Wed 12/22/2021 19:36 PM
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In an opinion released today on the Hertz debtors’ motion to dismiss unsecured notes indenture trustee Wells Fargo’s adversary complaint seeking payment of make whole and contract-rate postpetition interest amounts, Judge Mary Walrath grants the motion to dismiss on the indenture trustee's bid for contract-rate postpetition interest, finding the federal judgment rate the appropriate rate. On the make whole count, the court grants the debtors’ motion to dismiss as to the 2022/2024 senior notes but denies the motion to dismiss as to the 2026/2028 senior notes. Wells Fargo said in its briefing that the 2026/2028 notes represent “approximately 82% of the disputed [make whole] dollars.”

The court leaves open the possibility that the make whole is the “economic equivalent of” unmatured interest, which would be disallowed under Bankruptcy Code section 502(b)(2), calling the issue a matter of fact rather than law. “[T]o the extent that the Court determines that the redemption premium is the economic equivalent of interest, that claim too would be limited by the application of the federal judgment rate,” the opinion says (emphasis added).

The wide-ranging opinion touches not only on contract interpretation and unmatured interest, but “Code impairment” versus “plan impairment” and whether the solvent debtor exception exists.

The court heard oral argument on Nov. 9 and took the motion under advisement.

U.S. Bank, indenture trustee for the 7% unsecured promissory noteholders, intervened as a plaintiff seeking relief only on the postpetition interest claim. In the main case, U.S. Bank filed a motion seeking damages analogous to a make whole. That motion is being held in abeyance pending a ruling on the motion to dismiss.

Make Whole

Judge Walrath distinguishes between the 2022/2024 senior notes and the 2026/2028 senior notes, granting the debtors’ motion to dismiss with respect to the 2022/2024 senior notes but denying the request as it relates to the 2026/2028 senior notes. The judge’s decision is based on the relevant redemption provisions of the notes indenture and supplemental indentures. The 2026/2028 notes make whole claims only survive because the court finds further that it cannot rule as a matter of law that make whole claims are the equivalent of unmatured interest under the Bankruptcy Code, leaving that issue alive for another day.

Indenture Language

The opinion begins by siding with Wells Fargo’s interpretation of the Third Circuit’s Energy Future Holdings, or EFH, opinion for the proposition that “the acceleration clause in the Indentures is not the operative provision in determining whether the redemption premium is due.” The debtors had argued that the acceleration and redemption provisions could be read together to foreclose the payment of the make whole.

Moving to the indentures’ redemption provisions, the court concludes that Wells Fargo has alleged sufficient facts that, when accepted as true, state a facially plausible claim “that the redemption of the Senior Notes was at the Debtors’ option.” The court rejects a number of the debtors’ arguments as to why the notes were not redeemed “at the Debtors’ option,” beginning with the argument that the notes were automatically accelerated upon the bankruptcy filing, a position consistent with the findings in MPM Silicones/Momentive. “Although MPM is to the contrary, it is not the law in this Circuit [and] [t]he Third Circuit in EFH disagreed with the bankruptcy court’s decision which was upheld in MPM and distinguished the AMR decision (on which the Second Circuit relied in MPM),” the opinion says.

The court also rejects the debtors’ argument that EFH is distinguishable because Hertz “did not file bankruptcy in a strategic effort to avoid the payment of a redemption premium.” The court agrees with Wells Fargo’s position that “there is nothing in EFH requiring an intent to avoid the make-whole obligation in order to find that a redemption of notes is voluntary,” and adds that “several cases have found a redemption voluntary even where the issuer acted in the utmost good faith,” citing in a footnote to Chesapeake.

Finally, the court dismisses the debtors’ argument that “any option to reinstate the Senior Notes was hypothetical at best,” disagreeing with the debtors’ reasoning that because the exercise of their fiduciary duty to maximize value led to a plan not providing for reinstatement, the debtors were constrained by that outcome and could not have voluntarily reinstated the notes. The court cites again to EFH for the voluntary nature of the debtors’ decisions to select from among multiple options for treatment of the notes.

The decision to file for bankruptcy “was perhaps the best option for the Debtors in light of the drastic effects on their business caused by the pandemic, but it was not the only option,” the court says, noting that while the debtors “chose” to conduct an auction for a plan sponsor and ultimately selected the highest and best offer, “that too was not the Debtors’ only option.” “At numerous junctures in any bankruptcy case, a debtor in possession has multiple paths from which to choose,” the opinion continues, concluding that “[e]ven though the Debtors acted in good faith and in the fulfillment of their fiduciary duties, the Court concludes that their actions were voluntary.”

Next, the court addresses the different indenture language applicable to the 2022/2024 notes versus the 2026/2028 notes, which leads to the court’s disparate treatment of the two sets of notes. Under section 6(a), applicable to the 2022/2024 notes, the court agrees with the debtors’ interpretation of the terms “stated maturity” and “prior to maturity” to conclude that Wells Fargo has failed to state a plausible claim that a redemption premium is due on the 2022/2024 notes “because they were redeemed after the initial period stated therein but not prior to the maturity arising as a result of the bankruptcy filing.”

Conversely, the court finds that a different subsection of the indenture, 6(c), applies to the 2026/2028 notes and, agreeing with Wells Fargo’s indenture language interpretation, says that the plaintiff has stated a plausible claim that a premium would be due “because [the notes] were redeemed before the initial period stated” in the relevant indenture section.

Unmatured Interest

The opinion next addresses the debtors’ argument that even if the make whole is due under the relevant indenture language, it must be disallowed under section 502(b)(2) as the “economic equivalent of” unmatured interest. “The Court is not prepared to conclude, as a legal matter, that make-wholes cannot be disallowed as unmatured interest as Wells Fargo, the cases it cites, and academics suggest,” the opinion says (emphasis added).

The court says that the inquiry turns on “‘the economic substance of the transaction to determine what counts as interest’” rather than the title of an indenture provision. The court concludes that the determination “is not a legal question, but is instead a factual one,” in this case, “whether the redemption provision in the 2026/2028 Senior Notes is actually the economic equivalent of unmatured interest.”

Although the court leaves the factual issue open, the opinion provides insight on what Judge Walrath found instructive from the motion to dismiss briefing and oral argument. The opinion begins by saying that “[i]n considering the actual language of the redemption premium in this case, the Court finds it significant that it is calculated, in large part, on the present value of the unmatured interest due on the Senior Notes as of the Redemption Date.”

However, any weight for the debtors from that statement is counterbalanced by the PowerPoint slides used by Wells Fargo at oral argument “that appeared to suggest [] that the redemption provision was much less than a simple present value of the unmatured interest and very favorable to the Debtors because it is tied to the Treasury rate.”

The court warns that the presentation “was, of course, merely argument and no evidence was presented to support that assertion [n]or did the Debtors have an opportunity to rebut the assertion with any evidence.” Nonetheless, the court concludes that “[t]he presentation by Wells Fargo (and the language of the redemption provision itself) [] are sufficient to convince the Court that Wells Fargo has stated a plausible claim for relief.” “While the redemption premium clearly was not due until the redemption occurred on the Effective Date of the Plan and, therefore, was ‘unmatured’ as of the petition date, the Court concludes that Wells Fargo may be able to present evidence that the redemption premium in the 2026/2028 Senior Notes is not, in fact, the economic equivalent of unmatured interest due under those Senior Notes,” the opinion concludes.

Unimpairment, Solvent Debtor Exception

The court agrees with the debtors that Wells Fargo’s “other arguments” would only be relevant if the redemption premium is determined to be the economic equivalent of unmatured interest. Wells Fargo had argued that the solvent debtor exception would apply, or the plan’s treatment of the notes claims as unimpaired means they are entitled to all contractual and equitable rights, which would be impaired if the make whole is not paid.”

“[I]f it is unmatured interest,” the court says, “then the claim would be subject to the same analysis as the claims of all Noteholders’ to post-petition interest,” discussed below. As a result, the court considers the parties’ arguments on impairment and the solvent debtor exception together.

On unimpairment, the court concludes that “any modification of the Noteholders’ claim to unmatured interest or to the redemption premium (if it is the economic equivalent of unmatured interest) is an impairment of the Noteholders’ contract claims by operation of section 502(b)(2) of the Bankruptcy Code, not the Debtors’ Plan,” agreeing with the Fifth Circuit’s distinction between Code impairment and plan impairment in Ultra Petroleum. As a consequence, the court rules that the noteholders’ claims “are not impaired within the meaning of section 1124(1).” In addition to Ultra, the court cites to PPI Enterprises (Third Circuit) and PG&E (Bankr. N.D. Cal.) (affirmed by the district court).

Regarding the solvent debtor exception, the court says the Bankruptcy Code “is silent,” finds no support for anything beyond the federal judgment rate of interest in the repeal of former Code section 1124(3) and critiques recent holdings in Ultra Petroleum and EFH favorable to Wells Fargo. On the repeal of section 1124(3), the court disagrees with the debtors’ analysis of the PPI Enterprises case, yet does not find for the indenture trustee either, concluding only that there is nothing to suggest that “any interest due to unimpaired creditors cannot be capped at the federal judgment rate applicable under section 726(a)(5).”

“Nowhere in the repeal of section 1124(3) or its Legislative History did Congress state what the Indenture Trustees argue, namely that unimpaired creditors must be paid their contract rate of interest in a solvent chapter 11 debtor case,” the opinion says, providing two examples of ways in which Congress could have so provided for that result.

The court agrees with the debtors that cases regarding secured creditors’ entitlement to contract-rate interest are not applicable to unsecured claims, such as the notes here, and further disagrees with two recent cases cited by Wells Fargo. The court says that the analysis in the 2020 Ultra Petroleum bankruptcy court ruling, which concluded that the solvent debtor exception exists and unimpaired creditors are entitled to contract-rate postpetition interest “because they were entitled to have their equitable rights fully enforced under section 1124(1),” “is not persuasive.” “A bankruptcy court cannot use equitable principles to modify express language of the Code,” such as section 502(b)(2), which “expressly disallows claims of unsecured creditors for unmatured interest,” the court says, arguing further that “[w]hen a debtor is solvent, the Bankruptcy Code does not waive the application of section 502(b)(2).”

The court also says that “[t]he Third Circuit has held that section 1124(1) does not mandate that unimpaired creditors receive all of their contract rights where those rights are expressly disallowed by section 502(b) of the Code,” citing to PPI Enterprises.

The opinion also finds fault with the 2015 bankruptcy court opinion in EFH, which held that a bankruptcy court has the equitable power to award the contract rate “‘or such other rate as the Court deems appropriate.’” Judge Walrath finds the test articulated in EFH “to be problematic” because (i) the court relied on the “fair and equitable” test of section 1129(b), “which by its express terms does not apply to unimpaired creditors,” (ii) “it provides no guidance to debtors or creditors as to precisely how unimpaired creditors must be treated and thus will result in endless litigation,” and (iii) it “runs counter to recent Supreme Court jurisprudence (and Congressional amendments) that have sought to curb the bankruptcy court’s exercise of equitable discretion.”

Postpetition Interest

In rejecting the bondholders’ claim for postpetition interest at their indentures’ “contract” rate - as opposed to the lower federal judgment rate - Judge Walrath concludes that the “solvent debtor exception” should not be read as broadly as other courts have in done in cases like Ultra Petroleum or EFH. Specifically, Judge Walrath writes, “​​the Court is convinced that the solvent debtor exception survived passage of the Bankruptcy Code only to a limited extent.”

Instead, Judge Walrath adopts the postpetition interest findings of the PG&E bankruptcy court, which in turn relied on the Ninth Circuit’s Cardelucci opinion. In a footnote, Judge Walrath cites to her own prior opinion in Washington Mutual, which discussed similar issues and reached similar conclusions.

Judge Walrath concludes that the 1984 amendment to the Bankruptcy Code made section 1129(a)(7) (requiring creditors receive value at least as high as their rights in a chapter 7 liquidation) applicable “to impaired creditors only” out of a legislative desire “to require voting only by impaired creditors, rather than by a desire to assure that unimpaired creditors get their contract rate of interest.” Turning to section 726(a)(5) of the Bankruptcy Code - a liquidation provision requiring creditors to receive interest at the “legal rate” - the judge finds that there are strong textual and policy reasons for this controlling the question of postpetition interest for both impaired and unimpaired creditors:

“While section 726(a)(5) is made applicable in chapter 11 cases only to impaired creditors, when a debtor is solvent, impaired creditors essentially are unimpaired, in the sense that they are entitled to payment in full of their allowed claims and postpetition interest, albeit at the federal judgment rate, before any distribution can be made to equity … The Legislative History to section 1124(3)’s repeal suggests that Congress believed that there is no legitimate reason when a debtor is solvent to distinguish between impaired and unimpaired unsecured creditors who are receiving payment of their claims in cash in full. Consequently, the Court concludes that both should receive the same treatment: payment of their allowed claim plus post-petition interest at the federal judgment rate in accordance with section 726(a)(5)” (emphasis added).

Judge Walrath says that this result bolsters “the principle that creditors with the same priority (such as unsecured creditors) should be similarly treated” in that “providing that all general unsecured creditors are entitled to the same post-petition interest in a solvent chapter 11 debtor case prevents a debtor from paying preferred creditors more than others simply by classifying them as unimpaired.” The result is also an “easy and predictable rule to apply,” the judge writes.

Crucially, Judge Walrath writes that her decision on postpetition interest now means that with respect to the surviving make whole claims “to the extent that the Court determines that the redemption premium is the economic equivalent of interest, that claim too would be limited by the application of the federal judgment rate” (emphasis added).

The opinion offers a caveat, however: “It is important to emphasize that the Court’s ruling in this case is limited to the issue of what post-petition interest unimpaired creditors must receive in the rare case when a chapter 11 debtor proves to be solvent and their claims are being paid in full in cash on the effective date of the plan.” In that circumstance, Judge Walrath finds that the interest must be paid at the federal judgment rate.
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