In In re Energy Future Holdings Corp., 540 B.R. 109 (Bankr. D. Del. 2015), the bankruptcy court ruled that, although a chapter 11 plan proposed by solvent debtors need not provide for the payment of postpetition interest on unsecured claims to render the claims unimpaired, the plan must provide that the court has the discretion to award such interest at an appropriate rate “under equitable principles.” The ruling highlights the important distinction between the allowance of a claim in bankruptcy and the permissible treatment of the claim under a chapter 11 plan.
In 2012, Energy Future Intermediate Holding Co. LLC and EFIH Finance Inc. (collectively, the “debtors”) issued approximately $1.4 billion in unsecured notes. The note indenture provided for the payment of postpetition interest on overdue principal at the contract rate.
In April 2014, the debtors filed for chapter 11 relief in the District of Delaware. They proposed a chapter 11 plan under which holders of general unsecured claims, including the noteholders, would receive payment in full in cash of the allowed amount of their claims “or other treatment rendering such Claim[s] unimpaired.” The proposed plan further provided that allowed claims would include accrued principal, fees, and interest due as of the petition date, plus “accrued postpetition interest at the Federal Judgment Rate.”
The proof of claim filed by the indenture trustee on behalf of the noteholders included a claim for postpetition interest at the contract rate. The debtors objected, contending that: (i) postpetition (i.e., “unmatured”) interest on an unsecured claim is disallowed under section 502(b)(2) of the Bankruptcy Code; and (ii) to the extent that a claim for postpetition interest is allowed, it should be limited under sections 726(a)(5) and 1129(a)(7)(A)(ii) to “interest at the legal rate,” which the debtors argued is the federal judgment rate.
Unmatured Interest Disallowed
Initially, the bankruptcy court held that, even though the debtors were solvent, the claim for amounts due under the notes was limited to unpaid principal, interest, and fees as of the bankruptcy petition date. Any claim for postpetition interest at the contract rate specified in the indenture, the court explained, must be disallowed under section 502(b)(2) as “unmatured interest.”
However, the court noted, “[T]o say that [the indenture trustee’s] allowed claim excludes post-petition interest is the beginning of the analysis[,] not the end.” According to the court, because the debtors filed for relief under chapter 11, the Bankruptcy Code’s plan confirmation requirements dictate what the unsecured noteholders and other stakeholders must receive under a confirmable chapter 11 plan. This is a “critical distinction,” the court wrote.
“Best Interests” Test May Require Payment of Postpetition Interest on Unsecured Claims
The chapter 11 plan confirmation requirements include section 1129(a)(7) of the Bankruptcy Code—the “best interests” test—which mandates that, unless each claimant in an “impaired” class (discussed elsewhere in this article) accepts a chapter 11 plan, the claimant must receive at least as much under the plan as it would receive in a chapter 7 liquidation of the debtor. Thus, because the chapter 7 distribution scheme under section 726 of the Bankruptcy Code designates as fifth, in priority of payment, interest on allowed unsecured claims “at the legal rate,” a chapter 11 plan for a solvent debtor may have to provide for the payment of postpetition interest on unsecured claims to satisfy section 1129(a)(7).
The court emphasized that these provisions do not conflict with section 502(b). Although section 502(b)(2) disallows unsecured claims for postpetition interest, the court explained, a chapter 11 plan for a solvent debtor (due to the “best interests” test) may be confirmable only if it provides for the payment of interest “at the legal rate” on the unsecured claim. The court concluded that “the legal rate” should be the federal judgment rate.
“Fair and Equitable” Does Not Mean Payment of Postpetition Interest on Unsecured Claims
The court also considered the application of the plan cramdown provisions set forth in section 1129(b)(2) of the Bankruptcy Code. That subsection specifies the requirements which a cramdown chapter 11 plan must meet to be “fair and equitable” with respect to each dissenting class of secured claims, unsecured claims, or interests.
On the basis of its examination of the text of the statute and relevant case law, the bankruptcy court ruled that section 1129(b)(2)—despite its nonexclusive language—does not require a chapter 11 plan providing value to a junior class to pay postpetition interest to a more senior class of objecting unsecured creditors. Instead, the court held, section 1129(b)(2) permits (but does not require) a court to exercise its equitable powers to direct the payment of postpetition interest at whatever rate of interest the court deems appropriate.
Failure to Pay Postpetition Interest Impairment?
Finally, the court examined the concept of “impairment” under section 1124 of the Bankruptcy Code. Only impaired classes of creditors are entitled to vote on a chapter 11 plan. Section 1124 provides that a class is impaired under a plan unless, among other things, the plan: (1) “leaves unaltered the legal, equitable, and contractual rights” to which the claimant is entitled; or (2) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates the claimant for resulting losses.
Section 1124 originally included a third option for rendering a claim unimpaired—by providing the claimant with cash equal to the allowed amount of its claim. In In re New Valley Corp., 168 B.R. 73 (Bankr. D.N.J. 1994), the court ruled that a solvent debtor’s chapter 11 plan which paid unsecured claims in full in cash, without postpetition interest, did not impair the claims. Under the New Valley rationale, a solvent debtor could avoid paying postpetition interest to “unimpaired” unsecured creditors by paying them in full in cash, even if the plan provided a distribution to a junior class, while the same solvent debtor would be obligated to pay postpetition interest to an “impaired” dissenting class of unsecured creditors.
Due to the perceived unfairness of New Valley, Congress removed this option from the Bankruptcy Code in 1994. Since then, most courts considering the issue have held that, if an unsecured claim is paid in full in cash with postpetition interest at an appropriate rate, the claim is unimpaired under section 1124(1).
According to the Energy Future court, because postpetition interest on an unsecured claim is disallowed by statute—section 502(b)—rather than a chapter 11 plan, such “statutory impairment” may not constitute impairment under section 1124(1). According to the court, this is a logical extension of In re PPI Enterprises (U.S.), Inc., 324 F.3d 197 (3rd. Cir. 2003). In PPI, the Third Circuit held that a landlord’s future rent claim capped under section 502(b)(6) of the Bankruptcy Code was not impaired because the text of section 1124(1) mandates that the relevant barometer for impairment is whether the plan itself, as distinguished from another provision of the Bankruptcy Code, limits the claimant’s legal, equitable, or contractual rights. However, the Energy Future court noted that this extension of PPI resurrects the inequity which Congress sought to excise in amending section 1124 in 1994.
To reconcile this, the court explained that section 1124(1) also provides that a plan must leave equitable rights unaltered to render a claim unimpaired. It further noted that allowing postpetition interest on an allowed claim to unimpaired unsecured creditors in a solvent debtor case might be appropriate to preserve such equitable rights.
Ultimately, the bankruptcy court ruled that the debtors’ chapter 11 plan need not provide for the payment of postpetition interest on the unsecured noteholder claims to render the claims unimpaired. However, the court held that the plan must provide for the payment of postpetition interest at an appropriate rate “under equitable principles.” According to the court, “[T]he fair and equitable test as applied to unsecured creditors in solvent debtor cases . . . must also be met in solvent debtor cases for such creditors to be unimpaired.” Whether such interest would be awarded and at what rate in this case, the court wrote, “cannot be determined at this time.”