Ultra Petroleum Confirms Only Plan Can Prejudice Creditors, but What About the Solvent-Debtor Rule?

The Fifth Circuit’s opinion in In re Ultra Petroleum[1] clarifies what “unimpaired” means under § 1124 of the Bankruptcy Code. The Fifth Circuit joined the Third Circuit[2] in holding that “[t]he plain text of § 1124(1) requires that ‘the plan’ do the altering. We therefore hold a creditor is impaired under § 1124(1) only if ‘the plan’ itself alters a claimant’s ‘legal, equitable, [or] contractual rights.’”[3] However, the Fifth Circuit did not answer whether the solvent-debtor exception to the prohibition on claims for unmatured interest survived the enactment of the modern Code in the context of a solvent chapter 11 debtor.

Impairment Under § 1124

Ultra Petroleum Corp. and several affiliates (collectively referred to as “Ultra Petroleum”) filed for chapter 11 relief following the crash of oil prices in 2015. Prior to filing, Ultra Petroleum issued unsecured notes worth $1.46 billion to various noteholders (the “Note Agreements”) and took out an additional $999 million in a revolving-credit facility (the “Credit Facility”). In the midst of the bankruptcy cases, however, oil prices rose again, resulting in the rare solvent debtor.

Under the Note Agreements, the noteholders were entitled to a “make-whole amount” to compensate them for lost future interest, which was triggered upon the company filing bankruptcy. Similarly, the Credit Facility had an acceleration clause that was also triggered upon filing bankruptcy. Both provisions in the Note Agreements and the Credit Facility provided for a contractual default interest rate that was well above the federal judgment rate.

The proposed plan did not include payment of the make-whole amount or the post-petition interest rate as set forth in the Note Agreements and the Credit Facility. Rather, the plan provided that the debtors would pay (1) the outstanding principal, (2) pre-petition interest at a rate of 0.1% and (3) post-petition interest at the federal judgment rate. Despite deviating from the Note Agreements, the proposed plan labeled the unsecured noteholders “unimpaired,” thereby preventing them from objecting to the plan. The noteholders argued that because they were deprived of the make-whole amount and the contractual default rate (as opposed to the judgment rate), they were “impaired” and would only be “unimpaired” if granted the make-whole amount and post-petition interest at the contractual default rate.

The bankruptcy court held that because the noteholders did not receive everything that they would have been entitled to under the Note Agreements, they did not receive everything that they were entitled to under state law and were therefore impaired and entitled to vote on the plan. Section 1124(1) states that a claim is unimpaired if “the plan ... leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest.” (emphasis added). The Fifth Circuit granted a direct appeal and, in reversing the bankruptcy court, followed the Third Circuit and held that when the Bankruptcy Code (or other applicable law) is the source of the impairment, as opposed to the plan itself, there is no impairment under § 1124.

However, the Fifth Circuit did not answer whether the so-called “solvent-debtor exception” applies to chapter 11 of the Bankruptcy Code and whether the noteholders were entitled to post-petition interest at the contractual or federal judgment rate.

The Withdrawn Opinion

The Fifth Circuit first entered an order on Jan. 17, 2019.[4] Following a Petition for Panel Rehearing, the court withdrew its Jan. 17 opinion and substituted a new opinion, filed on Nov. 26, 2019.[5] The two opinions both arrive at the same substantive conclusions, but the withdrawn opinion contained a lengthy discussion on old English bankruptcy law as well as a discussion regarding to what extent the solvent-debtor exception was incorporated into the modern Bankruptcy Code. Under the old law — and under § 502(b)(2) of the modern Code — creditors were prohibited from including future unmatured interest in their claims. However, in the rare case where the debtor became solvent (thereby providing sufficient funds in the estate to pay post-petition interest) and there was a pre-petition contract allowing for interest, such creditors were allowed to collect post-petition interest after full payment of all other claims.

The withdrawn opinion suggested that the make-whole amounts were the economic equivalent of post-petition interest and should be prohibited by § 502(b)(2) because the purpose of a make-whole provision is to compensate the creditor for lost interest going forward.[6] The withdrawn opinion also noted certain examples where the solvent-debtor exception was codified in the Code, including, among other things, § 506(b) (allowing recovery of post-petition interest for oversecured creditors), § 726(a)(5) (allowing for recovery in chapter 7 cases of post-petition interest after all other creditors — secured and unsecured — have been paid in full) and § 1129(a)(7) (“best interest of creditor’s test requiring that all creditors receive not less than what they would receive under chapter 7”).[7] The withdrawn opinion also noted certain notable differences between the old rule and modern Code, including § 1129(a)(7)’s limitation to only impaired creditors.[8] The substituted Nov. 26 opinion removed that entire discussion, along with a discussion of how that historical backdrop could apply to the case at hand.[9]

One last notable difference between the two opinions is the removal of language from the withdrawn opinion that suggested the appropriate post-petition interest rate would be at the federal judgment rate as opposed to the contractual rate.[10]

Solvent-Debtor Exception

Because the bankruptcy court held that the noteholders were impaired, it never considered whether the solvent-debtor exception would apply to unimpaired creditors in a chapter 11 case. Noting that it was a court of review, neither the withdrawn opinion nor the substituted opinion issued by the Fifth Circuit decided the solvent-debtor issue in the first instance, but there is a significant difference between the two. The substituted opinion stated that “[o]ur review of the record reveals no reason why the solvent-debtor exception could not apply.”[11] This statement stands in contrast to the withdrawn opinion, which stated that “the creditors can recover the Make-Whole Amount if (but only if) the solvent-debtor exception survives Congress’s enactment of § 502(b)(2). We doubt it did.”[12]

As the appellate court noted in the withdrawn opinion (but not the substituted opinion), the modern Bankruptcy Code includes a similar version of the solvent-debtor exception in § 726(a)(5), which provides for the payment of post-petition interest, but only after all other claims (secured and unsecured) have been paid in full.[13] Of note on this issue is that chapters 12 and 13 of the Code both include the solvent-debtor-like exception by identical references to the order of distribution under chapter 7.[14] Chapter 11, however, contains a qualified version of that language. Section 1129(a)(7) provides that the court shall confirm a plan if “with respect to each impaired class of claims ... each holder of such claim ... will receive or retain under the plan on account of such claim or interest property of a value ... that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7....”[15] Thus, § 726(a)(5) only applies to impaired creditors, not unimpaired creditors in a chapter 11.

That does not end the discussion, however. As pointed out above, the withdrawn opinion seemed to suggest that the solvent-debtor exception was not incorporated into the modern Code in the context of solvent chapter 11 debtors.[16] The substituted opinion not only removed this language but substituted new language suggesting just the opposite, stating that “absent compelling equitable considerations, when a debtor is solvent, it is the role of the bankruptcy court to enforce the creditor’s contractual rights”[17] and “review of the record reveals no reason why the solvent-debtor exception could not apply.”[18]

Applicable Interest Rate

Similarly, the court did not decide whether the term “legal rate” of interest as used in § 726(a)(5) means the contractual rate or the federal judgment rate due to the fact that the bankruptcy court originally held that the noteholders should receive the contractual rate based on its understanding that the noteholders were “impaired” under the plan.[19] It should be noted that other courts have held that “legal rate” in § 726(a)(5) means the federal judgment rate (even if otherwise contractually provided for).[20] However, as the bankruptcy court noted[21] and the Fifth Circuit confirmed in the withdrawn opinion, § 726 is inapplicable in the case of unimpaired creditors. Nevertheless, the withdrawn opinion suggested that the federal judgment rate may be preferable, but this discussion was completely withdrawn from the substituted opinion. As such, it remains unclear how this issue will be resolved.

Conclusion

The Fifth Circuit’s withdrawn opinion provided heavy guidance that (1) the make-whole amounts were economically equivalent to post-petition interest, (2) the solvent-debtor exception did not survive the enactment of the modern Code, and (3) the proper post-petition interest rate in solvent chapter 11 cases should be the federal judgment rate. All of this was removed, which could suggest an effort on the part of the Fifth Circuit to grant greater deference to the bankruptcy court. However, given that the removal was also combined with contradictory language as to the survival of the solvent-debtor exception, it may also suggest a reversal of opinion by the Fifth Circuit. Given that the limitation placed on chapter 11 cases (i.e., only impaired creditors can receive post-petition interest) was not placed on cases under chapters 12 and 13, it stands to reason that Congress knew how to implement the solvent-debtor exception when it wanted to, but deliberately chose to limit its application in the context of solvent chapter 11 debtors. While bankruptcy courts are courts of equity and are granted leeway to provide for equitable treatment of all parties, they cannot go directly against the clear intentions of Congress.

At a status conference held on Feb. 20, 2020, the principal discussion concerned whether to leave the evidentiary record open,[22] but significant discussion centered around whether the Fifth Circuit left any hints in its opinion. Specifically, the bankruptcy court took note of footnote 2 in the substituted opinion, which addressed the possibility that the solvent-debtor exception, if it did survive, would be enforceable through the bankruptcy court’s equitable powers and be moored in 11 U.S.C. § 1124.[23] The bankruptcy court took this to suggest that instead of the legal analysis that it had previously used, perhaps an equitable analysis would lead to a different result, but was simultaneously careful not to over-read the Fifth Circuit’s thinking and stick solely to the words printed in the opinion. Whether the bankruptcy court takes a legal or equitable approach to this issue remains to be seen. This matter is set to be heard before the U.S. Bankruptcy Court for the Southern District of Texas on May 12, 2020, but obviously could be continued because of the current coronavirus pandemic. The developments before Judge Marvin Isgur should continue to be monitored.