“Credit Debtor Exception” for Post-Petition Interest on Unsecured Claims (In re Hertz)

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The notice is Wells Fargo Bank, Indenture Trustee c. The Hertz Corp. (In re The Hertz Corp)

The question is whether (and at what rate) post-petition interest can be recovered on pre-petition unsecured debts, where the debtor is solvent, under the “solvent debtor exception”. The responses make fair arguments against statutory provisions and even revisit case law under the Bankruptcy Act of 1898.

Basic rule and exception

Post-claim interest on unsecured claims is not permitted! This is the basic rule established by Section 502(b)(2) of the Bankruptcy Code, like this:

  • the bankruptcy court “must allow such a claim. . . except to the extent that. . . (2) this claim is for unearned interest. »

However, the “solvent debtor exception” to the basic rule allows post-petition interest on unsecured claims where the debtor is solvent.

Questions and answers

Questions and answers in the context of the “solvent debtor exception”, according to the Hertz opinion, are as follows.

-When?

First question: When does post-demand interest accrue on unsecured debt?

Answer: Only when the debtor is solvent.

– What price?

Second question: at what rate does interest accrue on unsecured debts when the debtor is solvent? This rate could be either:

  • the rate contracted between the parties (these rates are often very high); Where
  • the federal judgment rate (this rate has been very low lately).

Answer: Post-petition interest accrues against a solvent debtor only at the federal judgment rate.

Fair arguments c. Legislative provisions

–By unsecured creditors (equitable arguments)

The unsecured creditors in the case argue that they are entitled to receive post-petition interest at their contract rates against a creditworthy debtor, as a matter of fairness.

Such an exception is based on the idea that where a debtor is solvent, unsecured creditors should receive their full contractual rights before owners receive a penny. [Note: this is the same idea animating the absolute priority rule.]

In HertzDebtors are not only solvent, they are full of cash:

  • All authorized claims are paid in full; and
  • More than $1.5 billion is returned to owners of debtors.

Therefore, considerations of equity require that unsecured debts receive interest after the petition at contractual rates, before the funds are returned to the owners of the debtor.

–By debtors (legal provisions)

The debtors argue that the principles of equity cannot prevail over the following express provisions of the Bankruptcy Code:

  • § 502(b)(2) prohibits post-petition interest on unsecured claims, regardless of debtor’s creditworthiness;
  • § 726(a)(5) requires the payment of post-petition interest on unsecured debts where the debtor is solvent, but the accrued interest rate is set at the “legal rate” (that is to say., the federal judgment rate)—not the contract rate; and
  • § 726(a)(5) is incorporated into Chapter 11 by § 1129(a)(7).

Arguments from Bankruptcy Act Cases

–By unsecured creditors

A Hertz The oddity is this: the confirmed plan identifies some unsecured creditors as “uncompromised”. Thus, these unsecured creditors make a two-part argument regarding (i) an impaired and non-impaired distinction, and (ii) case law under the Bankruptcy Act of 1898.

Stage One—Beginnings.

  • The solvent debtor exception began under the Bankruptcy Act;
  • The Bankruptcy Code adopts the “solvent debtor exception” for unsecured claims in § 726(a)(5) – provided that post-petition interest accrues on unsecured claims at the “statutory rate” (that is to say, the federal judgment rate), when the debtor is solvent; and
  • § 726(a)(5) is incorporated into Chapter 11 by § 1129(a)(7)—but only with respect to unsecured claims that are with weakened faculties.

Step Two—Jurisprudence.

Unsecured receivables in Hertz are treated as intactand Chapter 11 of the Bankruptcy Code is silent on post-petition interest for intact claims in a solvent case.

Therefore, the “solvent debtor exception” set forth by the United States Supreme Court under bankruptcy law applies. This is because the exception originated under the Bankruptcy Act and survives today because the Bankruptcy Code did not disallow it.

–By debtors

The debtors argue that none of the Supreme Court cases cited by the unsecured creditors supports the creditors’ assertion. It’s because:

  • all of these cases deal with the rights of secured creditors (not unsecured creditors) to post-petition interest; and
  • secured creditors have an entirely different analysis based on different laws (that is to say, § 506(b) & § 1129(b)(2)(A)).

Decision

The bankruptcy court agrees with the debtors that the opinions of the bankruptcy law do not control.

However, unsecured creditors are entitled to post-petition interest when the debtor is solvent: it’s just that their interest only accrues at the “legal rate” (i.e. the federal judgment rate), not at the contractual rate.

It’s because:

  • a bankruptcy court cannot use equitable principles to alter the express language of the Bankruptcy Code;
  • § 502(b)(2) expressly denies unsecured creditors’ claims for unearned interest; and
  • Where a debtor is solvent, the Bankruptcy Code does not waive the application of § 502(b)(2).

Contrary bankruptcy court opinions exist, such as:

  • In re Ultra Petroleum Corp., 624 BR 178 (Bankr. SD Tex. 2020), held that unsecured creditors are entitled to post-petition interest at contractual rates, notwithstanding the rejection by Section 502(b); and
  • In re Energy Future Holdings Corp., 540 BR 109 (Bankr. D. Del. 2015), indicates that bankruptcy courts have broad and equitable discretion in determining post-petition interest, if any, that unaggrieved creditors are entitled receive.

Such contrary opinions are not convincing, says the Hertz To research. The “solvent debtor exception” survives from the bankruptcy law to the bankruptcy code only by codification:

  • by § 506(b) for oversecured creditors; and
  • by § 502(b), § 726(a)(5) and § 1129(a)(7) for unsecured creditors.

Such contrary views are also opposed to Third Circuit precedent. In In re PPI Enterprises, Inc.324 F.3d 197 (3rd Cir. 2003), for example, the amount of an owner’s claim is capped by § 502(b), even if the debtor is solvent and its owners are entitled to a distribution in this case of chapter 11 .

Moreover, the Hertz The opinion spills a lot of electronic ink by stating that a 1984 amendment to § 1129(a)(7) does not change the analysis. That’s because Congress tailored the amendment to solve a diet voting problem, not an interest rate problem.

Conclusion

the Hertz The opinion discussed above offers a rationale for limiting the “solvent debtor exception” to the “legal rate of interest”.

It will be interesting to see if the advice is followed.

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