Court immediately certified its decision for a direct appeal to the Third Circuit.
The Third Circuit concluded that notwithstanding the Bankruptcy Code’s explicit prohibition on claims for unmatured interest, because (i) Hertz was solvent and (ii) Hertz’s shareholders received significant value under the plan, the Bankruptcy Code’s absolute priority rule required that noteholders receive the make-whole payments and post-petition interest at the contract rate. This rule, codified in Section 1129(b) of the Bankruptcy Code, generally mandates that unless creditors are paid in full or consent, junior claimants may not recover value under a plan on account of their interests, and for Hertz’s plan to comply, it was required that noteholders be left “unimpaired”, mandating that noteholders receive the make whole payments and interest before shareholders receive value.
This decision results in a consensus among the Third, Fifth and Ninth Circuits that unsecured creditors of a solvent debtor are generally entitled to receive interest at the applicable contract rate prior to equity holders receiving any value.
[1] See In re MPM Silicones, L.L.C. 874 F.3d 787 (2d Cir. 2017).
[2] See In re Ultra Petroleum Corporation, 51 F.4th 138 (5th Cir. 2022).
[3] See In re PG&E Corporation, 46 F.4th 1047 (9th Cir. 2022).
[4] See In re Energy Future Holdings Corp., 842 F.3d 247 (3d Cir. 2016).
[5] See Wells Fargo Bank, N.A. v. Hertz Corp. (In re Hertz Corp.), 637 B.R. 781 (Bankr. D. Del. 2021) and In re Hertz Corp., Adv. Proc. No. 21-50995 (Bankr. D. Del. Nov. 9, 2022).
For more information about Hertz and how it may apply to your business, please contact the attorneys at Pashman Stein Walder Hayden P.C.