Relevant Document:
Opinion
A divided three-judge panel of the U.S. Court of Appeals for the Third Circuit issued an opinion today affirming in part and reversing in part Judge Mary Walrath’s
decisions denying Hertz noteholders’ claims for postpetition interest at the contract rate and make whole premiums. The majority opinion, written by Circuit Judge Thomas L. Ambro, holds the noteholders have a right to contractual postpetition interest and redemption premiums on Hertz 2026/2028 notes “because Hertz was solvent.”
The decision follows similar rulings from the Fifth Circuit in
Ultra Petroleum and the Ninth Circuit in
PG&E, reinforcing the pre-Bankruptcy Code solvent-debtor exception to the general prohibition on unmatured interest. As a result of the ruling, Hertz must pay the noteholders more than $270 million in postpetition interest and premiums unless overturned. The U.S. Supreme Court
declined to review the
Ultra and
PG&E decisions in May 2023.
Judge Mary Walrath
certified her
December 2021 and
November 2022 opinions disallowing the noteholders’ claims for contractual postpetition interest and make whole premiums for direct appeal to the Third Circuit in December 2022. In her December 2021 decision, the bankruptcy judge concluded that the noteholders could be classified as unimpaired under Hertz’s plan if paid postpetition interest at the federal judgment rate rather than the contract rate, which is “more than 30 times” as large, according to the majority.
The December decision also disallowed the 2022/2024 senior noteholders’ make whole claims (approximately 18% of the amounts at issue). The November 2022 decision disallowed the 2026/2028 noteholders’ $223.7 million make whole claims as unmatured interest barred by section 502(b)(2) of the Bankruptcy Code. The Third Circuit heard
oral argument on the dispute in October 2023.
Judge Ambro’s majority opinion, joined by Circuit Judge Cheryl Ann Krause, focuses on whether the Bankruptcy Code gave the debtors’ “leverage to deny their unsecured noteholders more than a quarter billion dollars of interest they promised to pay pre-bankruptcy” while “giving lower priority equityholders four times that amount” under their
chapter 11 plan. According to the majority, although the make whole claims would be disallowed as the “economic equivalent” of interest under section 502(b)(2) of the Bankruptcy Code in an insolvent case, the absolute priority rule requires the debtors to pay contractual postpetition interest and make whole claims in full before making distributions to equityholders in a solvent case.
If Hertz was allowed to “cancel more than a quarter billion dollars” of obligations owed to the noteholders and distribute a “
massive gift” to shareholders, that would “impermissibly ‘depart’” from the Bankruptcy Code’s “‘basic priority rules,’” the opinion concludes, citing the U.S. Supreme Court’s 2017
Jevic decision.
Judge Ambro cites the “thoughtful opinions” in
Ultra and
PG&E as support for this conclusion. The Fifth Circuit required the debtors to pay make whole premiums and contract-rate postpetition interest (including default interest) in order to be classified as unimpaired, and the Ninth Circuit ruled that unimpaired creditors were entitled to postpetition interest at the contractual or default state law rate.
Judge Ambro notes that under the plan the debtors “committed to pay whatever was necessary” to ensure the holders of the four series of senior notes were unimpaired and reserved the amount of that payment obligation for
post-confirmation litigation. The plan went
effective in June 2021.
Although Judge Ambro disagrees with Judge Walrath on the solvent debtor exception, he agrees that the 2022/2024 early redemption premium was not triggered because the notes matured by their terms when Hertz filed bankruptcy. Although the ruling allows Hertz to redeem the notes without a fee well before their stated maturity, Judge Ambro suggests that this result is “not absurd” and the “commercially sophisticated” noteholders agreed to the terms that “compel” the result.
Judge Ambro also affirms the bankruptcy judge’s determination that the 2026/2028 notes redemption premiums are subject to disallowance under section 502(b)(2). The majority opinion traces the “two common” make whole analyses and concludes that the make whole claims are unmatured interest under “both” of the “definitional” and economic equivalency tests.
Nevertheless, Judge Ambro invokes the absolute priority rule to conclude the debtors must pay the 2026/2028 premiums despite section 502(b)(2) and postpetition interest at the contract rate. Prior to
Jevic, Judge Ambro explains, the Third Circuit “saw the absolute priority rule as a procedural protection that applied only when § 1129(b) is invoked,” but in
Jevic the Supreme Court extended the absolute priority rule to apply “everywhere.” Consequently, Judge Ambro concludes, the Bankruptcy Code “entitles every creditor - not just the dissenting impaired creditors who can invoke § 1129(b) - to treatment consistent with absolute priority absent a clear statement to the contrary.”
The majority says this result flows from
Jevic’s “condemnation of ‘backdoor means’ to defeat the absolute priority rule.” The majority refuses to leave a “back door wide open” in solvent debtor cases that would allow plan proponents to “force creditors to accept a ‘priority-violating’ distribution.”
Judge Ambro also rejects the debtors’ argument that the Bankruptcy Code is “silent” on whether the payment of postpetition interest factors into the absolute priority calculus. The majority cites the “fair and equitable” standard or confirmation in the Bankruptcy Code, which incorporates the pre-Code common law absolute priority rule, in addition to section 1129(b)(2)’s “enumerated requirements.”
Judge Ambro concludes that full payment of postpetition interest at contract rates is the appropriate remedy to satisfy the absolute priority rule, even though the rule only “imposes” postpetition interest at an “equitable rate.” Although the appellate court would ordinarily remand the matter to the bankruptcy court to evaluate equitable considerations and set the postpetition interest rate, Judge Ambro says that it would be “profoundly unfair to scrimp” after junior equityholders already received more substantial distributions “more than three years ago.”
In a dissenting opinion, Circuit Judge David J. Porter aligns himself with the dissenting opinions in the
Ultra and
PG&E cases, which recognize that the Bankruptcy Code “plainly disallows” claims for unmatured interest - including postpetition interest and make whole premiums - despite the fact Hertz was solvent. Judge Porter rejects the majority’s reliance on
Jevic because section 502(b)(2) “expressly
disempowers” courts from allowing claims for postpetition interest and make whole premiums.