Texas Bankruptcy Court Allows Make-Whole Premiums, Post-Petition Interest on Unsecured Claims at Contractual Default Rate

The Bottom Line

On Oct. 26, in a highly anticipated decision, the Bankruptcy Court for the Southern District of Texas, In re Ultra Petroleum Corp. Corp., et al., Case No. 16-32202 (Bankr. S.D. Tex. 2020), held that certain noteholders were entitled to make-whole premiums and post-petition interest at contractual default rates. The court determined that (i) the noteholders’ make-whole premium was not unmatured interest and was allowed under the Bankruptcy Code and (ii) the solvent debtor exception entitles creditors of a solvent debtor to post-petition interest at the contractual default rate rather than the federal judgment rate.

What Happened?

This opinion is the latest in connection with Ultra’s claims objection and disallowance motion it filed during its 2016 Chapter 11 bankruptcy cases. Ultra, a natural gas exploration and production company, filed voluntary Chapter 11 bankruptcy petitions in April 2016 following a precipitous decline in natural gas prices. Shortly thereafter, commodity prices increased significantly, thereby allowing Ultra to propose and confirm a Chapter 11 plan that purported to pay its creditors in full. Creditors under a Master Note Purchase Agreement (MNPA) and the Revolving Credit Facility (RCF) (Class 4 Creditors) were considered to be “unimpaired” under the plan notwithstanding the fact that the proposed plan distribution did not include the make-whole amount or the Class 4 Creditors’ post-petition interest at the contractual default rates. Instead, Class 4 Creditors were entitled to receive outstanding principal, pre-petition interest at a rate of 0.1% and post-petition interest at the federal judgment rate. Thus, the Class 4 creditors objected, insisting their claims were impaired because the plan failed to require payment of a make-whole amount (due under the MNPA upon prepayment of the notes) and additional post-petition interest under the MNPA and RCF at contractual default rates.

On Sept. 21, 2017, the bankruptcy court issued an opinion allowing the make-whole amount and post-petition interest at the default rates.[1] Following a direct appeal to the Fifth Circuit, the Fifth Circuit reversed and held that a creditor is not impaired if a plan refuses to pay an amount that the Bankruptcy Code disallows.[2] The Fifth Circuit remanded to the bankruptcy court and directed it to consider whether the Bankruptcy Code disallowed the make-whole amount and the appropriate post-petition interest rate, and whether the solvent-debtor exception applied.[3]

Bankruptcy Court Decision

On remand, the bankruptcy court was required to answer two questions in turn.

• Does the Bankruptcy Code disallow a contractual claim for “make-whole” liquidated damages when an interest-bearing obligation is prepaid?

This question ultimately turned on whether the amounts due under the make-whole constitute unmatured interest (or its economic equivalent). Section 502(b)(2) of the Bankruptcy Code disallows claims for “unmatured interest.” Because the Fifth Circuit had held in its earlier opinion that failure to pay amounts that the Bankruptcy Code disallows does not result in impairment, it followed that classifying the make-whole as unmatured interest would permit non-payment without rendering the holders of the claims “impaired.” The bankruptcy court relied on a three-step analysis to hold that the make-whole did not constitute unmatured interest or its economic equivalent.

First, the court defined “interest” relying on the dictionary definition — “[t]he compensation fixed by agreement or allowed by law for the use or detention of money, or for the loss of money by one who is entitled to its use; especially the amount owed to a lender in return for the use of borrowed money.”[4] The bankruptcy court reasoned that the make-whole amount is not interest because it did not compensate the noteholders for OpCo’s use or forbearance of the noteholders’ money, but instead compensated the noteholders “for OpCo’s breach of a promise to use money.”

Next, the court defined “unmatured interest” as “interest that has not accrued or been earned as of a reference date.” Because the make-whole premium did not constitute interest, the bankruptcy court reasoned that it could not constitute unmatured interest. In so doing, the bankruptcy court distinguished the Second Circuit’s decision in In re MPM Silicones, LLC, noting that the question presented there was not whether the make-whole was unmatured interest, but whether the make-whole became due under the relevant terms of the notes.[5] The bankruptcy court observed that, in MPM Silicones, the make-whole premium was not disallowed by the Bankruptcy Court, and “[a]ny statement by the Second Circuit about the characterization of the make-whole was dicta.”

Finally, the bankruptcy court found that the make-whole premium was not the “economic equivalent” of unmatured interest. Interest accrues over time, but the make-whole amount was akin to liquidated damages, which fixed the noteholders’ damage “for the cost of reinvesting in a less favorable market.” Although the amount of damages is, in large part, tied to the timing of prepayment, nothing suggested that the make-whole amount accrued over time. The bankruptcy court observed that the make-whole amount does not become the economic equivalent of unmatured interest merely because the make-whole referenced interest rates, but “the high-water mark of damages a lender may suffer when a loan is paid off ahead of schedule is equal to the expected interest lost.” Thus, the bankruptcy court determined that “[u]nmatured interest is merely an ingredient in the liquidated damage pie.”

Because the make-whole amount was not the economic equivalent of unmatured interest, the bankruptcy court determined that it need not decide whether liquidated damages and unmatured interest are mutually exclusive such that the make-whole amount could be liquidated damages under New York law and unmatured interest under the Bankruptcy Code.

• Does the Bankruptcy Code permit a solvent debtor to forgo contractual obligations to an unimpaired class of unsecured creditors, but still pay a distribution to its shareholders?

The second question before the bankruptcy court was whether the solvent-debtor exception survived following the enactment of the Bankruptcy Code, and, if it did, whether the exception entitled the Class 4 Creditors to post-petition interest at contractual default rates. After reviewing the historical basis of the solvent debtor exception and equitable principles underlying the Bankruptcy Code, the bankruptcy court determined that the solvent-debtor exception survived the adoption of the Bankruptcy Code and therefore entitled the noteholders to post-petition interest at contractual default rates.

Simply put, the bankruptcy court framed the rationale for the solvent-debtor exception as: “an individual with the means to pay his debts in full should be required to do so.” Though the bankruptcy court observed that the exception is equitable in nature, it reasoned that the exception is not rooted in Section 105(a) of the Bankruptcy Code and thus its application is straightforward. The exception applies when a debtor’s assets exceed its liabilities, and requires a debtor to pay creditors the “post-petition interest to which they are legally or contractually entitled.”

Thus, the Bankruptcy Court found that the Class 4 Creditors were entitled to post-petition interest at the contractual default rates, rather than the federal judgment rate.

Why This Case Is Interesting

Pending a possible appeal of the bankruptcy court decision, the case suggests that unsecured make-whole premiums in the Fifth Circuit will not be categorically disallowed by the Bankruptcy Code. Moreover, the bankruptcy court decision clarified that the solvent-debtor exception survived the enactment of the Bankruptcy Code in 1978. Under the rare circumstance where a Chapter 11 debtor is solvent, unsecured creditors may now be entitled to recover post-petition interest at the contractual default rate.

^[1] _{In re Ultra Petroleum Corp., 575 B.R. 361 (Bankr. S.D. Tex. 2017).}

^[2] _{In re Ultra Petroleum Corp., 943 F.3d 758 (5th Cir. 2019).}

^[3] _Id.

^[4] _{Interest, Black’s Law Dictionary (11th ed. 2019).}

^[5] _{874 F.3d 787, 801-02 (2d Cir. 2017).}