Fifth Circuit Revokes a Controversial Opinion with Dicta on the Solvent-Debtor Exception

Granting a petition for panel rehearing, the Fifth Circuit vacated a controversial opinion from January that included reams of dicta about the allowance of so-called makewhole premiums and the survival of the solvent-debtor exception after adoption of the Bankruptcy Code.

Among other things, the panel had said in January that a makewhole is allowable only if the solvent-debtor exception survived the adoption of Section 502(b)(2), the provision that disallows claims for unmatured interest. With regard to whether the exception survived, Circuit Judge Andrew S. Oldham in January said, “We doubt it did.” Ultra Petroleum Corp. v. Ad Hoc Committee of Unsecured Creditors (In re Ultra Petroleum Corp.), 913 F.3d 533, 547 (5th Cir. Jan. 17, 2019). Despite ruling almost definitively on the question, Judge Oldham had remanded for “the bankruptcy court to answer the question in the first instance.” Id.

The creditors claiming the makewhole premium filed a petition in late January for panel rehearing or rehearing en banc. They argued that the panel should not have reached the question of whether a makewhole amounts to unmatured interest, principally because the bankruptcy court had not ruled on the issue.

Granting panel rehearing, the same three circuit judges vacated the earlier opinion and handed down a substitute opinion on November 26, chopping the 27-page January decision down to 12 pages. In the new opinion, the panel this time limited its ruling to a declaration that disallowance of portions of a claim by the operation of provisions of the Bankruptcy Code does not amount to “impairment” of the claim entitling the creditor to vote for or against confirmation of a chapter 11 plan.

The 15 deleted pages surveyed 300 years of English and U.S. legal history about the solvent-debtor exception to the general rule that unsecured creditors are not entitled to interest on their claims in bankruptcy. In other words, if the debtor is solvent, the exception allows an unsecured creditor to claim interest.

The new opinion also omits speculation about the allowance of makewholes, but with a curious hint about how the bankruptcy court should rule on remand. To read ABI’s discussion of the January opinion, click here.

The Facts Remain the Same

In the new opinion, also by Judge Oldham, the facts and the discussion of impairment remained the same.

The debtors were oil and gas producers plunged into chapter 11 in 2016 after the price of petroleum collapsed. The companies were insolvent on filing, but they became solvent after the price of oil rose.

The bondholders’ loan agreement included provisions calling for the payment of makewhole premiums. In substance, a makewhole compensates a lender for being forced to reinvest at lower interest rates if the loan is paid before maturity.

The debtors proposed a chapter 11 plan where none of the creditors were impaired, thus theoretically barring them from voting on the plan. Allegedly unimpaired creditors included holders of unsecured bonds, whose loan agreement contained the makewhole premiums. The plan did not propose to pay the makewholes.

The debtors also proposed to pay revolving credit lenders in full. However, the plan offered post-petition interest at the federal judgment rate, not the higher default rate imposed by the loan agreement.

Because the plan did not pay the makewhole or the higher default interest rate, the creditors objected to the plan. To permit confirmation, the debtors set aside almost $400 million to compensate the bondholders and the revolving credit lenders if their claims for the makewhole and the default rate must be paid to render their claims unimpaired.

The Decision in Bankruptcy Court

Both sides agreed that the makewhole and the default interest rate were enforceable under state law. Bankruptcy Judge Marvin Isgur of Houston ruled after confirmation that the creditors must receive everything under state law to render their claims unimpaired, including the makewhole and the higher default rate.

The debtors appealed, and Judge Isgur certified the questions for direct appeal to the Fifth Circuit. The Court of Appeals accepted the direct appeal.

Judge Oldham’s Original Opinion and New Opinion on Impairment

In the opinion handed down after granting panel rehearing, Judge Oldham in substance issued the same opinion holding that a claim is not impaired just because some portion of the claim is disallowed under the Bankruptcy Code.

He agreed with In re PPI Enterprises (U.S.) Inc., 324 F.3d 197 (3d Cir. 2003), where the cap in Section 502(b)(6) of the Bankruptcy Code reduced the allowed claim of a landlord to an amount lower than it would have been outside of bankruptcy under state law. The Third Circuit held that the landlord’s claim was not impaired, because the amount of the claim outside of bankruptcy “is not the relevant barometer for impairment.” Id. at 204.

Judge Oldham said that the Collier treatise and every reported decision all agree that impairment arises from what the plan does, not from disallowance of a portion of a claim under the Bankruptcy Code. Thus, he held for a second time this year that the bondholders were unimpaired, and thus not entitled to vote, because the Bankruptcy Code reduced the amount of their claims, not the plan.

Judge Oldham said his conclusion was based on the plain language of the statute, Section 1124(a), which says that a claim is not impaired “if the plan . . . leaves unaltered the [claimant’s] legal, equitable, and contractual rights.” The focus, he said, is on whether “‘the plan’ itself alters a claimant’s ‘legal, equitable [or] contractual rights.’”

Allowance of the Makewhole?

Ruling that the bondholders’ claim was not impaired did not end the inquiry. Two questions remained: (1) Does the Bankruptcy Code disallow makewhole premiums; and (2) are the lenders entitled to interest at the higher default rate contained in the loan agreements?

The lenders argued that the solvent-debtor exception permitted the allowance of both the makewhole and the higher post-petition default rates.

At that point in the January opinion, Judge Oldham launched into pages and pages of speculation about the answers to both questions. This time, he didn’t.

Instead, Judge Oldham said in his new opinion that the “bankruptcy court never reached either question.”

Quoting a treatise, Judge Oldham said that courts disagree about the allowance of makewholes. Although he did not, he could have cited the disagreement between the Second and Third Circuits regarding the allowance of makewholes. The New York-based appeals court disallowed a makewhole, while the circuit court in Philadelphia allowed a makewhole claim to stand. See Delaware Trust Co. v. Energy Future Intermediate Holding Co. LLC (In re Energy Future Holdings Corp.), 842 F.3d 247 (3d Cir. 2016), and BOKF NA v. Momentive Performance Materials Inc. (In re MPM Silicones LLC), 874 F.3d 787 (2d Cir. 2017). For some of ABI’s coverage of those cases, click here and here.

Judge Oldham said that the bankruptcy court was “best able” to rule in the first instance on the allowance of the makewholes and default interest. Nonetheless, he went on to say, “Our review of the record reveals no reason why the solvent-debtor exception could not apply.”

But mindful of the circuit court’s role as a court of review, he said that “we will not make the choice ourselves or weigh the equities on our own.”

Judge Oldham therefore reversed the bankruptcy court’s ruling on impairment and remanded for the bankruptcy court to consider the allowance of the makewhole and the higher default rate.