Courts Are Split on the Interest Rate for Unsecured Creditors of a Solvent Debtor

On an issue where the courts are split, Bankruptcy Judge Louise D. Adler of San Diego decided that unsecured creditors of a solvent debtor in chapter 11 are only entitled to post-petition interest at the lower federal judgment rate, not at the higher contract rate or state judgment rate.

Judge Adler disagreed with Bankruptcy Judge Marvin Isgur of Houston, who had ruled in October that the survival of the so-called solvent debtor exception entitles creditors of a solvent debtor to receive interest at the higher contract rate. See In re Ultra Petroleum Corp., 16-322032, 2020 BL 413677, 2020 WL 6276712 (Bankr. S.D. Tex. Oct, 26, 2020). To read ABI’s report on Ultra Petroleum, click here.

Judge Adler sided with the Bankruptcy Appellate Panel and a decision last year by Bankruptcy Judge Dennis Montali of San Francisco in the reorganization of Pacific Gas & Electric Co. See In re Pacific Gas & Electric Co., 610 B.R. 308 (Bankr. N.D. Cal. Dec. 30, 2019).

The Debtor Offers Interest at 2.69%

The corporate debtor in the chapter 11 case before Judge Adler was solvent. All creditors were unimpaired and thus not entitled to vote on the plan. For unsecured creditors, the plan gave them post-petition interest at the federal judgment rate of 2.69% or whatever rate the court might fix.

Several unsecured creditors objected to the plan, contending that the plan must pay their higher contract rates to prevent their claims from being impaired. Judge Adler disagreed in her December 3 opinion.

The Ninth Circuit Had Spoken Already

The primary authority for Judge Adler was In re Cardelucci, 285 F.3d 1231 (9th Cir. 2002), where the Ninth Circuit read Section 726(a)(5) to imply that unsecured creditors of a solvent debtor are entitled to interest at the federal judgment rate. In a chapter 7 case, that section means that unsecured creditors must be paid interest at the “legal rate” before the debtor is entitled to a distribution.

The creditors contended that Cardelucci did not apply because Section 726(a)(5) would only be applicable in a chapter 11 case with regard to the best interests test for impaired claims under Section 1129(a)(7). The case on appeal dealt with unimpaired claims.

Judge Adler was not persuaded by the distinction. She also latched onto the opinion by the Ninth Circuit Bankruptcy Appellate Panel in In re Beguelin, 220 B.R. 94 (B.A.P. 9th Cir. 1998), a case on point. The BAP held that a solvent debtor pays post-petition interest to unsecured creditors at the federal judgment rate.

PG&E was “factually on point,” Judge Adler said. She said that Bankruptcy Judge Montali “read Cardelucci expansively and ultimately adopted its holding as applying to all unsecured creditors in a solvent-debtor case.”

The Solvent-Debtor Exception

The creditors contended that Judge Montali was wrong and that Judge Adler should follow Judge Isgur in Ultra Petroleum. Like Judge Isgur, the creditors wanted Judge Adler to adopt the so-called solvent-debtor exception and award interest under state law when a debtor is solvent.

Judge Adler said she could not adopt Ultra Petroleum because she was bound by Cardelucci. She read her circuit’s precedent as calling for unsecured creditors to receive the federal judgment rate when they are unimpaired.

Judge Adler said that the solvent-debtor exception would pose “a significant threat to the bankruptcy court’s administrative efficiency in larger cases.” At a potentially “huge administrative expense,” she said the exception would require judging “the individual contractual rights of each individual unsecured creditor; and perhaps, resulting in different treatment to creditors of the same class.”

Ruling that unsecured creditors were entitled to the lower federal judgment rate, Judge Adler read Cardelucci to mean there was “no reason Congress would have intended to create such a costly administrative inefficiency in the bankruptcy courts.”