So far, New York and Delaware agree that post-petition interest accruals are not taken into consideration when calculating distributions among undersecured creditors with liens on the same collateral.
In the reorganization of Energy Future Holding Corp. in Delaware, two different groups of first-lien creditors had claims on the same collateral, but the collateral was insufficient to pay first lien debt in full. Therefore, neither group was entitled to post-petition interest on their claims.
The interest rate on the first lien notes was higher than the interest rates on the other first lien debt. Despite the rule against interest on undersecured debt, the indenture trustee for first lien noteholders nevertheless argued that the hypothetical accrual of post-petition interest should be taken into consideration when parceling out distributions under the confirmed chapter 11 plan. Among other things, the plan gave first lien creditors stock in a reorganized company, cash remaining on the balance sheet, and the right to receive payments under a tax-receivable agreement.
In a pair of decisions in March 2016 and April 2017, Bankruptcy Judge Christopher S. Sontchi of Delaware held that post-petition interest accruals are not taken into consideration when calculating distributions among undersecured creditors with liens on the same collateral. Judge Sontchi agreed with Bankruptcy Judge Robert Drain of White Plains, N.Y., who decided the same question in In re MPM Silicones LLC, 518 B.R. 740 (Bankr. S.D.N.Y. 2014).
In the Delaware court as in New York, the result turned on the interpretation of the intercreditor agreement among first lien creditors whose collateral was insufficient to pay their collective claims in full. Agreeing with Judge Drain, Judge Sontchi held that property distributed under the plan was not “collateral” on which the creditors held liens. Therefore, he said that the intercreditor agreement did not apply and that distributions were to be made under the Bankruptcy Code.
The indenture trustee with the higher interest rate appealed, but District Judge Richard G. Andrews of Wilmington upheld Judge Sontchi in a March 29 opinion. Functionally, if not technically, he also upheld Judge Drain because he agreed with Judge Drain’s analysis.
Siding with Judge Sontchi and parsing the agreement under New York law, Judge Andrews held that stock in the reorganized company that was distributed under the plan was not “collateral” or “proceeds of collateral,” because “it was issued as part of a chapter 11 plan.” Collateral was not being distributed, Judge Andrews said, because there was no sale to create proceeds. Instead, the company was spun off to creditors akin to a “standard debt-for-equity reorganization.”
Similarly, there was no “disposition” of the collateral that would make the intercreditor agreement’s waterfall applicable.
Judge Andrews also rejected the idea that there was an “exhaustion” of collateral making the intercreditor agreement applicable.
Although they were no longer secured creditors with liens on the collateral, Judge Andrews said the noteholders still benefitted from the collateral’s economic value because they became equity owners. Therefore, he said, the collateral was not exhausted as it would have been under a Section 363 sale.
As a result, undersecured creditors in a debt-for-equity exchange will receive distributions in proportion to what they were owed at the outset of bankruptcy, in the process disregarding hypothetical post-petition interest accruals. Since New York and Delaware are on the same page, the issue is not important in terms of forum shopping, unless the noteholders appeal Judge Andrews and the Third Circuit has a different opinion.
To read ABI’s discussion of Judge Sontchi’s two decisions, click here and here.