On September 21, 2017, the United States Bankruptcy Court for the Southern District of Texas (the Court) held, over the objection of Ultra Petroleum Corp. and its affiliated debtors (the Debtors), that holders of notes (the Noteholders) issued by one of the Debtors pursuant to a master note purchase agreement (the MNPA) were entitled to payment of the full make-whole amount provided under the MNPA and post-petition interest at the contractual default rate (the Decision).1 The Decision, which the Debtors have since appealed, requires the Debtors to pay the Noteholders in excess of $320 million on account of the make-whole and post-petition default interest

Background: Ultra Chapter 11 Case

The Debtors filed voluntary petitions for chapter 11 relief on April 29, 2016. The Debtors became solvent during the course of their bankruptcy cases and consequently proposed a joint plan of reorganization (the Plan) under which all unsecured claims would be paid in full in cash, with a substantial recovery for equity holders. The Plan classified the Noteholders’ claims as “unimpaired” pursuant to Section 1124(1) of the Bankruptcy Code, and provided that the Noteholders would receive payment in cash of the outstanding principal amount and pre-petition interest at the rate provided under the MNPA, and post-petition interest “calculated at the Federal Judgment Rate or such other rate as determined by a Final Order of the Bankruptcy Court to render the [Noteholders’ claims] Unimpaired.” The Plan further provided that the allowance of the Noteholders’ claims for make-whole amounts or post-petition interest at a rate other than the federal judgment rate “shall be determined by a Final Order of the Bankruptcy Court.

Prior to the hearing on confirmation of the Plan, the Debtors objected to allowance of the Noteholders’ make-whole claim, which was triggered by the automatic acceleration of the notes resulting from the bankruptcy default, and payment of post-petition interest at the default rate under the MNPA, which was similarly triggered by the bankruptcy filing. The Debtors acknowledged that they were solvent, but argued, among other things, that the Noteholders were not entitled to payment of the make-whole claims because (i) the make-whole amount constituted unmatured interest subject to disallowance under Section 502(b)(2) of the Bankruptcy Code; and (ii) the MNPA provision setting forth the formula for calculating the make-whole amount (the Make-Whole Amount) was an unenforceable liquidated damages provision under New York law (which governed the MNPA). The Debtors also argued that payment of the Make-Whole Amount and post-petition contractual default interest on the outstanding principal amount of the notes and Make-Whole Amount from the date of the bankruptcy filing would be “double counting,” and that post-petition interest on the Noteholders’ claims should be assessed, at most, at the “legal rate” under Section 726(a)(5) of the Bankruptcy Code, i.e., the federal judgment rate.

For their part, the Noteholders argued that in order for their claims to be “unimpaired” as contemplated under the Plan, the Debtors must pay the Noteholders’ make-whole claims and post-petition interest on the Noteholders’ claims at the contractual default rate provided for in the MNPA.

On March 14, 2017, the Court confirmed the Debtors’ Plan, which treated the Noteholders’ claims as “unimpaired,” without making any final determination regarding the Debtors’ objections to the allowance of the Noteholders’ make-whole claims or the appropriate rate of post-petition interest. On August 14, 2017, the Court ordered supplemental briefing on the issue of whether the acceleration of the notes was affected by any ipso facto provision within the Bankruptcy Code. In their supplemental brief, the Debtors argued that the automatic acceleration and default interest provisions were ipso facto provisions that should not be enforced because they would put the Noteholders in a better position merely because the Debtors filed bankruptcy. After supplemental briefing from the parties, the Court issued the Decision ruling in favor of the Noteholders.

On October 5, 2017, the Debtors filed a notice of appeal of the Decision.

Ultra Decision

The Court first addressed whether the Make-Whole Amount was an unenforceable liquidated damages provision under New York law, and determined that it was not. The Court found that the Debtors had “fail[ed] to rebut the Noteholders’ claim for the Make-Whole Amount because they fail[ed] to prove that the damages resulting from prepayment were readily ascertainable at the time the parties entered into the [MNPA] or that they were conspicuously disproportionate to foreseeable damage amounts.” The Court acknowledged that the Make-Whole Amount was “enormous,” but found that “[b]ecause the Make-Whole Amount does not lead to a double recovery of actual and liquidated damages for the same injury, there is no reason for the Court to conclude that this provision is in any way disproportionate or invalid only because it is higher than potentially contemplated at the time the parties entered into the [MNPA].”

The Court did not squarely address the Debtors’ arguments that the Make-Whole Amount was “merely a proxy for” unmatured interest under Section 502(b)(2) of the Bankruptcy Code and that the ipso factoautomatic acceleration provision, which triggered the Noteholders’ right to payment of the Make-Whole Amount, should not be enforced. Instead, the Court held that the confirmed Plan controlled on the issue of impairment, and that unimpairment under the Plan required that valid state law claims be paid in full regardless of whether such claims would otherwise be subject to disallowance under the Bankruptcy Code. The Court explained that “[i]n a chapter 11 case, a discharge is granted under 11 U.S.C. § 1141(d)” and “the extent of the discharge is governed by the terms of the confirmed plan.” Thus, because the Plan provided that the Noteholders’ claims were unimpaired, “[t]he Debtors’ liability on the Make-Whole [claims] [wa]s thus not discharged under § 1141(d) unless the Make-Whole [claims] [we]re actually paid in their state law amount.”

Lastly, with respect to post-petition interest, the Court held that the Noteholders were entitled to payment at the contractual default rate under the MNPA rather than the federal judgment rate advocated by the Debtors. Again relying on the Noteholders’ unimpaired status under the Plan, the Court held that “[t]he Debtors fail[ed] to rebut the Noteholders’ claim for post-petition interest at the rate listed in the [MNPA] because the Noteholders’ claims are treated as unimpaired under the Debtors’ chapter 11 plan,” and reasoned that “[p]aying post-petition interest on the Make-Whole [Claim] at the federal judgment rate instead of the rate within the [MNPA] would cause the Noteholders to be impaired.” The Court found that Section 726(a)(5), which provided for payment of post-petition interest at the federal judgment rate, did not apply to the Noteholders’ claims because “its only application in a chapter 11 case — through the ‘best interest of creditors’ test in 11 U.S.C. § 1129(a)(7) — limits impaired, not unimpaired claims.” The Court therefore concluded that the “Noteholders are entitled to the contractual rate of interest under the [MNPA] regardless of any disallowance provisions in the Bankruptcy Code.”

Take-Aways From the Ultra Decision and Unresolved Issues

Unlike many of the recent make-whole decisions in the Second and Third Circuits,2 which have primarily focused on whether the express language of the noteholders’ agreements with the debtors was sufficiently clear to entitle the noteholders to their asserted make-whole claims, the Decision focused on the enforceability of the make-whole provision under New York law and the effect of classifying and treating claims, including disputed make-whole claims as unimpaired under a plan of reorganization.

With respect to the former issue, the Decision should provide comfort to noteholders insofar as the Court concluded that the mere fact that a make-whole claim is “enormous” and/or exceeds the amount originally anticipated by the parties, does not necessarily render the make-whole provision an unenforceable liquidated damages provision under New York law, which governs many note purchase agreements and indentures.

With respect to the latter issue, the Decision is noteworthy for its holding that if claims are treated as unimpaired under a confirmed plan that discharges such claims against the debtor, the debtor may be deemed to have forfeited its right to seek disallowance of any disputed or unresolved claim or portion of such claim pursuant to the disallowance provisions of the Bankruptcy Code. However, as the Court noted, its ruling on the statutory-versus-plan impairment issue conflicts with a prior Third Circuit ruling,3 so the availability of arguments on this issue may depend on the jurisdiction and the outcome of any appeal.

As for the issues not directly addressed by the Court, there continues to be a level of uncertainty under existing case law as to whether make-whole claims are subject to disallowance as unmatured interest under Section 502(b)(2) of the Bankruptcy Code and whether ipso facto bankruptcy-based acceleration provisions triggering the payment of a make-whole and/or bankruptcy-based default interest provisions are or should be enforceable in bankruptcy. Accordingly, parties can be expected to continue asserting arguments on both sides of these issues unless and until further precedent is established.

Whether and to what extent the Decision will be upheld on appeal remains to be seen. To be sure, however, it still remains critical that any make-whole provision in the underlying agreement must expressly and unambiguously provide for the payment of a make-whole upon a bankruptcy.