In re Ultra Petroleum Corporation is one case that has caused the Fifth Circuit Court of Appeals to revisit the permissibility of Make-Whole provisions, at least three times, over several years. Earlier discussions of the case have been the subject of prior CRR articles. See Fifth Circuit Holds that Chapter 11 Plan Does not “Impair” Claimants by Denying Make-Whole Rights and Contractual Interest (March 29, 2019); Ultra Petroleum Redux: Make-Whole Provisions and Solvent-Debtor Exception Remain Intact in the Southern District of Texas (November 29, 2020). The most recent Fifth Circuit opinion, rendered on October 14, 2022, leaves in doubt whether Make-Whole provisions, premised solely on lost interest, are enforceable in most bankruptcy cases. See In re Ultra Petroleum Corporation, 51 F.4th 138 (5th Cir. 2022). The history of the case illustrates how difficult the debate over Make-Whole provisions can be.
Ultra Petroleum Redux
Ultra Petroleum Corporation and its affiliates (collectively, “Ultra”), a family of oil and gas exploration companies, were insolvent when they entered bankruptcy in early 2016, due to declines in oil and natural gas prices. But when those commodities prices soared during the middle of the bankruptcy, Ultra found itself “supremely solvent” towards the end of its case, when it came time to confirm its $2.5 billion plan of reorganization.
Part of Ultra‘s chapter 11 plan was to pay, in full, unsecured creditors, including noteholders and revolving credit facility creditors, with prepetition interest at the contractual rate and post-petition interest at the Federal Judgment rate, as specified in 28 U.S.C. § 1961(a). In Ultra‘s view, this plan treatment made this class of creditors “unimpaired” under 11 U.S.C. §§ 1123(a)(2) and 1124, thereby deeming such class to have presumptively voted in favor of the Ultra‘s chapter 11 plan. Two groups of creditors, the noteholder and revolving credit lenders, complained that the plan was not confirmable because such creditors were entitled to, but did not receive, (a) the Make-Whole premiums, which would have made them whole for prepetition debts and (b) post-petition interest at the contractual default rate.
Procedural Ping Pong Match
The Bankruptcy Court initially held that creditors remained impaired unless they were paid the full contractual interest rate for accrued prepetition and post-petition interest, including the Make-Whole amounts and default rate of interest for the post-petition period. See In re Ultra Petroleum Corp., 575 B.R. 361, 373, 375 (Bankr. S.D. Tex. 2017) (Isgur, J.) (“Ultra Petroleum I“). On direct appeal, the Fifth Circuit initially held that the Bankruptcy Court erred in determining that section 502(b)(2) of the Bankruptcy Code impaired the creditors for plan confirmation purposes, but it remanded the case to allow the Bankruptcy Court to determine (a) whether the solvent-debtor exception survived the 1978 enactment of the Bankruptcy Code and affected prepetition interest and (b) what rate of post-petition interest left creditors unimpaired. See In re Ultra Petroleum Corp., 913 F.3d 533, 547-551 (5th Cir. 2019) (“Ultra Petroleum II“). In an en banc reconsideration, the Fifth Circuit refined its earlier opinion and remanded the case to the Bankruptcy Court for a determination of whether, in light of the solvent-debtor exception, the creditors were unimpaired because of the Bankruptcy Code’s own restriction on the collection of prepetition and post-petition interest, not the Ultra‘s plan’s implementation of such restrictions. See In re Ultra Petroleum Corp., 943 F.3d 758, 763-766 (5th Cir. 2019) (en banc) (“Ultra Petroleum III“); see also Fifth Circuit Holds that Chapter 11 Plan Does not “Impair” Claimants by Denying Make-Whole Rights and Contractual Interest (March 29, 2019). On remand from Ultra Petroleum III, the Bankruptcy Court, consistent with Ultra Petroleum I, held that the Make-Whole amounts did not constitute unmatured interest or the “economic equivalent” for purposes of section 502(b)(2) of the Bankruptcy Code. See In re Ultra Petroleum Corp., 624 B.R. 178, 184 (Bankr. S.D. Tex. 2020) (“Ultra Petroleum IV“) (“The Make-Whole Amount represents liquidated damages and should not be characterized as unmatured interest, or its economic equivalent.”); see also Ultra Petroleum Redux: Make-Whole Provisions and Solvent-Debtor Exception Remain Intact in the Southern District of Texas (November 29, 2020). The Bankruptcy Court also held that the historically rooted “solvent-debtor exception” to section 502(b)’s prohibition of unmatured interest entitled creditors to the contractual default rate of interest rather than the lower Federal Judgment rate. See Ultra Petroleum Corp., 624 B.R. at 204 (“The Class 4 Claimants are entitled to post-petition interest at the MNPA and RCF default rates.”). In all, the Bankruptcy Court’s latest ruling required Ultra to pay creditors an additional $387 million in Make-Whole premiums and post-petition interest at contractual default rates. An appeal by Ultra subsequently ensued, again, giving the Fifth Circuit an opportunity to have a final say on these matters. See In re Ultra Petroleum Corp., 51 F.4th 138 (5th Cir. 2022) (“Ultra Petroleum V“).
Ultra Petroleum V
In Ultra Petroleum V, the Fifth Circuit finally determined that Make-Whole provisions are generally not enforceable pursuant to section 502(b) of the Code, because such provisions provide creditors with the “economic equivalent of unmatured interest.” According to the Fifth Circuit,
Contractual make-whole amounts, like the one at issue here, are expressly designed to liquidate fixed-rate lenders’ damages flowing from debtor default while market interest rates are lower than their contractual rates. Lenders’ damages equal the present value of all their future interest payments. In other words, a make-whole amount is nothing more than a lender’s unmatured interest, rendered in today’s dollars . . . . It is—rather precisely—the “economic equivalent of ‘unmatured interest.’”
Ultra Petroleum, 51 F.4th at 146 (citations omitted). Because section 502(b)(2) of the Bankruptcy Code disallows claims for unmatured interest or, pursuant to the Fifth Circuit’s prior Pengo decision, the “economic equivalent of unmatured interest,” the Fifth Circuit held that such provisions would normally be disallowed. Citing In re Pengo Indus., Inc., 962 F.2d 543, 546 (5th Cir. 1992) (citation omitted); accord In re Chateaugay Corp., 961 F.2d 378, 380–81 (2d Cir. 1992). But, significantly, in Ultra Petroleum V the Fifth Circuit does not find that section 502(b) disallows a liquidated damages provision that compensates a lender for transactional costs or similar damages that are not intended to compensate lenders for unrealized interest. See Ultra Petroleum, 51 F.4th at 150. In Ultra Petroleum V, the Court just felt that the Make-Whole provisions impermissibly extended beyond liquidated damages and, despite formulaic computations, compensated lenders for unmatured interest.
Solvent Debtor Exception
Even though the Fifth Circuit held that the Make-Whole provisions in Ultra Petroleum V constituted unmatured interest, the Court, for the first time, held that the common law solvent-debtor exception survived the enactment of the Bankruptcy Code in 1978, and such surviving exception required Ultra to pay the Make-Whole premiums. See Ultra Petroleum, 51 F.4th at 150. As with many bankruptcy laws, the solvent-debtor exception originated in eighteenth-century English practice. See id. at 150-51. The reason for this traditional, judicially-crafted exception is that solvent debtors are, by definition, able to pay their debts in full on their contractual terms. See id. at 151. As the Court reasoned:
Because the Code’s general bar on claims for unmatured interest does not specifically address the solvent-debtor scenario, for which traditional bankruptcy practice has always provided an exception, we conclude that the pre-Code doctrine concerning solvent debtors’ obligations remains good law, and the exception operates in this case to suspend § 502(b)(2)’s disallowance of Creditors’ Make-Whole Amount.
Id. Accordingly, the Fifth Circuit held that the solvent-debtor exception survived the enactment of the 1978 Bankruptcy Code and is “alive and well.” Id. at 152, 154, 156 (citing Cohen v. de la Cruz, 523 U.S. 213, 221–22, 118 S.Ct. 1212, 140 L.Ed.2d 341 (1998)). The Fifth Circuit concluded that “[f]or th[is] reason, Ultra must pay Creditors the contractual Make-Whole Amount—even though, as we have already determined . . . it is indeed otherwise disallowed unmatured interest.” Ultra Petroleum, 51 F.4d at 156 (emphasis added).
Lastly, the Fifth Circuit determined the appropriate post-petition interest owed to creditors. There appeared to be no issue that, if the solvent-debtor exception applied, creditors were entitled to post-petition interest. The only issue was the appropriate rate for such post-petition interest. See Ultra Petroleum, 51 F.4d at 158. While Ultra maintained that the Federal Judgment rate was appropriate and uniform, creditors argued that the much higher contractual default rate applied. See id. The Fifth Circuit goes through a very winding analysis in reaching its conclusion, starting with the “best interest of creditors test,” which requires that cramdown creditors (impaired and dissenting) to receive distributions no less than they would receive in a chapter 7 liquidation case. See 11 U.S.C. § 1129(a)(7)(A)(ii). In a chapter 7 case, unsecured creditors would normally receive the “legal rate” of interest before equity receives any distribution. See 11 U.S.C. § 726(a)(5). But, the Fifth Circuit ultimately found that this “legal rate” sets a floor–not a ceiling–on the amount of interest unsecured creditors are entitled to receive in solvent debtor situations. See Ultra Petroleum, 51 F.4d at 159. According to the Court, “even if ‘the legal rate’ is the Federal Judgment Rate, the Code does not preclude unimpaired creditors from receiving default-rate post-petition interest in excess of the Federal Judgment Rate in solvent-debtor Chapter 11 cases.” Id. The Fifth Circuit ultimately held that “as a matter of equity, creditors are entitled to contractually specified rates of interest on their claims when a solvent debtor is fully capable of paying up” and “[t]his equitable right is the root of the solvent-debtor exception.” Ultra Petroleum, 624 B.R. at 203.
In Ultra Petroleum V, the Fifth Circuit solidified that Make-Whole provisions, which reimburse a lender for lost interest, are impermissible pursuant section 502(b) of the Code. The Fifth Circuit, however, affirmed that the solvent-debtor exception, which survived the enactment of the Bankruptcy Code, changes this statutory dynamic and allow such premiums. The Fifth Circuit also affirmed that the solvent-debtor exception allowed post-petition interest at the contractual default rate of interest pursuant to principles of equity. But, the debate over Make-Whole provisions is not remotely over. A Delaware bankruptcy judge ruled on November 9, 2022, that a $223 million Make-Whole premium owed by reorganized debtor Hertz Global for redeeming unsecured notes early is the same as unmatured interest and is disallowed under section 502(b) of the Bankruptcy Code. The appeal of this decision is uncertain. Overall, the enforceability of Make-Whole provisions generally turns on the facts of the case, in particular, the terms of the loan documents. But, for now, section 502(b)’s restrictions on post-petition interest and the solvent-debtor exception seem to be alive and well in the Fifth Circuit.