A three-judge panel of the U.S. Court of Appeals for the Third Circuit heard
oral argument today in the long-running
Hertz make whole premium and postpetition interest litigation. Through the appeal, indenture trustees Wells Fargo Bank and U.S. Bank challenge bankruptcy court decisions denying noteholders’ claims to postpetition interest at the contract rate and redemption premiums.
In a
December 2021 decision, Judge Mary Waltrath rejected the trustees’ claims, concluding that the debtors need only pay noteholders postpetition interest at the federal judgment rate (and not the contract default rate) to render them unimpaired under (and thus not entitled to vote on) the debtors’ plan, even if the debtors were solvent. The bankruptcy court then granted Hertz’s motion to disallow the noteholders’ $223.7 million make whole claim as unmatured interest barred by section 502(b)(2) of the Bankruptcy Code in a
November 2022 decision.
Hertz’s unexpected recovery from the Covid-19 pandemic rendered the company solvent in the course of the bankruptcy, with equityholders enjoying a
substantial recovery of more than
$1 billion. Hertz’s
confirmed plan provided that holders of four series of senior notes would receive any payments required to render them unimpaired but left the allowance of claims for postpetition interest and make whole premiums subject to
post-confirmation litigation. The plan went
effective in June 2021.
Judge Walrath’s decisions appear to conflict with rulings by the courts of appeals for the Fifth Circuit and the Ninth Circuit in the
Ultra Petroleum and
PG&E cases, respectively. In those cases, the appellate courts concluded that creditors must receive contractual postpetition interest and make whole premiums in order to be deemed unimpaired under a solvent debtor’s plan - an issue raised by Mark Stancil of Willkie Farr, counsel for Wells Fargo.
However, Stancil went further, arguing that the decisions below violated the Bankruptcy Code separately by rejecting postpetition interest claims for unimpaired creditors and independently under the “solvent debtor exception” affirmed in
Ultra Petroleum and
PG&E.
Stancil pointed the panel to the legislative history of Congress’ repeal of former section 1124(3) of the Bankruptcy Code, which provided that a creditor is unimpaired under a plan if it receives cash equal to the allowed claim amount. According to Stancil, that repeal affirmed an “undisputed” pre-Code rule that creditors would “get contract interest when a debtor is solvent.”
Stancil then confronted the concept of “Code impairment” - that a creditor may be treated as unimpaired under a plan even if it does not receive full payment on claims disallowed by the Bankruptcy Code (such as claims for unmatured interest). According to Stancil, disallowance of claims for unmatured interest is not “absolute” such that the Code, and not the plan, impairs those claims. Stancil asserted that section 502(b)(2)’s disallowance of claims for unmatured interest is “perfectly consistent” with the pre-Code Bankruptcy Act solvent-debtor exception.
Circuit Judge Thomas Ambro suggested that the “stronger argument” for the trustees is the plan’s “designation” of the noteholders as unimpaired. “The big picture here is where does the money go? Does it go to equity or does the money go to the noteholders?” the judge asked. Stancil said the noteholders still had the equitable right to be paid what they are owed, even if the claims for postpetition interest and make whole premiums could be disallowed as unmatured interest.
Stancil said it was “undisputed” that the Hertz plan would not have been confirmable had Wells Fargo been properly classified as impaired due to the absence of an accepting impaired class - an impossibility with a solvent debtor. Wells Fargo, Stancil continued, was denied the right to vote on the plan and the protection of the Bankruptcy Code’s confirmation requirements, which should have required an impaired consenting class.
Circuit Judge Cheryl Ann Krause summarized the trustees’ argument as Hertz “taking away the legal right to preclude confirmation of the plan.” Stancil asserted that the “only way” this was permissible would be to render the noteholders truly unimpaired, and that the plan must otherwise give creditors a right to “have their voice heard and dissent from the plan.” Although the cramdown requirement was “not the hardest to satisfy,” Stancil said that it was essential to ensure someone would “care” about excess value being “misdirected.”
Judge Krause asked Stancil how the make whole is distinguishable from damages resulting from reinvestment risk due to “differences” in interest rates - a category of damages more widely recognized as valid by bankruptcy courts. Stancil responded that in a hypothetical contractual dispute over a supply of oranges, damages reflecting an increase in the market price of oranges are not equivalent to recovering the oranges themselves.
Judge Ambro questioned whether Judge Walrath made a factual finding that the make whole payment was “not tied” to reinvestment costs and asked if the dispute was a matter of fact or law. Clement said that the appeal was purely a legal question and stated that the parties were in agreement on “how the math works” under the notes.
Paul Clement of Clement & Murphy, arguing for Hertz, said the “critical question” in the appeal is whether an unimpaired class is entitled to a claim for “more than the legal rate of interest” when the claim is the “precise amount of unmatured interest that section 502(b)(2) disallows.”
Responding to a question from Circuit David J. Porter, Clement asserted it was not “anomalous” for Hertz equityholders to recover without the debtors paying postpetition interest and make whole premiums to the noteholders. The result was dictated by “operation of law,” Clement argued, and the solvent-debtor exception “doesn’t revive disallowed claims.”
Judge Ambro told Clement there were “good arguments on your side,” but the “tough one” was the solvent-debtor exception. Clement distinguished between the “common law” solvent-debtor exception and the exception as codified in section 726(a)(5) of the Bankruptcy Code, which provides for postpetition interest at the statutory federal judgment rate. Even under pre-Code practice, Clement asserted, interest in a solvent case “wouldn’t go back to the contractual rate no matter what.”
Clement said the Third Circuit has recognized the concept of Code impairment as opposed to plan impairment, finding that it is “not good” for the trustees.