Ultra Petroleum entered bankruptcy in significant financial distress, but then – thanks to a spike in oil prices – the debtor’s fortunes changed almost literally overnight. It is generally accepted that a solvent debtor must pay its creditors their complete contractual entitlement before any amount is paid to equity or retained by the debtor.[1] So, in light of the debtor’s newfound solvency, bondholders and other lenders demanded payment of post-petition interest at the contract rate and payment of a “make-whole premium.”[2] Anything less, they said, would render them “impaired” and entitled to vote on the proposed plan.[3]

The debtor insisted that the creditors were unimpaired – and thus ineligible to vote on the plan – because the plan would pay them everything they were entitled to under the Bankruptcy Code. The debtor argued that the make-whole claims should be disallowed as claims for unmatured interest, which are barred by section 502(b)(2) of the Bankruptcy Code. According to the debtor, it did not matter that creditors would be entitled to a make-whole premium and post-petition interest at the contract rate under state law, because it was the Bankruptcy Code, not the plan itself, that freed the debtor from the obligation to pay these amounts.

The Bankruptcy Court agreed with the creditors and held that they must receive their entire contractual entitlement – including the make-whole premium and post-petition interest at the contract rate – in order to be unimpaired.[4] The debtor appealed directly to the Fifth Circuit, which reversed and sided squarely with the debtor:

Section 1124(1) says ‘a class of claims or interests’ is not impaired if ‘the plan . . . leaves unaltered the [claimant's] legal, equitable, and contractual rights.’ The Class 4 Creditors spill ample ink arguing their rights have been altered. But that’s both undisputed and insufficient. The plain text of § 1124(1) requires that ‘the plan’ do the altering. We therefore hold a creditor is impaired under § 1124(1) only if ‘the plan’ itself alters a claimant's ‘legal, equitable, [or] contractual rights.’[5]

The Fifth Circuit also pointed out that every bankruptcy court (save for the bankruptcy court below in this case) and the one other circuit court of appeals to consider the question all took the same approach.[6]

In its January ruling, however, the Fifth Circuit went further. Even though the Bankruptcy Court had not specifically opined on the question, the Fifth Circuit expressed doubt that the “solvent debtor” exception applied to claims for make-whole premiums because Section 502(b)(2) of the Bankruptcy Code calls for disallowance of claims for “unmatured interest.”[7] The creditors sought rehearing because, they argued, it was inappropriate for the Fifth Circuit to opine on a question that the Bankruptcy Court never reached (i.e., whether a make-whole is tantamount to a claim for unmatured interest and thus should be disallowed).

Last week, the Fifth Circuit replaced the January Opinion with a new one that removes the discussion of whether the solvent debtor exception survived enactment of Section 502(b)(2).[8] What remains in the new, streamlined opinion is the Court’s discussion on impairment, unchanged from the opinion issued in January. As to the enforceability of make-wholes in bankruptcy, the Fifth Circuit sent that question back to the Bankruptcy Court (albeit with some hint as to where it was leaning):

That leaves the questions of whether the Code disallows the creditors’ claims for the Make-Whole Amount and the creditors’ request for post-petition interest at the contractual default rates specified in the [loan documents]. The creditors say their contracts entitle them to both amounts, and that their contracts should be honored under bankruptcy law’s longstanding “solvent-debtor” exception. The debtors argue no such exception exists in modern bankruptcy law. And the debtors further argue both claims are governed by the Bankruptcy Code, not the pre-Code law or the parties’ contracts. The bankruptcy court never reached either question. [. . .] Our review of the record reveals no reason why the solvent-debtor exception could not apply. [. . . ] But mindful that we are a court of review, not of first view, we will not make the choice ourselves or weigh the equities on our own. Accordingly, the bankruptcy court should consider the Make-Whole Amount, the appropriate post-petition interest rate, and the applicability of the solvent-debtor exception on remand.[9]