A handful of recent high-profile court rulings have considered whether a chapter 11 debtor is obligated to pay postpetition, pre-effective date interest ("pendency interest") to unsecured creditors to render their claims "unimpaired" under a chapter 11 plan in accordance with the pre-Bankruptcy Code common law "solvent-debtor" exception requiring a solvent debtor to pay pendency interest to unsecured creditors. The U.S. Court of Appeals for the Second Circuit weighed in on this question in In re LATAM Airlines Grp. S.A., 55 F.4th 377 (2d Cir. 2022).
The Second Circuit ruled as a matter of first impression that a claim is "impaired" within the meaning of the Bankruptcy Code only when a chapter 11 plan, rather than the Bankruptcy Code, alters the creditor's legal, equitable, or contractual rights. It also ruled as a matter of first impression that the solvent-debtor exception requiring a solvent debtor to pay pendency interest to unsecured creditors to render their claims unimpaired survived the enactment of the Bankruptcy Code.
The Bankruptcy Code's Priority Scheme
The Bankruptcy Code sets forth certain priority rules governing distributions to creditors in both chapter 7 and chapter 11 cases. Secured claims enjoy the highest priority under the Bankruptcy Code. See generally 11 U.S.C. § 506. The Bankruptcy Code then recognizes certain priority unsecured claims, including claims for administrative expenses, wages, and certain taxes. See id. § 507(a). General unsecured claims come next in the priority scheme, followed by any subordinated claims and the interests of equity holders.
In a chapter 7 case, the order of priority for distributions on unsecured claims is determined by section 726 of the Bankruptcy Code. The order of distribution ranges from payments on claims in the order of priority specified in section 507(a), which have the highest priority, to payment of any residual assets after satisfaction of all claims to the debtor, which has the sixth or lowest priority. Fifth priority in a chapter 7 liquidation is given to "interest at the legal rate from the date of the filing of the petition" on any claim with a higher liquidation priority, including various categories of unsecured claims. See id. § 726(a)(5).
Distributions are to be made pro rata to parties of equal priority within each of the six categories specified in section 726. If claimants in a higher category of distribution do not receive full payment of their claims, no distributions can be made to parties in lower categories.
In a chapter 11 case, the chapter 11 plan determines the treatment of secured and unsecured claims (as well as equity interests), subject to the requirements of the Bankruptcy Code.
Impairment of Claims Under a Chapter 11 Plan
Creditor claims and equity interests must be placed into classes in a chapter 11 plan and treated in accordance with the Bankruptcy Code's plan confirmation requirements. Such classes of claims or interests may be either "impaired" or "unimpaired" by a chapter 11 plan. The distinction is important because only impaired classes have the ability to vote to accept or reject a plan. Under section 1126(f) of the Bankruptcy Code, unimpaired classes of creditors and interest holders are conclusively presumed to have accepted a plan. Section 1126(g) provides that classes of creditors or interest holders that receive or retain nothing under a plan are deemed not to have accepted the plan.
Section 1124 provides that a class of creditors is impaired under a plan unless the plan: (i) "leaves unaltered the legal, equitable, and contractual rights" to which each creditor in the class is entitled; or (ii) cures any defaults (with limited exceptions), reinstates the maturity and other terms of the obligation, and compensates each creditor in the class for resulting losses.
Section 1124 originally included a third option, then section 1124(3), 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, in light of this third option, and because sections 726(a)(5) and 1129(a)(7) of the Bankruptcy Code (described below) are applicable in a chapter 11 case only to impaired creditors, a solvent debtor's chapter 11 plan that paid unsecured claims in full in cash, but without pendency interest, did not impair the claims. The perceived unfairness of New Valley led Congress to remove this option from section 1124 of 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 pendency interest at an appropriate rate, the claim is unimpaired under section 1124. See, e.g., In re PPI Enterprises (U.S.), Inc., 324 F.3d 197, 205–07 (3d Cir. 2003).
Section 1124(1) "define[s] impairment in the broadest possible terms," so that "any change in legal, equitable or contractual rights creates impairment." In re Taddeo, 685 F.2d 24, 28 (2d Cir. 1982); accord PPI, 324 F.3d at 202 ("If the debtor's Chapter 11 reorganization plan does not leave the creditor's rights entirely 'unaltered,' the creditor's claim will be labeled as impaired under § 1124(1) of the Bankruptcy Code."); In re L&J Anaheim Assocs., 995 F.2d 940, 942 (9th Cir. 1993) (adopting the Taddeo approach).
However, the Third, Fifth, and Ninth Circuits have concluded that, because section 1124(1) expressly refers to impairment imposed by a "plan," it does not apply to modifications that occur by operation of the Bankruptcy Code. See PPI, 324 F.3d at 204 ("[A] creditor's claim outside of bankruptcy is not the relevant barometer for impairment; [courts] must examine whether the plan itself is a source of limitation on a creditor's legal, equitable, or contractual rights."); In re Ultra Petroleum Corp., 943 F.3d 758, 763 (5th Cir. 2019) ("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.'"); In re PG&E Corp., 46 F.4th 1047, 1063 n.11 (9th Cir. 2022) ("[A]n alteration of pre-bankruptcy rights that occurs by operation of the Code does not result in impairment."), petition for cert. filed sub nom. Pacific Gas & Electric Co. v. Ad Hoc Committee of Holders of Trade Claims, No. 22-733 (U.S. Feb. 6, 2023).
Cram-Down Confirmation Requirements
If a creditor class does not agree to impairment of the claims in the class under the plan and votes to reject it, the plan can be confirmed only under certain specified conditions. Among these conditions are requirements that: (i) each creditor in the impaired class receive at least as much under the plan as it would receive in a chapter 7 liquidation (11 U.S.C. § 1129(a)(7)) (commonly referred to as the "best interests" test); and (ii) the plan be "fair and equitable" (Id. § 1129(b)(1)).
Therefore, in the case of a chapter 11 debtor that can pay its creditors in full with interest, the best interests test in section 1129(a)(7) would arguably require that any impaired unsecured creditors be paid pendency interest on their allowed claims "at the legal rate." See id. § 726(a)(5).
The best interests test, however, applies only to impaired classes of claims or interests. This was not always the case. When the Bankruptcy Code was enacted in 1978, the provision applied to all classes—impaired or not. Congress amended section 1129(a)(7) in 1984 so that it now applies only to impaired classes. See Bankruptcy Amendments and Federal Judgeship Act of 1984, 98 Stat. 333, Pub. L. 98-353 (1984) § 512(a)(7); In re Wonder Corp. of Am., 70 B.R. 1018, 1024 (Bankr. D. Conn. 1987) ("[T]he 1984 Amendments also modified § 1129(a)(7) so that its provisions now only apply to 'each impaired class of claims or interests' rather than to 'each class of claims or interests.'").
Section 1129(b)(2)(B) of the Bankruptcy Code provides that a plan is "fair and equitable" with respect to a dissenting impaired class of unsecured claims if the creditors in the class receive or retain property of a value equal to the allowed amount of their claims or, failing that, if no creditor or equity holder of lesser priority receives any distribution under the plan. This is commonly referred to as the "absolute priority rule," which was derived in part from common law and practice under the former Bankruptcy Act of 1898 (as amended).
Disallowance of Claims for Unmatured Interest and the Solvent-Debtor Exception
Section 502(b)(2) of the Bankruptcy Code provides that a claim for interest that is "unmatured" as of the petition date shall be disallowed. See generally Collier on Bankruptcy ¶ 502.03 (16th ed. 2022) ("fixing the cutoff point for the accrual of interest as of the date of the filing of the petition is a rule of convenience providing for equity in distribution"). Charges that have been deemed to fall into this category include not only ordinary interest on a debt, but items that have been deemed the equivalent of interest, such as original issue discount. Id. This means that, unless there is an exception stated elsewhere in the Bankruptcy Code (see below), any claim for postpetition interest will be disallowed.
The bar on recovery by creditors of interest accruing after a bankruptcy filing pre-dates the enactment of the Bankruptcy Code and is derived from English law. Nicholas v. U.S., 384 U.S. 678, 682 (1966) (explaining that "[i]t is a well-settled principle of American bankruptcy law that in cases of ordinary bankruptcy, the accumulation of interest on claims against a bankruptcy estate is suspended as of the date the petition in bankruptcy is filed[, which rule is] grounded in historical considerations of equity and administrative convenience"); Sexton v. Dreyfus, 219 U.S. 339, 344 (1911) (recognizing the rule that interest ceases to accrue on unsecured debt upon commencement of bankruptcy cases is a fundamental principle of English bankruptcy law, which is the basis of the U.S. system). Section 63 of the Bankruptcy Act of 1898, as amended by the Chandler Act of 1938, expressly disallowed unmatured interest as part of a claim. Bankruptcy Act of 1938, ch. 575, § 63, 52 Stat. 840 (repealed 1978).
English law contained notable exceptions to the rule. One of those was the "solvent-debtor" exception, which provided that interest would continue to accrue on a debt after a bankruptcy filing if the creditor's contract expressly provided for it, and would be payable if the bankruptcy estate contained sufficient assets to do so after satisfying other debts. See In re Ultra Petroleum Corp., 913 F.3d 533, 543-44 (5th Cir.) (citing treatises and cases), opinion withdrawn and superseded on reh'g, 943 F.3d 758 (5th Cir. 2019). In such cases, the post-bankruptcy interest was treated as part of the underlying debt obligation, as distinguished from interest "on" a creditor's claim. Id.
The fundamental principle barring creditors from recovering postpetition interest on their claims was incorporated into U.S. bankruptcy law—as were some of the exceptions, but only in part.
In pre-Bankruptcy Code cases where the debtor possessed adequate assets to pay all claims in full with interest—meaning that the payment of interest to one creditor did not impact the recovery of other creditors—principles of equity dictated that creditors be paid interest to which they were otherwise entitled, most commonly at the rate determined by their contracts with the debtor. See Am. Iron & Steel Mfg. Co. v. Seaboard Air Line Ry., 233 U.S. 261, 266–67 (1914) (concluding "in the rare instances where the assets ultimately proved sufficient for the purpose, that creditors were entitled to interest accruing after adjudication"); Debentureholders Protective Comm. of Cont'l Inv. Corp. v. Cont'l Inv. Corp., 679 F.2d 264, 269 (1st Cir. 1982) (in refusing to confirm a plan under chapter X of the Bankruptcy Act because it did not pay postpetition interest on unsecured claims, noting that "[w]here the debtor is solvent, the bankruptcy rule is that where there is a contractual provision, valid under state law, providing for interest on unpaid [installments] of interest, the bankruptcy court will enforce the contractual provision with respect to both [installments] due before and [installments] due after the petition was filed"); Ruskin v. Griffiths, 269 F.2d 827, 832 (2d Cir. 1959) ("where there is no showing that the creditor entitled to the increased interest caused any unjust delay in the proceedings, it seems to us the opposite of equity to allow the debtor to escape the expressly bargained-for" contractual interest provision); Sword Line, Inc. v. Indus. Comm'r of N.Y., 212 F.2d 865, 870 (2d Cir. 1954) (explaining that "interest ceases upon bankruptcy in the general and usual instances noted … unless the bankruptcy bar proves eventually nonexistent by reason of the actual solvency of the debtor"); Johnson v. Norris, 190 F. 459, 466 (5th Cir. 1911) (determining that debtors "should pay their debts in full, principal and interest to the time of payment whenever the assets of their estates are sufficient").
Even though section 502(b)(2) of the Bankruptcy Code provides that a claim for unmatured interest shall be disallowed, there are specific exceptions to the rule included elsewhere in the Bankruptcy Code. For example, section 506(b) of the Bankruptcy Code provides that an oversecured creditor is entitled to interest on its allowed secured claim.
In addition, as noted above, in a chapter 7 case, the distribution scheme set forth in section 726 of the Bankruptcy Code designates as fifth in priority of payment postpetition interest on an unsecured claim at "the legal rate."
Whether the solvent-debtor exception survived enactment of the Bankruptcy Code in 1978 is disputed. However, prior to LATAM, four federal circuit courts—including two in 2022, albeit with vigorous dissents—had ruled or suggested that the exception survived. See, e.g., In re Ultra Petroleum Corp., 51 F.4th 138 (5th Cir. 2022) (a divided Fifth Circuit panel concluded that "the solvent-debtor exception is alive and well" and ruled that a solvent chapter 11 debtor was obligated to pay a make-whole premium to unimpaired noteholders amount "even though … it is indeed otherwise disallowed unmatured interest"), reh'g denied, No. 21-20008 (5th Cir. Nov. 15, 2022), petition for cert. filed sub nom. Ultra Petroleum Corp. v. Ad Hoc Comm. Of OpCo Unsecured Creditors, 22-772 (U.S. Feb. 13, 2023); PG&E, 46 F.4th at 1062 (a divided Ninth Circuit panel ruled that "pursuant to the solvent-debtor exception, unsecured creditors possess an 'equitable right' to postpetition interest [under section 1124(1) of the Bankruptcy Code] when a debtor is solvent"); Gencarelli v. UPS Capital Bus. Credit, 501 F.3d 1, 7 (1st Cir. 2007) (stating that "[t]his is a solvent debtor case and, as such, the equities strongly favor holding the debtor to his contractual obligations as long as those obligations are legally enforceable under applicable non-bankruptcy law"); In re Dow Corning Corp., 456 F.3d 668, 678 (6th Cir. 2006) (noting that "[t]he legislative history of the Bankruptcy Code makes clear that equitable considerations operate differently when the debtor is solvent: '[C]ourts have held that where an estate is solvent, in order for a plan to be fair and equitable, unsecured and undersecured creditors' claims must be paid in full, including postpetition interest, before equity holders may participate in any recovery'" (quoting 140 Cong. Rec. H10,752–01, H10,768 (1994)).
Most lower courts that have recently addressed the question have also concluded that the exception is still viable in some cases. Compare In re Moore & Moore Trucking, LLC, 2022 WL 120189, *10 (Bankr. E.D. La. Jan. 12, 2022) (ruling that the solvent-debtor exception remains in force but cannot prevent a solvent debtor from extending the maturity date of a prepetition promissory note under a chapter 11 plan); In re Mullins, 633 B.R. 1, 10-11 (Bankr. D. Mass. 2021) (reasoning that lawmakers' use of the phrase "fair and equitable" in section 1129(b) "was intended to codify at least a century of bankruptcy jurisprudence … and grounded the solvent debtor exception as it related to impaired creditors in that provision" and explaining that the legislative history of the provision does not suggest that "Congress intended to abrogate the solvent debtor exception"); and In re Cuker Interactive, LLC, 622 B.R. 67, 69 (Bankr. S.D. Cal. 2020) (in accordance with Ninth Circuit precedent, a solvent debtor must pay pendency interest to general unsecured creditors "at the legal rate"), with In re The Hertz Corp., 637 B.R. 781, 800 (Bankr. D. Del. 2021) (noting that "the solvent debtor exception survived passage of the Bankruptcy Code only to a limited extent" and applies only in section 506(b) as to oversecured creditors and to impaired classes of unsecured creditors in a chapter 11 case pursuant to sections 1129(a)(7) and 726(a)(5); when Congress amended the Bankruptcy Code in 1984 to limit the scope of section 1129(a)(7) to impaired classes (which was not previously the case), "it was motivated by the desire to require voting only by impaired creditors, rather than by a desire to assure that unimpaired creditors get their contract rate of interest"), motion for reconsideration denied and direct appeal certified, Adv. Pro. No. 21-50995 (MFW) (Bankr. D. Del. Nov. 9, 2022); and In re RGN-Grp. Holdings, LLC, 2022 WL 494154, *6 (Bankr. D. Del. Feb. 17, 2022) (concluding that the solvent-debtor exception survived the enactment of the Bankruptcy Code only to a limited extent, and ruling that a landlord was entitled to interest on its allowed unsecured claim at the federal judgment rate).
In LATAM, the Second Circuit examined chapter 11 plan versus Bankruptcy Code impairment and the solvent-debtor exception.
In May 2020, LATAM Airlines Group S.A. and certain affiliates (collectively, "LATAM"), Latin America's leading airline group, filed for chapter 11 protection in the Southern District of New York after losing 95% of its passenger business due to travel restrictions imposed during the COVID-19 pandemic.
LATAM's proposed chapter 11 plan classified holders of claims and interests into 11 classes, of which class 1 (claims under a prepetition revolving credit facility), class 5 (general unsecured claims against the LATAM parent company), and class 7 (general unsecured claims against a single LATAM debtor) were classified as impaired and therefore entitled to vote.
General unsecured creditors of other LATAM debtor entities, including unsecured creditors (the "TLA Creditors") asserting claims against LATAM affiliate TAM Linhas Aereas S.A. ("TLA") based on defaulted debt instruments governed by Brazilian law, were to be paid in full, but without pendency interest. The plan provided that the class of TLA Creditors (class 6) was unimpaired—and therefore deemed to accept the plan—even though the TLA Creditors' debt instruments provided for the payment of post-default interest (approximately $150 million).
The shareholders of the LATAM parent company (class 10) received nothing under the plan and were deemed to reject it. The shareholders of the remaining LATAM debtors (class 11) retained their interests under the plan and were presumed as an unimpaired class to accept it.
The plan was overwhelmingly accepted by all impaired classes of creditors that were entitled to vote.
Several parties objected to confirmation of the plan. Among the objectors, the TLA Creditors argued that, because TLA was solvent, they were entitled to pendency interest on their claims, failing which those claims would be impaired under section 1124(1).
In June 2022, the bankruptcy court confirmed LATAM's chapter 11 plan over all objections in an unpublished opinion. See In re LATAM Airlines Group S.A., 2022 WL 2206829 (Bankr. S.D.N.Y. June 18, 2922), corrected, 2022 WL 2541298 (Bankr. S.D.N.Y. July 7, 2022), aff'd, 643 B.R. 741 (S.D.N.Y. 2022), aff'd, 55 F.4th 377 (2d Cir. 2022).
Among other things, the bankruptcy court ruled in its confirmation opinion that the claims of the TLA Creditors in class 6 were not impaired by the plan. According to the court, "to hold otherwise would ignore the ban on 'unmatured interest' (i.e., [pendency interest]) under section 502(b)(2) of the Bankruptcy Code and caselaw reasoning that section 1124(1) speaks to impairment by a bankruptcy plan, not limitations set forth by the Bankruptcy Code."
The court found that TLA was insolvent. However, it noted, had TLA been solvent, the TLA Creditors would have been entitled to pendency interest on their claims because:
the solvent debtor exception to the ban on unmatured interest survived the enactment of the Bankruptcy Code through section 1129(a)(7) (as relevant here), not section 1124(1), and, thus, would demand [LATAM] pay [pendency interest] on the TLA [claims] at the federal judgment rate (i.e., the 'legal rate' under section 726(a)(5) of the Bankruptcy Code), not at the rate called for in the Debt Instruments.
LATAM, 2022 WL 2206829, at *8.
The TLA Claimants appealed the ruling to the district court, which affirmed. According to the district court, the bankruptcy court did not err in finding that TLA was insolvent. For that reason, the district court noted, it was unnecessary to resolve the debate over whether the solvent-debtor exception survived the enactment of the Bankruptcy Code. LATAM, 643 B.R. at 750 n.2
Moreover, the district court concluded, the TLA Creditors' argument, "[r]elying on the absolute priority rule and a complex and novel reading of §§ 726(a)(5), 1124(1), and 1124(2) of the Code (informed by Congress's decision in 1994 to strike § 1124(3) from the Code)," that they were entitled to pendency interest even though TLA was insolvent was barred because the TLA Creditors failed to make the argument below and it was "contrary to foundational principles in bankruptcy law." Id. at 752.
The TLA Creditors appealed to the Second Circuit.
The Second Circuit's Ruling
A three-judge panel of the Second Circuit affirmed on appeal.
At the outset of its opinion, the Second Circuit noted that, based upon its review of the record, the TLA Creditors made the argument before the bankruptcy court that, regardless of a debtor's solvency, a creditor must receive pendency interest to render its claim unimpaired under section 1124(1). Addressing that issue, the Second Circuit joined the Third, Fifth, and Ninth Circuits in holding that "a claim is impaired under Section 1124(1) only when the plan of reorganization, rather than the Code, alters the creditor's legal, equitable, or contractual rights." LATAM, 55 F.4th at 384-85. Although the TLA Creditors had a contractual right to such interest, Circuit Judge Pierre N. Leval explained, "'this contractual right, as applied to postpetition debts, was superseded by the Code—specifically, by § 502(b)(2)'s prohibition on the inclusion of "unmatured interest" as part of their claim.'" Id. at 385 (quoting PG&E, 46 F.4th at 1063).
The Second Circuit rejected the TLA Creditors' argument that, because section 1124(1) refers to "claims" instead of "allowed claims," section 502(b)(2) does not apply. According to Judge Leval, section 1124(1) does not provide that "claims" themselves must remain unaltered, but instead states that "the legal, equitable, and contractual rights to which such a claim or interest entitles the holder of such claim or interest" must remain unaltered to render a claim unimpaired. Id. As such, he emphasized, impairment must be assessed "'after considering everything that defines the scope of the right or entitlement,' including the Bankruptcy Code." Id. (quoting Ultra, 943 F.3d at 764).
The Second Circuit also rejected the TLA Creditors' argument that sections 1124(2) and 1123(d) (the former defining as "unimpaired" a claim that is reinstated upon cure of pre- and postpetition defaults and the latter providing that "the amount necessary to cure the default shall be determined in accordance with the underlying agreement and applicable nonbankruptcy law") indicate that pendency interest must be paid to render a claim unimpaired. "Because Section 1124(1) does not refer to cure and reinstatement," Judge Leval wrote, "we find no guidance in these authorities considering the interaction of Sections 1124(2) and 1123(d)." Id. at 386.
In addition, the Second Circuit was unpersuaded by the TLA Creditors' argument that, by removing section 1124(3) from the Bankruptcy Code in 1994—which had been construed in New Valley to mean that a claim was unimpaired under a plan that provided for payment of the claim in full without postpetition interest—Congress intended to foreclose this possibility in future chapter 11 cases. The 1994 repeal of section 1124(3), Judge Leval wrote, cannot be given such "sweeping effect." Instead, he agreed with the Fifth Circuit's rationale in Ultra that "Congress meant only to ensure that solvent debtors pay post-petition interest on their claims." Id. at 387 (citing Ultra, 943 F.3d at 764-65). Judge Leval also agreed with the Third and Ninth Circuits' conclusion that the repeal was motivated in large part by the "anomalous result" in New Valley, where the court ruled that a solvent debtor was not required to pay pendency interest to render unsecured claims unimpaired by a chapter 11 plan. "Although section 1124(1) does not expressly refer to solvency," the Second Circuit wrote, "it does protect a creditor's 'equitable rights[,]' … includ[ing] whatever survives of the solvent-debtor exception." Id.
Finally, the Second Circuit rejected the TLA Creditors' argument that the bankruptcy court's solvency analysis was flawed because it failed to account for LATAM's obligation under the absolute priority rule to pay the full amount of their claims, including pendency interest. According to the TLA Creditors, "the solvent-debtor exception arises from the absolute priority rule," and the exception is "triggered"—and unsecured creditors are entitled to pendency interest—whenever a chapter 11 plan proposes to distribute value to equity holders, as was the case here. As support for this proposition, the TLA Creditors relied principally upon a 1941 U.S. Supreme Court ruling construing the former Bankruptcy Act, where the Court held that a "prospective earnings analysis" was required to assess solvency to ensure, in accordance with the common-law absolute priority rule, that "junior securities" could not participate in a plan of reorganization. See Consolidated Rock Prods. Co. v. Du Bois, 312 U.S. 510, 525-26 (1941).
The Second Circuit found that the TLA Creditors' reliance on Consolidated Rock and the pre-Bankruptcy Code absolute priority rule was misplaced. As codified in section 1129(b)(2)(B), Judge Leval explained, the modern iteration of the rule requires that, in a cram-down scenario, a plan must provide either that: (i) members of a dissenting class of unsecured creditors receive or retain property equal to the allowed amount of their claims; or (ii) more junior creditors and shareholders receive or retain nothing.
In this case, Judge Leval noted, the TLA Creditors and other general unsecured creditors in class 6 were being paid the full allowed amount of their claims and "cannot insist on compliance with the absolute priority rule." In the TLA Creditors' view, he wrote, "they are effectively entitled to insist on compliance with the absolute priority rule, unless they are paid more than what they could recover under full compliance with the rule as codified." LATAM, 55 F.4th at 389. According to Judge Leval, the absolute priority rule cannot "provide the relevant test for solvency," and the bankruptcy court was not obligated, "as a matter of law, to apply the solvent debtor exception under these circumstances." Id.
With LATAM, the Second Circuit joined with the Third, Fifth, and Ninth Circuits in concluding that abridgement of a creditor's legal, equitable, or contractual rights under the Bankruptcy Code (e.g., through disallowance of claims for unmatured interest under section 502(b)(2) in a chapter 11 case involving an insolvent debtor) does not constitute impairment within the meaning of section 1124(1).
Notably, before the Second Circuit, the TLA Creditors "mention[ed] only in passing" their argument below that, because their claims were impaired, they were entitled to postpetition interest by operation of the section 1129(a)(7) best interests test and section 726(a)(5). The Second Circuit noted merely that "[w]e do not understand [the TLA Creditors] to argue that the Plan would have failed this test." Id. at 389 n.9.
The second key takeaway from LATAM is the Second Circuit's determination that the solvent-debtor exception survived the enactment of the Bankruptcy Code and requires solvent chapter 11 debtors to pay pendency interest on unsecured claims to render them unimpaired under a plan. The Second Circuit was the third circuit court of appeals to reach this conclusion in 2022. Moreover, the issue is presently on appeal before the Third Circuit, which may offer additional guidance on this question sometime in 2023.
LATAM and other similar recent rulings at the circuit level are significant, especially for their impact on large chapter 11 cases where the potential obligation to pay millions of dollars in pendency interest on unsecured claims may significantly impact a debtor's ability to confirm a plan.
With petitions for certiorari filed in Ultra Petroleum and PG&E, the U.S. Supreme Court will now have an opportunity to weigh in on the solvent-debtor exception.