“In chapter 11, a creditor should be able to assert the full amount of any guarantee claim against the debtor without reducing the claim for recoveries against another obligor.”
“Whether the Nortel Senior Notes will be entitled to post-petition interest, and at what rate, in the chapter 11 cases are open questions that may hinge, among other things, on proving solvency of the Nortel chapter 11 debtors.”
The Nortel cross-border insolvency and the dramatic success of the estates’ asset sales have raised an old question of how a creditor may assert guarantee claims in a new context. Nortel Networks Corporation (NNC), Nortel’s Canadian parent entity, and Nortel Networks Limited (NNL), a Canadian corporation, issued multiple series of senior notes (the Nortel Senior Notes) guaranteed by their US affiliate, Nortel Networks Inc. (NNI). On January 14, 2009, Nortel entered bankruptcy. NNI filed for chapter 11 protection, and NNC and NNL commenced proceedings in Canada under the Canada Companies’ Creditors Arrangement Act (the CCAA). Recoveries on the Nortel Senior Notes now depend on distributions in both the chapter 11 cases and the CCAA proceedings, which forces creditors to consider how guarantee claims against NNI may be asserted in chapter 11 to determine what will be the noteholders’ share of NNI’s estate.
The Supreme Court decided long ago in Ivanhoe Building & Loan Association v. Orr, 295 U.S. 243 (1935) that a creditor is not required to deduct the amount of any payment received from a co-obligor from a guarantee claim against the debtor.1 A creditor may recover a portion of its claim from a non-debtor party and still assert its claim for the full amount of the debt against the debtor, but a creditor may never collect more than the total amount of the debt that creditor is owed.2 One scholar has referred to this ceiling on payments received by a creditor as the “single satisfaction” rule.3
The “single satisfaction” rule however does not define what is the amount of the claim, which can still be subject to dispute. For example, in the case of National Energy & Gas Transmission, Inc. v. Liberty Elec. Power, LLC, a creditor sought to allocate recoveries against a non-debtor obligor to interest first (and in particular, interest that accrued on the claim against the non-debtor after the debtor’s petition date and was not an allowable claim in the debtor’s bankruptcy) and then to payment of principal, so as to assert a guarantee claim against the debtor for the outstanding principal and ultimately recover both principal and post-petition interest. The Fourth Circuit rejected this approach based on the fundamental rule that, while a creditor is not required to reduce guarantee claims by amounts received from a co-obligor, chapter 11 still defines the nature and amount of the underlying claim.4 In chapter 11, a claim is determined as of the petition date, and a creditor is not entitled to post-petition interest unless the estate is solvent and able to pay all unsecured claims in full. Accordingly, the Fourth Circuit held that permitting the creditor to allocate its recoveries outside the chapter 11 case to postpetition interest and seek recoveries of the outstanding principal in chapter 11 would violate the “single satisfaction” rule by permitting the creditor to receive more than the amount of its claim as defined by chapter 11. NEGT emphasizes that recoveries of Nortel’s creditors may depend on how recoveries are allocated in Nortel’s chapter 11 cases and, separately, in the CCAA proceedings.
The NEGT decision, while ostensibly following the Supreme Court’s decision in Ivanhoe, arguably conflicts with the underlying holding of Ivanhoe and has led to confusion as to exactly what Ivanhoe means in the context of multinational cases with many affiliated debtors, only some of whom are debtors under chapter 11. Resolving that confusion and legal uncertainty could have a material impact on recoveries by holders of the Nortel Senior Notes. Indeed, whether the Nortel Senior Notes will be entitled to post-petition interest in the chapter 11 cases, and at what rate, in the chapter 11 cases are open questions that may hinge, among other things, on proving solvency of the Nortel chapter 11 debtors. This question may be resolved if the U.S. Bankruptcy Court enters a finding of fact that the NNI estate is solvent.
In a recent decision in In re W.R. Grace & Co., the U.S. District Court for the District of Delaware found that creditors were not entitled to post-petition interest at the default rate and that their claims may be subject to reinstatement with payment of a lower post-petition interest rate. The bankruptcy court rejected arguments that the court should presume solvency based on the unimpaired treatment of creditors, and the district court agreed, stating that the burden is on the objecting creditors to prove solvency.5 Further, the district court held that the Third Circuit’s decision in In re PPI Enterprises (U.S.), Inc., 324 F.3d 197 (3d Cir. 2003) does not require payment of post-petition interest at the contractual default rate even if solvency is established. The district court affirmed use of a hybrid rate of interest provided under the plan that was higher than the contractual non-default rate and federal judgment rate but lower than the contractual default rate.
If post-petition interest is allowed, statute and case law do not guarantee a particular rate. If a bankruptcy court is forced to decide what rate should apply, it could take one of four paths: (1) the federal judgment rate (as in In re Washington Mutual, Inc.), (2) the applicable state law judgment rate, (3) the contract rate (non-default or default rate), depending on the facts of the case and issues before the court or (4) a hybrid rate (as in In re W.R. Grace & Co.). Furthermore, the court’s determination and allocation of the amount of the prepetition claim in accordance with Ivanhoe and NGET will affect the base upon which interest builds.