Hertz Bankruptcy Court Weighs In On Make-Whole Premiums, Solvent-Debtor Exception, And Pendency Interest

• Published date: 05 April 2022
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Law Firm: Jones Day
• Author: Mr Mark Douglas and Daniel J. Merrett

Perhaps surprisingly given the rarity of such cases, a handful of high-profile court rulings recently have addressed whether a solvent chapter 11 debtor is obligated to pay postpetition, pre-effective date interest ("pendency interest") to unsecured creditors to render their claims "unimpaired" under a chapter 11 plan and, if so, at what rate. Some of these cases have also involved the enforceability of noteholder claims for "make-whole" premiums triggered by the debtors' redemption of their notes prior to maturity and whether such claims must be disallowed as the "economic equivalent" of unmatured interest. All of these issues were recently examined by the bankruptcy court that presided over the chapter 11 cases of auto rental giant The Hertz Company and its affiliates.

In In re The Hertz Corp., 2021 WL 6068390 (Bankr. D. Del. Dec. 22, 2021), the U.S. Bankruptcy Court for the District of Delaware dismissed in part claims asserted by unsecured noteholders for make-whole premiums and pendency interest. In so ruling, the court held that: (i) a make-whole premium was due under the terms of one, but not the other, of two note indentures; (ii) the court would not discount the possibility that the make-whole premiums could be disallowed as the economic equivalent of unmatured interest, but it lacked sufficient evidence to make that determination; (iii) even if make-whole premium claims were disallowed as unmatured interest, such claims would be impaired by the Bankruptcy Code, rather than by the debtors' chapter 11 plan; (iv) the pre-Bankruptcy Code "solvent debtor" exception obligating a solvent debtor to pay interest on unsecured claims only partially survived enactment of the Bankruptcy Code; and (v) the appropriate rate of pendency interest under the "solvent debtor" exception is the federal judgment rate rather than the contract rate.

Hertz is far from the end of the story on many of these issues. Appeals involving some of them are currently pending before two circuit courts of appeals, which are expected to issue decisions in the near future.

The Bankruptcy Code's Priority Scheme

The Bankruptcy Code sets forth certain priority rules governing distributions to creditors in both chapter 7 and chapter 11 cases. Secured claims enjoy the highest priority under the Bankruptcy Code. See generally 11 U.S.C. ' 506. The Bankruptcy Code then recognizes certain priority unsecured claims, including claims for administrative expenses, wages, and certain taxes. See id. ' 507(a). General unsecured claims come next in the priority scheme, followed by any subordinated claims and the interests of equity holders.

In a chapter 7 case, the order of priority for the distribution of unencumbered assets is determined by section 726 of the Bankruptcy Code. The order of distribution ranges from payments on claims in the order of priority specified in section 507(a), which have the highest priority, to payment of any residual assets after satisfaction of all claims to the debtor, which has the lowest priority. The second to lowest priority in a chapter 7 case is given to "interest at the legal rate from the date of the filing of the petition" on any claim with a higher liquidation priority, including unsecured claims. See id. ' 726(a)(5).

Distributions are to be made pro rata to parties of equal priority within each of the six categories specified in section 726. If claimants in a higher category of distribution do not receive full payment of their claims, no distributions can be made to parties in lower categories.

In a chapter 11 case, the chapter 11 plan determines the treatment of secured and unsecured claims (as well as equity interests), subject to the requirements of the Bankruptcy Code.

Impairment of Claims Under a Chapter 11 Plan

Creditor claims and equity interests must be placed into classes in a chapter 11 plan and treated in accordance with the Bankruptcy Code's plan confirmation requirements. Such classes of claims or interests may be either "impaired" or "unimpaired" by a chapter 11 plan. The distinction is important because, among other things, only impaired classes have the ability to vote to accept or reject a plan. Under section 1126(f) of the Bankruptcy Code, unimpaired classes of creditors and shareholders are conclusively presumed to have accepted a plan.

Section 1124 provides that a class of claims is impaired under a plan unless the plan: (1) "leaves unaltered the legal, equitable, and contractual rights" to which each creditor in the class is entitled; or (2) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates each creditor in the class for resulting losses.

Section 1124 originally included a third option, then section 1124(3), for rendering a claim unimpaired'by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that, in light of this third option, and because sections 726(a)(5) and 1129(a)(7) of the Bankruptcy Code (described below) are applicable in a chapter 11 case only to impaired creditors, a solvent debtor's chapter 11 plan that paid unsecured claims in full in cash, but without postpetition interest, did not impair the claims. The perceived unfairness of New Valley led Congress to remove this option from section 1124 of the Bankruptcy Code in 1994. Since then, most courts considering the issue have held that, if an unsecured claim is paid in full in cash with postpetition interest at an appropriate rate, the claim is unimpaired under section 1124. See, e.g., In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 205-07 (3d Cir. 2003) ("PPI").

Cram-Down Confirmation Requirements

If a creditor class does not agree to impairment of the claims in the class under the plan and votes to reject it, the plan can be confirmed only under certain specified conditions. Among these conditions are requirements that: (i) each creditor in the class receive at least as much under the plan as it would receive in a chapter 7 liquidation (11 U.S.C. ' 1129(a)(7)) (commonly referred to as the "best interests" test); and (ii) the plan be "fair and equitable" (Id. ' 1129(b)(1)).

Therefore, in the case of a chapter 11 debtor that can pay its creditors in full, the best interests test in section 1129(a)(7) would require that any impaired unsecured creditors be paid pendency interest on their allowed claims "at the legal rate." Id. ' 726(a)(5).

The best interests test, however, applies only to impaired classes of claims or interests. This was not always the case. When the Bankruptcy Code was enacted in 1978, the provision applied to all classes'impaired or not. Congress amended section 1129(a)(7) in 1984 so that it now applies only to impaired classes. See Bankruptcy Amendments and Federal Judgeship Act of 1984, 98 Stat. 333, Pub. L. 98-353 (1984) ' 512(a)(7); In re Wonder Corp. of Am., 70 B.R. 1018, 1024 (Bankr. D. Conn. 1987) ("[T]he 1984 Amendments also modified ' 1129(a)(7) so that its provisions now only apply to 'each impaired class of claims or interests' rather than to 'each class of claims or interests.'").

Section 1129(b)(2)(B) of the Bankruptcy Code provides that a plan is "fair and equitable" with respect to a dissenting impaired class of unsecured claims if the creditors in the class receive or retain property of a value equal to the allowed amount of their claims or, failing that, if no creditor or equity holder of lesser priority receives any distribution under the plan. This is known as the "absolute priority rule."

Disallowance of Claims for Unmatured Interest and the Solvent Debtor Exception

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