Delaware Bankruptcy Court Rules That Unsecured Creditors Of A Solvent Debtor Are Entitled To Post-Petition Interest At The Federal Judgment Rate, Not The Default Interest Rate – Insolvency/Bankruptcy/Re-structuring


On December 22, 2021, Judge Mary Walrath of the Bankruptcy Court
for the District of Delaware held in In re The Hertz Corp.
that redemption premiums may potentially qualify as unmatured
interest, and that, to the extent that such redemption premiums are
unmatured interest on unsecured debt, then creditors would only be
entitled to receive the federal judgment rate, not the contractual
rate of interest.1 The decision departs from a recent
decision from the Texas bankruptcy court in the Ultra
Petroleum
case, which held that unimpaired unsecured creditors
of a solvent debtor would be entitled to receive the contractual
rate of interest.

Factual Background

In the wake of the COVID-19 pandemic, the Hertz Corporation and
its affiliates (the “Debtors”) filed voluntary petitions
under chapter 11 of the Iowa bankruptcy “}” data-sheets-userformat=”{“2″:513,”3”:{“1″:0},”12″:0}”>Iowa bankruptcy Code. During the course of its
bankruptcy case, Hertz’s liquidity position improved and thus,
under Hertz’s plan of reorganization, all creditors were being
paid in full. However, the plan provided that unsecured creditors
would receive post-petition interest accruing at the federal
judgment rate or at any rate necessary to render creditors
unimpaired.2 The federal judgment rate was lower than
the default interest provided in the indentures. The plan also
provided that prepetition equity holders would receive
distributions of cash and equity.3

In July 2021, Wells Fargo Bank, N.A., as indenture trustee for
the Debtors’ unsecured senior noteholders, filed an adversary
complaint against the Debtors seeking to recover (1) a make-whole
premium due under the senior notes (totaling approximately $147
million) and (2) post-petition interest on their claims at the
contract default rate in excess of the federal judgment rate
(approximately $125 million).4 The Debtors moved to
dismiss the complaint.

Discussion

In a comprehensive opinion, the Court granted in part and denied
in part the Debtors’ motion to dismiss. Of significance, the
Court held that only some of the senior noteholders were entitled
to receive a redemption premium under the indentures, that the
redemption premiums may potentially qualify as the economic
equivalent of unmatured interest (and thus could be subject to
disallowance), and that unsecured creditors of a solvent debtor are
only entitled to receive post-petition interest at the federal
judgment rate.

I. Entitlement to Redemption Premiums

Indentures and credit agreements may require a borrower to pay a
prepayment or redemption premium to “protect the lenders’
right to a yield that was expected at the time that they made their
loans.”5 A redemption premium thus refers to the
repayment of a debt at or before its maturity date at a certain
percentage above its face value, which in certain circumstances may
compensate the lender or noteholder for lost interest as a result
of the early redemption of the debt.6

The Court first addressed whether the senior noteholders were
entitled to redemption premiums. The Debtors moved to dismiss the
complaint on the grounds that the redemption premiums were not
payable under the express language of the indentures because the
acceleration provisions (which were triggered automatically upon
the Debtors’ filing) in the indentures did not provide for the
payment of redemption premiums. However, the Court rejected the
Debtors’ arguments that the indentures did not provide for the
payment of a redemption premium upon automatic acceleration by
virtue of the bankruptcy filing. Relying on the Third Circuit’s
decision in Energy Future Holdings, the Court held that
the applicable contractual provision for determining the
noteholders’ entitlement to redemption premiums was the
specific redemption provision, not the automatic acceleration
provision.7

Therefore, turning to the express language of the redemption
provisions, the Court determined that some-but not all-of the
noteholders were entitled to receive a redemption premium.
Specifically, the Court held that holders of certain senior notes
(the “2022/2024 Notes”) were not entitled to a redemption
premium because the applicable redemption provisions only provided
for redemption “prior to maturity thereof at the applicable
redemption price set forth below.”8 Given that the
redemption provision referred to an undefined term for maturity of
the debt, the Court held that no redemption premium was due on the
2022/2024 Notes because the notes matured as a result of the
bankruptcy filing.9 In other words, because the
bankruptcy filing and not the stated maturity date triggered
maturity under the terms of the indenture, no such right to any
redemption premium existed post-petition.

By contrast, the Court held that holders of other senior notes
(the “2026/2028 Notes”) were entitled to a redemption
premium under the express language of their indenture, which
differed from that of the 2022/2024 Notes. The redemption
provisions for the 2026/2028 Notes provided that “[a]t any
time prior to [a specified date], the [senior notes] may also be
redeemed (by the Company or any other person) in whole or in part,
at the Company’s option, at . . . the Redemption Price . . .
.” The Court read this provision to “simply [provide] the
Debtors with the ability to redeem under the circumstances”
specified in that provision, and notably did not contain the
requirement that redemption must occur before maturity. Because the
bonds were redeemed prior to the dates specified in the redemption
provision, the Court found that, unlike the 2022/2024 noteholders,
the 2026/2028 noteholders stated a plausible claim for relief as to
the 2026/2028 noteholders’ entitlement to a redemption
premium.10

II. Is the Redemption Premium the Equivalent of Unmatured
Interest?

The Court next addressed the Debtors’ contention that the
redemption premium should be disallowed as unmatured interest under
section 502(b)(2) of the Bankruptcy Code. Section 502(b)(2) of the
Bankruptcy Code provides that a claim is disallowed “to the
extent that . . . such claim is for unmatured interest.”
Notably, “unmatured interest” is not defined in the
Bankruptcy Code, but rather has been interpreted by courts to
include post-petition interest and contractual charges that are the
“contractual equivalent” of future
interest.11

The Court noted that while the Third Circuit in Energy
Future Holdings
did characterize a redemption premium as the
“contractual substitute for interest lost on Notes redeemed
before their expected due date,”12 it was not
addressing the issue in the context of section 502(b)(2)
disallowance.13 Further, the Court discussed the
decision in Ultra Petroleum, where the Fifth Circuit noted
that a make-whole premium could be considered unmatured interest
and remanded to the bankruptcy court to determine the
issue.14 On remand, the Bankruptcy Court for the
Southern District of Texas concluded that the make-whole premium
was not the economic equivalent of unmatured interest and not
disallowed under Section 502(b)(2).15 This decision is
currently on appeal.

When deciding whether a contractual charge is unmatured
interest, “courts look to the economic substance of the
transaction to determine what counts as
interest.”16 In Hertz, the Court concluded
that to determine whether the redemption premium is the economic
equivalent of unmatured interest is not a legal question, but a
factual one.17 Put another way, simply characterizing
the makewhole claim as liquidated damages, breach of contract
damages, or another separate contract right could avoid the effect
of section 502(b)(2) in the hands of an astute drafter. In
practice, a contract could provide that upon default or redemption,
“all unmatured interest” would be immediately due and
payable, therefore avoiding Bankruptcy Code section 502(b)(2)
disallowance in contravention of the Bankruptcy Code.

In considering the redemption premium provision here, the Court
found it significant that the premium is calculated on the present
value of unmatured interest due as of the redemption date, but left
the door open for the noteholders to introduce evidence to the
contrary. The Court thus denied the Debtors’ motion to dismiss
the noteholders’ claim that it must pay a redemption premium on
the 2026/2028 Notes.18

III. Unsecured Creditors of a Solvent Debtor May Only Receive
Interest at the Federal Judgment Rate

Finally, the Court addressed which interest rate would apply to
the redemption premium. Section 1124 of the Bankruptcy Code
provides that a claim is unimpaired if, among other things, the
plan “leaves unaltered the legal, equitable, and contractual
rights” of the holder of that claim.19 However,
section 502(b)(2) provides for the disallowance of any unmatured
interest.20 Whether a claim is impaired has significant
implications: creditors that are impaired generally are entitled to
certain rights in the context of plan confirmation, including (i)
the right to vote to accept or reject the plan and (ii) the right
to receive consideration equal to what the creditor would have
received in a hypothetical chapter 7 liquidation.21

The noteholders contended that because the plan designated
senior noteholders as unimpaired for purposes of section 1124 of
the Bankruptcy Code (which provides that a class of claims or
interests is impaired under a plan unless the plan leaves such
class’s legal, equitable, and contractual rights to such claims
or interests unaltered), the noteholders should be entitled to
receive interest at the contract rate. On the other hand, the
Debtors argued that because it was section 502(b)(2) of the
Bankruptcy Code that disallowed unmatured interest, rather than the
Debtors’ plan, the senior noteholders’ claim was unimpaired
under Third Circuit precedent.22 The Court ruled in
favor of the Debtors, holding that unsecured creditors “are
not impaired within the meaning of section 1124(1)” because
the senior noteholders’ claim to unmatured interest or the
redemption premium was modified by section 502(b)(2) of the
Bankruptcy Code, and not the Debtors’ plan.23

Nevertheless, the noteholders argued that they were entitled to
their contract rate of interest because “the Debtors are awash
in cash, paid all creditors in full, and provided a substantial
return on investment to equity.”24 The Court
acknowledged that prior to the enactment of the Bankruptcy Code,
courts applied a “solvent debtor” exception. This
exception provided that the contractual rights of unimpaired
creditors must be preserved in bankruptcy when a debtor is solvent.
The Court found, however, that “the solvent debtor exception
survived the passage of the Bankruptcy Code only to a limited
extent.”25 Indeed, the Court noted that Congress
expressly codified the solvent debtor exception in two sections of
the Bankruptcy Code: section 506(b) (which provides for payment of
post-petition interest to oversecured creditors)26 and
section 726(a)(5) as to impaired unsecured creditors.

However, the Bankruptcy Code “is silent on what treatment
unimpaired creditors must receive in a solvent chapter 11 debtor
case.”27 The Court found that nothing in the
express text of the Bankruptcy Code or in its legislative history
required the payment of post-petition interest at the contract rate
of interest. Thus, the Court held that even if the solvent debtor
exception survived the enactment of the Bankruptcy Code, the
Bankruptcy Code did not specify what interest rate would be
required to establish that an unsecured creditor is unimpaired. The
Court noted that Congress could have provided a solvent debtor
exception for unimpaired unsecured claims by (i) excepting
unmatured interest from disallowance under section 502(b) when the
debtor is solvent or (ii) by amending section 1124 to provide that
unimpaired creditors must receive their contract rate of interest,
in addition to payment in full of their allowed claim. But Congress
created neither exception.

Due to the lack of guidance from the text of the Bankruptcy
Code, courts have remained split on the applicable “legal
rate” of interest for unimpaired unsecured creditors in a
solvent chapter 11 debtor case. Some courts have held that
unsecured creditors are entitled to receive post-petition interest
at the “contract rate,” meaning the interest rate
specified in the prepetition contract (or if there is no contract,
the interest rate specified under state law).28 However,
other courts have held that creditors of a solvent debtor are only
entitled to receive interest at the federal judgment rate, which is
typically lower than the contract rate.29

The Court concluded that the federal judgment rate was the
appropriate applicable rate of interest in Hertz. In
support of its conclusion, the Court noted that neither the
Bankruptcy Code nor its legislative history indicated any intent
for unimpaired unsecured creditors of a solvent debtor to receive
better treatment than impaired unsecured creditors.30
The Court thus found no basis to distinguish between unimpaired and
impaired unsecured creditors in a solvent debtor case.31
Pursuant to sections 1129(a)(7) and 726(a)(5) of the Bankruptcy
Code,32 impaired unsecured creditors in a solvent debtor
chapter 11 case are entitled to receive post-petition interest at
the federal judgment rate. Specifically, section 726(a)(5) requires
payment of interest at the “legal rate” before any
distributions to equity holders can be made, and section 1129(a)(7)
provides that with respect to each impaired class of claims or
interests, creditors are entitled to receive what they would have
received in a liquidating chapter 7 case.

The Court noted that adopting a uniform rule to apply to all
unsecured creditors regardless of whether they are impaired
provides more certainty and fairness in bankruptcy cases. The Court
stated that providing that “all general unsecured creditors
are entitled to the same post-petition interest in a solvent
chapter 11 debtor case prevents a debtor from paying preferred
creditors more than others simply by classifying them as
unimpaired.”33 While the noteholders complained
that designation of their claims as unimpaired deprived them of the
right to vote on the plan, the Court found that the
noteholders’ impairment would not have resulted in different
treatment. Specifically, the Court stated that if the noteholders
“had been treated as impaired and if they had voted against
the Plan, they would have received the same treatment: payment in
full in cash of their allowed claim plus post-petition interest in
accordance with sections 1129(a)(7) and
726(a)(5).”34 In other words, the noteholders would
have still received interest at the federal judgment rate.

The Court thus rejected the noteholders’ reliance on the
Texas bankruptcy court’s decision in Ultra Petroleum.
In that case, the Texas bankruptcy court held that the Bankruptcy
Code did not abolish the solvent debtor exception and that the
solvent debtor exception would require payment of default interest
provided in the contracts. The Ultra Petroleum court’s
decision hinged on its determination that unimpaired creditors were
entitled to have their equitable rights fully enforced under
section 1124(1) in a “solvent debtor” case.35
Judge Walrath did not find this reasoning persuasive because
“[a] bankruptcy court cannot use equitable principles to
modify express language of the Code,” such as section
502(b)(2), which “expressly disallows claims of unsecured
creditors for unmatured interest.”36 The
Debtor’s solvency, according to the Court, does not “waive
the application of section 502(b)(2).”37 Therefore,
the Court concluded that the noteholders failed to state a
plausible claim that the Debtors must pay post-petition interest on
the senior notes at the contract rate rather than at the federal
judgment rate and dismissed this count in the noteholders’
complaint.

Conclusion

Judge Walrath’s decision in Hertz confirms that
under Third Circuit precedent, it is the applicable redemption
provision-not the acceleration provision-that is determinative as
to a creditor’s entitlement to receive a redemption premium in
bankruptcy. Where, as with the 2026/2028 noteholders in
Hertz, the entitlement to receive a premium is not
dependent on a redemption occurring prior to a maturity date, then
creditors may be entitled under their contracts to receive the
redemption premium in bankruptcy. By contrast, as with the
2022/2024 noteholders, if the redemption premium is dependent on
the redemption occurring prior to the maturity date and the
indenture provides for automatic acceleration upon a bankruptcy
filing, then a court could conclude, as the Court did here, that
the creditors are not entitled to the redemption premium under the
express language of the governing agreements.

Judge Walrath’s decision also underscores the split among
courts as to the proper treatment of unimpaired unsecured creditors
in a solvent chapter 11 case. Consistent with a recent decision in
the PG&E case in California,38 Judge
Walrath held that both impaired and unimpaired unsecured creditors
in a solvent chapter 11 debtor case are entitled to receive the
federal judgment rate, not the contractual rate of interest. The
Hertz decision thus conflicts with the Ultra
Petroleum
decision in Texas, which held that unimpaired
unsecured creditors of a solvent debtor are required to receive
their contractual default rate of interest.

Unimpaired unsecured creditors of a solvent debtor should
therefore be mindful that this is an evolving issue in bankruptcy
that remains unsettled and can vary among courts and districts.
Even where a debtor is solvent and has sufficient liquidity to pay
post-petition interest, a court may conclude that an unsecured
creditor of a solvent debtor may only be entitled to post-petition
interest at the federal judgment rate, which likely is
substantially lower than the default rate of interest.

Footnotes

1 Wells Fargo Bank, N.A. v. The Hertz Corp. (In re
The Hertz Corp.)
, Adv. No. 20-11218 (MFW), 2021 WL 6068390, at
*3 (Bankr. D. Del. Dec. 22, 2021).

2 Id. at *2.

3 Id.

4 Id. at *3.

5 See In re Chemtura Corp., 439 B.R. 561, 596
(Bankr. S.D.N.Y. 2010).

6 See In re MPM Silicones LLC, 874 F.3d 787, 802
(2d Cir. 2017).

7 In re The Hertz Corp., 2021 WL 6068390, at *3
(citing In re Energy Future Holdings Corp., 842 F.3d 247
(3d Cir. 2016)).

8 Id. at *5.

9 Id. at **5-6.

10 Id. at *7.

11 Id. at n.11.

12 In re Energy Future Holdings Corp., 842 F.3d
at 251; see also In re MPM Silicones, 874 F.3d, 787, 802
(2d Cir. 2017) (noting that a make-whole premium “was intended
to ensure that the Senior-Lien Note holders received additional
compensation to make up for the interest they would not receive if
the Notes were redeemed prior to the maturity
date.”).

13 In re Energy Future Holdings Corp., 842 F.3d
at 251, 253 n.1.

14 In re Ultra Petroleum Corp., 943 F.3d 758,
765 (5th Cir. 2019).

15 In re Ultra Petroleum Corp., 624 B.R. 178,
188-95 (Bankr. S.D. Tex. 2020).

16 In re Doctors Hosp. of Hyde Park, Inc., 508
B.R. 697, 705 (Bankr. N.D. Ill. 2014).

17 In re The Hertz Corp., 2021 WL 6068390, at
*8.

18 Id.

19 11 U.S.C. § 1124(1).

20 Id. § 502(b)(2).

21 See 11 U.S.C. §§ 1129(a)(7),
1126.

22 In re PPI Enters. (US), Inc., 324 F.3d 197,
204 (3d Cir. 2003) (holding that a creditor is unimpaired if it is
the effect of the Bankruptcy Code that modifies its rights, not the
debtor’s plan).

23 In re The Hertz Corp., 2021 WL 6068390, at
*11.

24 Id.

25 Id. at *16.

26 Id.

27 Id. at *11.

28 See, e.g., In re Dow Corning Corp.,
456 F.3d 668 (6th Cir. 2006) (&ldquldquo;When a debtor is
solvent, then, the presumption is that a bankruptcy court’s
role is merely to enforce the contractual rights of the parties,
and the role that equitable principles play in the allocation of
competing interest is significantly reduced.”).

29 See, e.g., In re Cuker Interactive,
622 B.R. 67, 71 (Bankr. S.D. Cal. 2020) (“[A]ssuming the
Creditors are unsecured, they must receive postpetition interest at
the Federal Judgment Rate to be unimpaired by the Plan.”);
In re PG&E, 610 B.R. 308, 312-313 (Bankr. N.D. Cal.
2019) (holding that unimpaired unsecured creditors are only
entitled to receive post-petition interest at the federal judgment
rate).

30 In re The Hertz Corp., 2021 WL 6068390, at
**11-13.

31 Id. at *14 (distinguishing Dow
Corning
, 456 F.3d at 678-80 because its ruling was premised on
section 1129(b), which considers the rights of impaired creditors,
not unimpaired creditors, in a solvent chapter 11 debtor
case).

32 See 11 U.S.C. § 726(a)(5) (providing
payment of post-petition interest at “the legal rate” to
creditors, before any distribution to the debtor (or equity), in
the event there are funds left after paying all other claims in a
chapter 7 liquidation case); id. § 1129(a)(7)
(providing that with respect to each impaired class of claims or
interests, each holder of such claim has either accepted the plan
or will receive at least what it would have received in a
liquidating chapter 7 case).

33 In re The Hertz Corp., 2021 WL 6068390, at
*17.

34 Id. at *16.

35 See In re Ultra Petroleum Corp., 624 B.R.
178, 196 (Bankr. S.D. Tex. 2020).

36 In re The Hertz Corp., 2021 WL 6068390, at
*15.

37 Id.

38 In re PG&E Corp., 610 B.R. 308 (Bank.
N.D. Cal. 2019).

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