By authorizing a direct appeal, Bankruptcy Judge Mary F. Walrath of Delaware is importuning the Third Circuit to split with the Fifth and Ninth Circuits by holding that adoption of the Bankruptcy Code in 1978 abrogated the so-called solvent-debtor exception to the allowance of post-petition interest.
A direct appeal will also allow the Third Circuit to give better definition to the circumstances in which a so-called makewhole is or is not an allowed claim in chapter 11.
Judge Walrath’s decision on November 21 in the reorganization of Hertz Corp. is a follow-up to her Hertz decision on December 22, 2021, in Wells Fargo Bank NA v. Hertz Corp. (In re Hertz Corp.), 637 B.R. 781 (Bankr. D. Del. Dec. 22, 2021). To read ABI’s report, click here.
Last year, Judge Walrath concluded that there were disputed issues of fact precluding her from deciding, on summary judgment, whether a so-called redemption price was or was not unmatured interest disallowed under Section 502(b)(2).
In the same opinion last year, Judge Walrath ruled that the solvent-debtor exception did not survive adoption of the Bankruptcy Code. In her new decision on November 21, Judge Walrath tackled both decisions a second time, this time ruling definitively on both and certifying a direct appeal to the circuit.
The Solvent Hertz Plan
Judge Walrath was dealing with unsecured notes where the indenture called for a so-called redemption price (a/k/a makewhole premium) and a higher rate of interest after default. Makewhole premiums and redemption price claims are often seen as compensating debt holders for being required to reinvest at lower rates of interest when the obligation is paid before maturity.
Hertz ended up being solvent and confirmed a plan that paid the noteholders’ claims in cash, in full, on the effective date. The unsecured notes were categorized in the plan as being unimpaired. The plan gave noteholders post-petition interest up to the plan’s effective date at the federal judgment rate or at whatever rate was necessary for the notes to be unimpaired. The federal judgment rate was lower than the contract default rate.
Regarding $2.7 billion in principal and pre-petition interest on the bonds, the indenture trustee filed an adversary proceeding seeking (1) payment of makewhole premiums totaling about $147 million and (2) post-petition interest at the default rate in the contract, amounting to another $125 million.
The debtor filed a motion to dismiss for failure to state a claim. In her 46-page opinion last year, Judge Walrath decided that the claims for the redemption price had been triggered but found disputed issues of fact as to whether the claims were for the equivalent of unmatured interest disallowed under Section 502(b)(2).
Judge Walrath last year did rule that the bondholders were only entitled to post-petition interest at the federal judgment rate, not the higher default rate under the bonds, because the solvent-debtor exception did not survive adoption of the Code.
The debtor and the indenture trustee filed new motions for summary judgment regarding the characterization of the redemption claims. The indenture trustee also filed a companion motion for Judge Walrath to reconsider her decision on the solvent-debtor exception.
This time, the debtor won all the way around.
Characterization of the Claim for the Redemption Price
To decide whether the claim for the redemption price was a claim for disallowed unmatured interest, Judge Walrath said that “the economic substance of the transaction governs, not the formalistic labels or dictionary definitions of the terms used.”
Judge Walrath found that all three components of the redemption price were “the equivalent of unmatured interest.” The first component, she said, was unmatured interest on the date of redemption. The second was the present value of remaining interest, and the third was the equivalent of one semi-annual interest payment.
Because all three elements were based on interest, Judge Walrath concluded that the redemption price was the equivalent of unmatured interest. She also rejected the indenture trustee’s contention that the redemption claim did not arise until after bankruptcy. The claim, she said, was contingent and arose alongside the filing of the petition.
Judge Walrath granted the debtor’s motion for summary judgment.
Reconsideration of Solvent-Debtor Exception
The indenture trustee wanted Judge Walrath to reconsider her 2021 decision because, over the last year, majorities on both the Fifth and Ninth Circuits had held that the solvent-debtor exception survives. See Ad Hoc Committee of Holder of Trade Claims v. Pacific Gas & Electric Co. (In re Pacific Gas & Electric Co.), 46 F.4th (9th Cir. Aug. 29, 2022); and Ultra Petroleum Corp. v. Ad Hoc Committee of OpCo Unsecured Creditors (In re Ultra Petroleum Corp.), 51 F. 4th (5th Cir. Oct. 14, 2022). To read ABI’s reports, click here and here.
Had Judge Walrath changed her mind, the noteholders would have had their makewhole plus the higher default rate of interest because Hertz was solvent. She was not persuaded by the circuit opinions, which were not binding on her.
Moreover, Judge Walrath said that the circuits “did not rely on any argument that was not considered by the Court in its [decision last year].” Furthermore, she said that the dissenters in both circuits concluded “that the solvent-debtor exception did not survive the passage of the Bankruptcy Code and that section 502(b)(2) expressly disallowed any claim for unmatured interest.”
Judge Walrath saw the disallowance of post-petition interest to be “clearly stated in section 502(b)(2).” The exception, she said, only survives when the secured creditor is over-secured under Section 506(b), when a chapter 7 debtor is solvent under Section 726(a)(5), or when an impaired creditor does not accept a chapter 11 plan under Section 1129(a)(7).
Judge Walrath denied the indenture trustee’s motion for reconsideration.
Certified Appeal
Judge Walrath certified a direct appeal to the Court of Appeals because there is no controlling authority from the Third Circuit, and the Fifth and Ninth Circuits both had dissenters that would have agreed with her.
Judge Walrath also alluded to the forthcoming petition for certiorari to the Ninth Circuit, which is due February 3, 2023. She said that a grant of certiorari would be “more likely if additional Circuits opine” on the survival of the solvent-debtor exception.
By authorizing a direct appeal, Bankruptcy Judge Mary F. Walrath of Delaware is importuning the Third Circuit to split with the Fifth and Ninth Circuits by holding that adoption of the Bankruptcy Code in 1978 abrogated the so-called solvent-debtor exception to the allowance of post-petition interest.
A direct appeal will also allow the Third Circuit to give better definition to the circumstances in which a so-called makewhole is or is not an allowed claim in chapter 11.
Judge Walrath’s decision on November 21 in the reorganization of Hertz Corp. is a follow-up to her Hertz decision on December 22, 2021, in Wells Fargo Bank NA v. Hertz Corp. (In re Hertz Corp.), 637 B.R. 781 (Bankr. D. Del. Dec. 22, 2021). To read ABI’s report, click here.
Last year, Judge Walrath concluded that there were disputed issues of fact precluding her from deciding, on summary judgment, whether a so-called redemption price was or was not unmatured interest disallowed under Section 502(b)(2).
In the same opinion last year, Judge Walrath ruled that the solvent-debtor exception did not survive adoption of the Bankruptcy Code. In her new decision on November 21, Judge Walrath tackled both decisions a second time, this time ruling definitively on both and certifying a direct appeal to the circuit.